Accounting for

Receivables and
Bad Debt
 Learning Objectives
1. Describe the accounting treatment of anticipated
uncollectible accounts receivable.
 Learning Objectives
1. Describe the accounting treatment of anticipated
uncollectible accounts receivable.
2. Describe the two approaches to estimating bad debts.
 Learning Objectives
1. Describe the accounting treatment of anticipated
uncollectible accounts receivable.
2. Describe the two approaches to estimating bad debts.
3. Describe the accounting treatment of short-term notes
receivable.
 Learning Objectives
1. Describe the accounting treatment of anticipated
uncollectible accounts receivable.
2. Describe the two approaches to estimating bad debts.
3. Describe the accounting treatment of short-term notes
receivable.
4. Differentiate between the use of receivables in financing
arrangements accounted for as a secured borrowing and
those accounted for as a sale.
 Learning Objective #1
Describe the accounting treatment
of anticipated uncollectible
accounts receivable.
 Uncollectible Accounts
Receivable
Bad debts result from credit customers who are
unable to pay the amount they owe, regardless
of continuing collection efforts.
Uncollectible Accounts Receivable
In conformity with the matching
principle, bad debt expense should be
recorded in the same accounting
period in which the sales related to the
uncollectible account were recorded.
Learning Objective #2
Describe the two approaches to
estimating bad debts.
Uncollectible Accounts Receivable
Most businesses record an estimate of
the bad debt expense by an adjusting
entry at the end of the accounting
period.
Uncollectible Accounts Receivable
Normally classified as a selling expense and
closed at year-end.

Bad debt expense xxx

Allowance for uncollectible accounts xxx

Contra asset account to accounts receivable.

 Income Statement Approach
 Focuses on past credit sales to make estimate of bad
debt expense.
 Emphasizes the matching principle by estimating the
bad debt expense associated with the current
period’s credit sales.
 Income Statement Approach

Bad debt expense is computed as follows:

Current Period Credit Sales
× Estimated Bad Debt %
= Estimated Bad Debt Expense
 Income Statement Approach

If XYZ Co. has credit sales of

$400,000 and estimates that 0.6%
of credit sales are uncollectible.
What is their Bad Debt Expense?
 Income Statement Approach
If XYZ Co. has credit sales of $400,000 and estimates that 0.6% of
credit sales are uncollectible.
What is Bad Debt Expense for 2014?
$ 400,000
× 0.60%
= $ 2,400

Bad debt expense 2,400

Allowance for uncollectible accounts 2,400
 Income Statement Approach
If XYZ Co. has credit sales of $400,000 and estimates that 0.6% of
credit sales are uncollectible.

What is Bad Debt Expense for 2014?

Bad debt expense 2,400
Allowance for uncollectible accounts 2,400
 Balance Sheet Approach
 Focuses on the collectability of accounts
receivable to make the estimate of uncollectible
accounts.
 Involves the direct computation of the desired
balance in the allowance for uncollectible
accounts.
 Balance Sheet Approach
Compute the desired balance in the allowance for
uncollectible accounts.
Bad debt expense is computed as:
Desired Balance in Allowance for
Uncollectible Accounts
Existing Year-End Balance in Allowance for
- Uncollectible Accounts
= Estimated Bad Debt Expense
Balance Sheet Approach Composite Rate
On Dec. 31, 2014, ABC Co. has $50,000 in accounts
receivable and a $200 credit balance in allowance for
uncollectible accounts.
Past experience suggests that 5% of receivables are
uncollectible.
What is ABC’s bad debt expense for 2014?
Balance Sheet Approach Composite Rate
Determine the desired balance in
allowance
for uncollectible accounts
$ 50,000 Allow ance for
× 5.00% Uncollectible
Accounts
= $ 2,500 200
2,300
2,500
 Balance Sheet Approach
Composite Rate
Allow ance for
Uncollectible
Accounts
200
2,300
2,500

Bad debt expense 2,300

Allowance for uncollectible accounts 2,300
 Balance Sheet Approach
Aging of Receivables
1. Year-end accounts receivable is broken down into
age classifications.
2. Each age grouping has a different likelihood of
being uncollectible.
3. Compute required uncollectible amount.
4. Compare required uncollectible amount with the
existing balance in the allowance account.
 Balance Sheet Approach
Aging of Receivables
At December 31, 2014, the receivables for
EastCo, Inc., were categorized as follows:
 Balance Sheet Approach
 Aging of Receivables 
EastCo, Inc.
Schedule of Accounts Receivable by Age
December 31, 2014
Accounts Estimated
Receivable Percent Estimated
Days Past Due Balance Uncollectible Allowance
Current $ 45,000 1% $ 450
1 - 30 15,000 3% 450
31 - 60 5,000 5% 250
Over 60 2,000 10% 200


$ 67,000 $ 1,350
 Balance Sheet Approach
Aging of Receivables
Allow ance for
• EastCo’s unadjusted balance in the Uncollectible
allowance account is $500. Accounts
500
• Per the previous computation, the 850

required balance is $1,350. 1,350

Bad debt expense 850

Allowance for uncollectible accounts 850
 Uncollectible Accounts
As accounts are deemed to be uncollectible, a journal
entry is made to record the actual write-off.

Allowance for uncollectible accounts 500

Accounts receivable 500
 Uncollectible Accounts
If a customer makes a payment after an account has been
written off, two journal entries are required.

Accounts receivable 500

Allowance for uncollectible accounts 500
Cash 500
Accounts receivable 500
 Direct Write-off Method
If uncollectible accounts are immaterial, bad debts
are simply recorded as they occur (without the
use of an allowance account).

Bad debts expense xxx

Accounts receivable xxx
Learning Objective #3
Describe the accounting treatment
of short-term notes receivable.
 Notes Receivable
A written promise to pay a specific
amount at a specific future date.
Face Fraction
Annual
amount of the
interest = Interest
of the × × annual
rate
note period

Even for maturities less than 1 year, the rate

is annualized.
 Interest-Bearing Notes
On November 1, 2014, West, Inc., loans $25,000 to
Winn Co. The note bears interest at 12% and is
due on November 1, 2015.

Prepare the journal entry on November 1, 2014,

December 31, 2014, (year-end) and
November 1, 2015, for West.
 Interest-Bearing Notes
November 1, 2014
Notes receivable 25,000
Cash 25,000
December 31, 2014
Interest receivable 500
Interest revenue 500
November 1, 2015
Cash 28,000
Note receivable 25,000
Interest receivable 500
Interest revenue 2,500
Noninterest-Bearing Notes
Actually do bear interest.
Interest is deducted
(discounted) from the face
value of the note.
Cash proceeds equal face
value of note less discount.
 Noninterest-Bearing Notes
On Jan. 1, 2014, West, Inc., accepted a $25,000
noninterest-bearing note from Winn Co. as
payment for a sale. The note is discounted at
12% and is due on Dec. 31, 2014.

Prepare the journal entries on Jan. 1, 2014,

and Dec. 31, 2014.
 Noninterest-Bearing Notes
January 1, 2014
Notes receivable 25,000
Discount on notes receivable 3,000
Sales revenue 22,000
($25,000 * 12% = $3,000)
December 31, 2014
Cash 25,000
Discount on notes receivable 3,000
Interest revenue 3,000
Note receivable 25,000
Learning Objective #4
Differentiate between the use of
receivables in financing arrangements
accounted for as a secured borrowing
and those accounted for as a sale.
Financing with Receivables
Companies may use their
receivables to obtain immediate
cash.
 Factoring Arrangements
A factor is a financial institution that buys
Receivables for cash, handles the billing
and collection of the receivables, and
charges a fee for the service.
 Factoring Arrangements
2. Accounts Receivable
SUPPLIER RETAILER
(Transferor) 1. Merchandise

FACTOR
(Transferee)
 Secured Borrowing
On December 1, 2013, the Santa Teresa Glass Company borrowed
$500,000 from Finance Bank and signed a promissory note. Interest at
12% is payable monthly. The company assigned $620,000 of its
receivables as collateral for the loan. Finance Bank charges a finance fee
equal to 1.5% of the accounts receivable assigned.

Cash (difference) 490,700

Finance charge expense (1.5% * $620,000) 9,300
Liability – financing arrangement 500,000
 Sale of Receivables
Treat as a sale if all of these conditions are met:
 receivables are isolated from transferor.
 transferee has right to pledge or exchange receivables.
 transferor does not have control over the receivables.
 Transferor cannot repurchase
receivable before maturity.
 Transferor cannot require return
of specific receivables.
 Sale of Receivables
Without recourse
 An ordinary sale of receivables to the factor.
 Factor assumes all risk of uncollectibility.
 Control of receivable passes to the factor.
 Receivables are removed from the books, fair value of
cash and other assets received is recorded, and a
financing expense or loss is recognized.
 Sale of Receivables
With recourse
 Transferor (seller) retains risk of uncollectibility.
 If the transaction fails to meet the three conditions
necessary to be classified as a sale, it will be
treated as a secured borrowing.
Is Transfer a Sale or Secured Borrowing?
 U.S. GAAP vs. IFRS
The U.S. GAAP and the IFRS approaches often
lead to similar accounting treatment for transfers
of receivables.
 U.S. GAAP vs. IFRS
• U.S. GAAP focuses on whether control of assets
has shifted from the transferor to the transferee.

• IFRS requires a more complex decision process.

The company has to have transferred the rights to
receive the cash flows from the receivable, and
then considers whether the company has
transferred “substantially all of the risks and
rewards of ownership,” as well as whether the
company has transferred control.
 Learning Objectives
1. Describe the accounting treatment of anticipated
uncollectible accounts receivable.
2. Describe the two approaches to estimating bad debts.
3. Describe the accounting treatment of short-term notes
receivable.
4. Differentiate between the use of receivables in financing
arrangements accounted for as a secured borrowing and
those accounted for as a sale.