CHAPTER
8
ACCOUNTING FOR
RECEIVABLES
Monday, Dec 1 will be Unit 3 Test
(covering chapter 7 and 8)
VALUING
ACCOUNTS RECEIVABLE
• Two methods of accounting for
uncollectible accounts are:
1. Allowance method
2. Direct write-off method
BASES USED FOR THE
ALLOWANCE METHOD
• Companies use either of two methods in
the estimation of uncollectible accounts:
1. Percentage of sales
2. Percentage of receivables
• Both bases are GAAP; the choice is a
management decision.
PERCENTAGE OF
RECEIVABLES BASIS
• Under this approach, you always subtract
the beginning balance of the Allowance
for DA from the estimated number.
• For example, The CK’s AR is 240,000 and
they estimate that 10% will be uncollectible
in the future. Then they should muliply 0.1
* 240,000 = 24000 (ending balance must be
24000)
• But they realized that beginning balance of
Allowance for DA is 1000 then the
difference is 23000.
ILLUSTRATION 9-4
COMPARISON OF BASES OF
ESTIMATING UNCOLLECTIBLES
Percentage of Sales
Matching
Sales
Percentage of Receivables
Net Realizable Value
Bad Debts
Expense
Emphasis on
Income Statement
Relationships
Accounts
Receivable
Allowance
for
Doubtful
Accounts
Emphasis on
Balance Sheet
Relationships
Collection Process
• Companies use various methods for collecting past
due accounts including letters, calls, and legal
actions.
• Some companies hire collection agency to collect.
• When everything was tried and it still seems
impossible to collect then the account should be
written off.
• Again, Internal control Purpose : Only manager
should authorize write off, otherwise, employees
can steal company’s cash.
Collection Process
March 1 Allowance for DA
4500
AR – Kids online
4500
Writing off AR – Kids online
• We do not increase bad debt expense, but we
increase ADA account and decrease AR.
NON-BANK CARD SALES
• Sales using American Express and other
non-bank cards are reported as credit sales,
(=debit AR) not cash sales.
• Conversion into cash does not occur until
American Express remits the net amount
to the seller.
NON-BANK CARD SALES
GENERAL JOURNAL
Date
July 31
Account Titles and Explanation
Accounts Receivable
Credit Card Expense ($500 x 5%)
Sales
To record American Express
credit card sales.
Kerr Music Co. accepts an
AMERICAN EXPRESS card
for a $500 sale. The service fee
that AMERICAN EXPRESS
charges is 5 percent.
Debit
Credit
475
25
500
NOTES RECEIVABLE
• A promissory note is a written promise to pay a
specified amount of money on demand (or at a
definite time.)
• Promissory note is used
1. When individuals (or companies) lend or borrow
money.
2. When the amount of the transaction and the
credit period are long term or
3. In settlement of accounts receivable
NOTES RECEIVABLE
• The party making the promise is the
maker.(=borrower)
• The party to whom payment is made is
called the payee. (=lender)
–
The same promissory note is a note payable for maker
and it is a note receivable for the payee.
NOTES RECEIVABLE
• The promissory note gives these details:
1.
2.
3.
4.
5.
Name of the maker and payee
Amount of the loan
Loan period (such as 1 year or 5 years)
Interest rate (such as 8%)
How interest will be paid = Whether interest is
repayable monthly or fully paid at maturity along with
the principal
6. Whether any security is pledged as collateral for the
loan and what happens if the maker defaults.
Difference between NOTES
RECEIVABLE and AR
• AR is informal promise to pay, whereas NR is more
formal written promise.
• The lender has stronger legal claim under NR.
• NR is a negotiable instrument, which means it can be
sold or transferred to another person or company by
endorsement.
• AR results from a credit sale transaction whereas NR
results from financing a purchase (such as when
buying a car), lending money, or extending AR for a
longer period.
Difference between NOTES
RECEIVABLE and AR
• AR is usually due in a short period of time (e.g. 30
days) while a note can extend for longer periods of
time.
• AR does not normally incur interest expense
(unless the account is overdue.)
• A NR usually bears interest for the entire period.
Similarities of NOTES
RECEIVABLE and AR
•
•
•
•
Both are credit instruments.
Both are valued at their net realizable values.
Both can be sold to another party.
The basic issues in accounting for notes receivable
are the same as those for AR as follows:
1. Recognizing NR
2. Disposing NR
ILLUSTRATION 9-8
FORMULA FOR
CALCULATING INTEREST
The basic formula for calculating interest on an
interest-bearing note is:
Face Value
of Note
X
Annual
Interest
Rate
X
Loan Period
in Terms of
One Year
=
Interest
The interest rate specified on the note is
an annual rate of interest.
For example 1000 * 0.06 * 6/12 = 30$ for 6 months
RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Titles and Explanation
May 1 Notes Receivable
Accounts Receivable — Brent Company
To record acceptance of Brent
Company note.
Debit
Credit
1,000
1,000
Wilma Company receives a $1,000, 6% promissory note, due
in two months (July 31) from Brent Company to settle an
open account. (Brant bought merchandise on account on
March 15. Brant did not pay in 30 days, but they will pay in
the future. )
HONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Sept. 30 Cash
Notes Receivable - Higly
Interest Revenue
To record collection of Higly note.
Debit
Credit
10,150
10,000
150
• A note is honoured when it is paid in full at its maturity date.
• Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5%
interest-bearing note, due in 4 months, on September 30.
• Wolder collects the maturity value of the note from Higley on
September 30.
Adjusting Entry on July 31
• If the year end was July 31, and the note receivable from
previous example was still outstanding, then they should make
the following adjusting entry to honor matching principle.
• Two months have passed from the issue date, so we must
recognize two months of accrued interest.
• 0.045 * 2/12 * 10,000 = 75
July 31 Interest Receivable
Interest Revenue
Sep 30 Cash
10150
Interest Receivable
Notes Receivable
Interest Revenue
75
75
75
10000
75
VALUING NOTES RECEIVABLE
• Like accounts receivable, short-term notes
receivable are reported at their net realizable
value. (you must estimate how much of it will
actually be collected)
• The notes receivable allowance account is
Allowance for Doubtful Notes. (or ADN, which is
same as ADA)
• Use bad debt expense and ADN to write off.
Classwork / Homework
• P438 E8.7, E8.8
• P443 P8.8
DISHONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Sept. 30 Accounts Receivable - Higly
Notes Receivable - Higly
Interest Revenue
To record the dishonour of Higly note.
Debit
Credit
10,150
10,000
150
• A dishonoured note is a note that is not paid in full at
maturity.
• A dishonoured note receivable is no longer negotiable.
• Since the payee still has a claim against the maker
of the note, the balance in Notes Receivable is
usually transferred to Accounts Receivable or ADA
RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date
May 1
Account Titles and Explanation
Cash
Accounts Receivable — Brent Company
To record acceptance of Brent
Company note.
Debit
Credit
1,000
1,000
•If a note is made to get cash, then the entry is a
debit to Notes Receivable and credit to Cash. (For
borrower)
•Company receives a $1,000, 6% promissory
note, due in two months (July 31) from Brent
Company.
•Interest will be recorded later when it is paid.