McGraw-Hill/Irwin
Reporting and
Interpreting Receivables,
Bad Debt Expense, and
Interest Revenue
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Accounts Receivable
Amounts owed by other companies or persons for cash, goods, or services.
Open accounts owed to the business by trade customers.
8-2

Notes Receivable
A note receivable is a written contract establishing the terms by which a company will receive amounts it is owed.
Companies may convert accounts receivable balances to notes for customers who are having difficulty paying their receivables.
8-3

Notes Receivable
Term
$1,200
Sixty days
Payee
January 5, 2008 after date I promise to pay to
Skechers U.S.A., Inc.
One thousand two hundred --------------------------------- Dollars
Payable at
Value received with interest at
March 6, 2008
8% per annum
Alan Jones
Jones Athletic Company
Due Date
8-4

Learning Objective 1
8-5

Pros and Cons of Extending Credit
Businesses extend credit to generate additional sales and to meet the terms offered by competitors.
Extending credit is likely to increase sales, but not without costs:
Bad debts costs
Increased wage costs to manage receivables
Delayed receipt of cash
8-6

Learning Objective 2
8-7

Accounts Receivable and Bad Debts
Bad debts result from credit customers who will not pay the business the amount they owe, regardless of collection efforts.
8-8

Accounts Receivable and Bad Debts
Bad debts are likely to be discovered in periods after the credit sale.
If bad debts are not reported until discovered, income is distorted in the periods of sale as well as in the period of bad debt discovery.
(Credit Sale Occurs)
Revenues
Cost of goods sold
Bad debt expense
Net income
Year 1
$ 10,000
6,000
$
Year 2
(Bad Debt discovered)
Revenues
Cost of goods sold
0 Bad debt expense
4,000 Net income
0
0
1,000
$ (1,000)
8-9

The Allowance Method of
Accounting for Bad Debts
Bad Debt
Expense
Matching
Principle
Record in same accounting period.
Sales
Revenue
8-10

The Allowance Method of
Accounting for Bad Debts
Most businesses record an estimate of the bad debt expense with an adjusting entry at the end of the accounting period.
8-11

Record Estimated
Bad Debt Expense
For the year ended December 31, 2005,
Skechers U.S.A., Inc., estimated its bad debt expense to be $2,882,000.
Prepare the adjusting entry.
Accounts Debit Credit
8-12

Record Estimated
Bad Debt Expense
For the year ended December 31, 2005,
Skechers U.S.A., Inc., estimated its bad debt expense to be $2,882,000.
Prepare the adjusting entry.
Bad Debt Expense is normally classified as a selling expense and is closed at year-end.
Accounts
Bad Debt Expense (+E, -SE)
Allowance for Doubtful Accounts (+xA, -A)
Debit
2,882,000
Credit
2,882,000
Contra asset account
8-13

Allowance for Doubtful Accounts
Balance Sheet Disclosure
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net Accounts Receivable
Amount the business expects to collect.
8-14

Remove (Write Off) Specific
Customer Balances
When it is clear that a specific customer’s account receivable will be uncollectible, the amount should be removed from the
Accounts Receivable account and charged to the Allowance for Doubtful Accounts.
8-15

Remove (Write Off) Specific
Customer Balances
Skechers’ total write-offs for
2005 were $1,729,000.
Prepare a summary journal entry for these write-offs.
Accounts Debit Credit
8-16

Remove (Write Off) Specific
Customer Balances
Skechers’ total write-offs for
2005 were $1,729,000.
Prepare a summary journal entry for these write-offs.
Accounts Debit
Allowance for Doubtful Accounts (-xA) 1,729,000
Accounts Receivable (-A)
Credit
1,729,000
8-17

Remove (Write Off) Specific
Customer Balances
Assume that before the writeoff, Skechers’
Accounts Receivable balance was
$56,000,000 and the Allowance for
Doubtful Accounts balance was $6,043,000.
Let’s see what effect the total write-offs of
$1,729,000 had on these accounts.
8-18

Remove (Write Off) Specific
Customer Balances
Accounts Receivable
Before
Write-Off
$ 56,000,000
Less: Allow. for Doubtful Accts.
Net Accounts Receivable
6,043,000
$ 49,957,000
After
Write-Off
$ 54,271,000
4,314,000
$ 49,957,000
Notice that the total write-offs of $1,729,000 did not change the net accounts receivable value nor did it affect any income statement accounts.
8-19

Estimating Bad Debts
Aging of Accounts Receivable
Focus is on determining the desired balance in the Allowance for Doubtful
Accounts on the balance sheet.
????
8-20

Aging Schedule
Each customer’s account is aged by separating the total amount owed by each customer into aging categories based on the number of days that have passed since uncollected amounts were first recorded in the account.
Let’s look on the next slide to see an aging of accounts receivable for Skechers (all amounts in thousands).
8-21

Aging Schedule
(in thousands)
Number of Days Unpaid
Customer
Adam's Sports
Backyard Shoe
Total A/R
Balance
$ 648
2,345
0-30
$ 405
30-60
$ 198
60-90 Over 90
$ 45
$ 2,345
Other Customers 138,803
Total $ 141,796
96,255
$ 96,660
18,458
$ 18,656
19,605
$ 19,650
4,485
$ 6,830
% Uncollectible
Next, based on past experience, the business accounts in each time category.
8-22

Aging Schedule
(in thousands)
Number of Days Unpaid
Customer
Adam's Sports
Backyard Shoe
Total A/R
Balance
$ 648
2,345
0-30
$ 405
30-60
$ 198
60-90
$ 45
Over 90
$ 2,345
Other Customers 138,803
Total $ 141,796
% Uncollectible
Estimated
96,255
$ 96,660
1%
18,458
$ 18,656
4%
19,605
$ 19,650
14%
4,485
$ 6,830
40% by the appropriate column totals.
8-23

Aging Schedule
(in thousands)
Customer
Adam's Sports arrive at the total estimate of
Total A/R uncollectible accounts of $7,196.
Over 90
$ 648 $ 405 $ 198 $ 45
Backyard Shoe 2,345 $ 2,345
Other Customers 138,803
Total $ 141,796
% Uncollectible
Estimated
Uncoll. Amount $ 7,196
$
96,255
96,660
1%
$ 967
18,458
$ 18,656
4%
$ 746
19,605
$ 19,650
14%
4,485
$ 6,830
40%
$ 2,751 $ 2,732
8-24

Aging of Accounts Receivable
(in thousands)
Customer
Adam's Sports
Backyard Shoe assuming that the Allowance for
Total A/R
0-30 30-60 60-90 Over 90
$4,314,000 credit balance.
45
2,345 $ 2,345
Other Customers 138,803
Total $ 141,796
% Uncollectible
Estimated
Uncoll. Amount $ 7,196
$
96,255
96,660
1%
$ 967
18,458
$ 18,656
4%
$ 746
19,605
$ 19,650
14%
4,485
$ 6,830
40%
$ 2,751 $ 2,732
8-25

Aging of Accounts Receivable
Accounts Debit
Bad Debt Expense (+E, -SE)
Allowance for Doubtful Accounts (+xA, -A)
2,882,000
Credit
2,882,000
$ 7,196,000
4,314,000
$ 2,882,000
Desired Balance
Credit Balance
Adjusting Entry
After posting, the
Allowance account would look like this . . .
8-26

Aging of Accounts Receivable
Allowance for Doubtful Accounts
6,043,000 Beg. Bal.
Write-offs 1,729,000
4,314,000
2,882,000
7,196,000
Unadj. Bal.
AJE
Adj. Bal.
Notice that the balance after adjustment is equal to the estimate of
$7,196,000 based on the aging analysis performed earlier.
8-27

Other Issues – Account Recoveries
Collections of accounts previously written off require that the original write-off entry be reversed before the cash collection is recorded.
Let’s record the entry that Skechers would make if
$50,000 is collected that had previously been written off.
Accounts
Accounts Receivable (+A)
Allowance for Doubtful Accounts (+xA)
Debit
50,000
Credit
50,000
Cash (+A)
Accounts Receivable (-A)
50,000
50,000
8-28

Learning Objective 3
8-29

Notes Receivable and
Interest Revenue
Accounting for notes receivable is similar to accounting for accounts receivable except for interest.
Accounts receivable do not charge interest until they become overdue, but notes receivable start charging interest the day they are created.
8-30

Calculating Interest
Interest =
Principal of the note
×
Annual interest rate
×
Time expressed in years
Even for maturities less than 1 year, the rate is annualized.
Number of months out of twelve that interest period covers.
8-31

Reporting Interest on
Notes Receivable
On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.
Record note receivable
2007 Interest
Accrue interest
2008 Interest
Record interest and principal received
11/01/07 12/31/07 10/31/08
8-32

Recording Notes Receivable
On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.
On November 1, to record the note:
Accounts
Note Receivable (+A)
Cash (-A)
Debit
100,000
Credit
100,000
8-33

Accruing Interest Earned
On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.
Interest =
Principal of the note
×
Annual interest rate
×
Time expressed in years
$ 2,000 = $ 100,000
×
12%
×
2 /
12
Interest revenue is
$1,000 per month.
8-34

Accruing Interest Earned
On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.
On December 31, to accrue $ 2,000 interest receivable:
Accounts
Interest Receivable (+A)
Interest Revenue (+R, +SE)
Debit
2,000
Credit
2,000
8-35

Recording Interest Received and Principal at Maturity
On November 1, 2007, Skechers loaned $100,000 cash and accepted a $100,000 one-year, 12 percent note. Skechers will receive the principal and all interest earned on October 31, 2008.
On October 31, to record $112,000 cash received:
Accounts
Cash (+A)
Interest Revenue (+R, +SE)
Interest Receivable (-A)
Note receivable (-A)
Debit
112,000
Credit
10,000
2,000
100,000
8-36

Accounting for Uncollectible Notes
When the collection of a note receivable is in doubt, a company should record an allowance for doubtful accounts against notes receivable just as is done with accounts receivable.
8-37

Learning Objective 4
8-38

Receivables Turnover Analysis
Receivables
Turnover
Ratio
=
Net Credit Sales Revenue
Average Net Trade Receivables
Skechers reported 2005 net credit sales of $1,006,000,000.
December 31, 2005, receivables were $134,600,000 and
December 31, 2004, receivables were $120,400,000.
8-39

Receivables Turnover Analysis
Receivables
Turnover
Ratio
=
Net Credit Sales Revenue
Average Net Trade Receivables
=
$1,006,000,000
($134,600,000 + $120,400,000) ÷ 2
= 7.9 times
This ratio measures how many times average receivables are recorded and collected for the year.
2005 Receivables Turnover Comparisons
Boeing
11.1
Deere & Co.
6.1
Skechers
7.9
8-40

Receivables Turnover Analysis
Days to
Collect
=
365 Days
Receivables Turnover Ratio
Days to
Collect
=
365 Days
7.9
= 46.2 Days
This ratio tells us the average number of days it takes a company to collect its receivables.
Boeing
32.9
2005 Days-to-Collect Comparisons
Deere & Co.
59.8
Skechers
46.2
8-41

Factoring Receivables
When a company desires to quickly convert receivables into cash, the receivables can be sold to a financing company or bank (called factoring ).
8-42

Credit Card Sales
Companies accept credit cards to:
1. To increase sales.
2. To avoid providing credit directly to customers.
3. To avoid losses due to bad checks.
4. To receive payment quicker.
When credit card sales are made, a fee is paid to the credit card company for the service it provides.
8-43

Percentage of Credit Sales Method
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Percentage of Credit Sales
Bad debt percentage is based on actual uncollectible accounts from prior years’ credit sales .
Focus is on determining the amount to record on the income statement as
Bad Debt Expense .
8-45

Percentage of Credit Sales
Net Credit Sales

% Estimated Uncollectible
Amount of Journal Entry
8-46

Percentage of Credit Sales
In the current year Skechers had credit sales of $1,152,800,000. Past experience indicates that bad debts are one-fourth of one percent (.25%) of sales.
What is the estimate of bad debt expense for the year?
$1,152,800,000 × .0025 = $2,882,000
Let’s prepare the adjusting entry.
8-47

Percentage of Credit Sales
Accounts Debit
Bad Debt Expense (+E, -SE)
Allowance for Doubtful Accounts (+xA, -A)
2,882,000
Credit
2,882,000
8-48

Direct Write-Off Method
No journal entries are made until a bad debt is discovered. The following journal entry is made to record $1,000 of bad debt expense when a customer account is determined to be uncollectible.
Accounts
Bad Debt Expense (+E, -SE)
Accounts Receivable (-A)
Debit
1,000
Credit
1,000
Acceptable for tax purposes, but unacceptable under generally accepted accounting principles.
8-49

End of Chapter 8
8-50