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Chapter 8

Accounting for Receivables


• A receivable is a company’s claims for
money, goods, or services.
• An account receivable is classified as a
current asset representing money due
for services performed or merchandise
sold on credit.
• When an account becomes
uncollectible, a bad debt expense is
incurred.
Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:
Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:

Credit Sale:
Accounts Receivable 1,000
Sales Revenue 1,000
Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:

Credit Sale:
Accounts Receivable..... 1,000
Sales Revenue......... 1,000

Collection--2/10,n/30:
Cash.............................. 980
Sales Discounts............. 20
Accounts Receivable 1,000
Uncollectible Accounts

Some receivables will never be


collected and must be written off
as uncollectible.
Uncollectible Accounts

• Occurs when customers do not pay for


items or services purchased on credit.
• Bad Debts are uncollectible accounts
receivables.
• The uncollectible expense is placed on
the income statement as a selling
expense.
Two Methods of Accounting for
Uncollectible Accounts

•Direct Method

Or:

•Allowance Method
EXAMPLE:
If We Have $100,000 in A/R
Invoice
ABC Inc. $
They would be represented by a
stack of invoices
Under the
Direct Method
• All invoices are presumed to be good . . .
• (Valued at $100,000)
• until we discover someone can’t pay
the amount owed.
Direct Method

• When an invoice is discovered to


Invoice
ABC Inc. $

be uncollectible — it must be
removed from A/R.

• That is it must be expensed or


written off.
Direct Method

Invoice
ABC Inc. $

Journal Entry to record Bad Debt:

Dr. Cr.
Bad Debt Expense 500
Accounts Receivable 500
Direct Method

Problem:
Invoice
ABC Inc. $

Accounts Receivable is reported at


the full $100,000 until bad debts are
specifically identified.

But, we know some customers in the


stack will not pay.

So, what is the real value of A/R?


Direct Method

Invoice
ABC Inc. $
Like all assets, the value of A/R is
only what you expect to collect.

1. Accounts Receivable is overstated.

2. Bad debt expense is understated!


It is not recorded in the same period the sale
was made.
The Matching Principle

• Requires expenses be recorded in the


same period the corresponding revenue
is recognized.

Direct Method is in conflict with the


Matching Principle

Not accepted under GAAP


Under the

Allowance Method

Invoice
ABC Inc. $
If We Have $100,000
in A/R

• We presume some invoices will not


be good . . .

• We just don’t know which ones.


Allowance Method

How do we write off an unknown


amount of Accounts Receivable?

ESTIMATE the amount,


but don’t remove any
invoices from A/R
Allowance Method

• An estimate can be based on:


a) Size of the receivables
b) Age of the receivables
c) Past loss experience
d) All of the above
Allowance Method

• An estimate can be based on:


a) Size of the receivables
b) Age of the receivables
c) Past loss experience
d) All of the above
Allowance Method

Assume you made an estimate that


$2000 will not be collectable. What
journal entry would you make?
Dr. Cr.

Hint: Accounts Receivable is NOT reduced because


which invoices will become uncollectable is unknown!
Allowance Method

Dr. Cr.
Bad Debt Expense 2000
Allowance for Doubtful Accounts 2000
To record estimated bad debts
Balance Sheet Presentation

Assets:
Cash 20,000
Accounts Receivable 100,000
Supplies 2,500
PP&E The Allowance
3,000,000
for Doubtful
Total Assets 3,120,500
Accounts is a
contra asset
that follows A/R
Balance Sheet Presentation

Assets:
Cash 20,000
Accounts Receivable 100,000
Less Allowance for DA 2,000
Net Accounts Receivable 98,000
Supplies 2,500
PP&E 3,000,000
Total Assets 3,120,500

Note: Accounts Receivable is NOT reduced but the


net receivable is!
Allowance Method

Journal Entry needed when an account


is identified as uncollectible:

Dr. Cr.
Allowance for Doubtful Accounts 500
Accounts Receivable 500
To write off Smith Co. (in bankruptcy)
Direct vs. Allowance Methods

Direct Method Dr. Cr.


May 5 Bad Debt Expense 500
Accounts Receivable 500
The
difference is
Allowance Method
Dr.
TIMING
Cr.
Dec 31 Bad Debt Expense 2000
Allowance for DA 2000
May 5 Allowance for DA 500
Accounts Receivable 500
Allowance Method
(1) The Allowance for Doubtful Accounts is a
contra-asset account which is subtracted from
accounts receivable on the balance sheet.
(2) The actual write-off entry does not reduce net
receivables, as shown below:

Acct Receivable $100,000 Acct Receivable $99,500


Less Allowance for Less Allowance for
Doubtful Accounts 2,000 Doubtful Accounts 1,500
Net Receivables $ 98,000 Net Receivables $98,000
Allowance Method
(1) The Allowance for Doubtful Accounts is a
contra-asset account which is subtracted from
accounts receivable on the balance sheet.
(2) The actual write-off entry does not reduce net
receivables.
(3) The estimation error inherent in this approach is
more acceptable than the violation of matching
with the direct write-off method.
Reversing Written-Off Receivables

Reverse Write Off:


Accounts Receivable 500
Allowance for Doubtful Accounts 500
To reinstate a written-off receivable.
Reversing Written-Off Receivables

Reverse Write Off:


Accounts Receivable 500
Allowance for Doubtful Accounts 500
To reinstate a written-off receivable.

Eliminate Receivable:
Cash 500
Accounts Receivable 500
Payment for written-off receivable.
Estimating the Allowance for
Uncollectible Accounts

• Percentage of Total Receivables--


Determines the desired balance for
Allowance for Doubtful Accounts. The
difference between the actual and the
desired balance is the expense entry.
• Aging Method--The process of
categorizing each account receivable by
the number of days it has been
outstanding.
Example: Bad Debt Expense
The ABC company had credit sales of $100,000. The
current accounts receivable balance is $30,510. The
allowance for doubtful accounts balance is $350.
Historically, 10 percent of the accounts receivable ending
balance is not collected.
Example: Bad Debt Expense
The ABC company had credit sales of $100,000. The
current accounts receivable balance is $30,510. The
allowance for doubtful accounts balance is $350.
Historically, 10 percent of the accounts receivable ending
balance is not collected.

Bad Debt Allowance for


Expense Doubtful Accounts

350 Balance

Expense 2,701 2,701 Expense


End. Balance 2,701 3,051 End. Bal.
Example: Bad Debt Expense
The ABC company had credit sales of $100,000. The
current accounts receivable balance is $30,510. The
allowance for doubtful accounts balance is $350.
Historically, 10 percent of the accounts receivable ending
balance is not collected.

Bad Debt Allowance for


Expense Doubtful Accounts

350 Balance

Expense 2,701 2,701 Expense


End. Bal. 2,701 3,051 End. Bal.

Bad Debt Expense 2,701


Allowance for Doubtful Accounts 2,701
To adjust the Allowance account to desired balance.
Example 2: Bad Debt Expense
The XYZ Company had credit sales during the year of
$200,000. Using the Aging Method, determine the
journal entry needed. The beginning balance for the
Allowance for Doubtful accounts is $150.

Percentage
Estimated to be
Age Balance Uncollectible Amount
Current.............. $10,000 1.5 $ 150
1-30 days.......... 4,000 4.0 160
31-90 days........ 2,100 20.0 420
Over 90 days..... 1,000 40.0 400
$17,000 $1,130
Example 2: Bad Debt Expense
The XYZ Company had credit sales during the year of
$200,000. Using the Aging Method, determine the
journal entry needed. The beginning balance for the
Allowance for Doubtful accounts is $150.
Uncollectible
Account Allowance for
Expense Doubtful Accounts

150 Balance

Expense 980 980 Expense


End. Bal. 980 1,130 End. Bal.
Example 2: Bad Debt Expense
The XYZ Company had credit sales during the year of
$200,000. Using the Aging Method, determine the
journal entry needed. The beginning balance for the
Allowance for Doubtful accounts is $150.
Uncollectible
Account Allowance for
Expense Doubtful Accounts

150 Balance

Expense 980 980 Expense


End. Bal. 980 1,130 End. Bal.
Uncollectible Account Expense 980
Allowance for Doubtful Accounts 980
To adjust the Allowance account to desired balance.
Accounting for Uncollectible Receivables
(Percentage of Credit Sales)

The ABC company had credit sales during the


year of $100,000. They estimate that 3% of all
credit sales will be uncollectible. Assuming the
allowance for doubtful accounts has a debit
balance of $ 1,000 what entry is necessary?
Accounting for Uncollectible Receivables
(Percentage of Credit Sales)

The ABC company had credit sales during the


year of $100,000. They estimate that 3% of all
credit sales will be uncollectible. Assuming the
allowance for doubtful accounts has a debit
balance of $ 1,000 what entry is necessary?

Uncollectible Accounts Expense 4,000


Allowance for Uncollectible Accounts 4,000

To record estimated uncollectible accounts for the


year.
Assessing Management of Receivables

• Accounts Receivable Turnover--A


measure used to determine a
company’s average collection period for
receivables. Computed by dividing net
sales (credit sales) by average accounts
receivables.
Assessing Management of Receivables

• Accounts Receivable Turnover


• Number of Days in Receivables--A
measure of the average number of days
it takes to collect a credit sale. It is
computed by dividing 365 days by the
accounts receivable turnover.
Example

The Wheeler Company had Net Credit Sales


of $150,000 during 2009. The accounts
receivables increased $5,000 to $40,000
during the same time. Calculate the Accounts
Receivable Turnover and Number of Days in
Receivables.
Example

The Wheeler Company had Net Credit Sales


of $150,000 during 2009. The accounts
receivables increased $5,000 to $40,000
during the same time. Calculate the Accounts
Receivable Turnover and Number of Days in
Receivables.

Accounts Receivable Turnover:

Net Sales $150,000 = 4.0


Average Accounts Receivable $ 37,500
Example

The Wheeler Company had Net Credit Sales


of $150,000 during 2009. The accounts
receivables increased $5,000 to $40,000
during the same time. Calculate the Accounts
Receivable Turnover and Number of Days in
Receivables.

Number of Days in Receivables:

Number of Days 365 = 91.25


Accounts Receivable Turnover 4.0
Notes Receivable

• A written promise that allows someone


to pay a certain amount of money on or
before a specific future date.

• Notes are classified as current or long-


term assets, depending on the due
date.
Notes Receivable -- Components

• Maker--The individual who signs the note and


assumes responsibility.
• Payee--The person to whom payment is made.
• Principal--The face amount of the note.
• Maturity Date--The date the note becomes due.
• Interest Rate--Annualized percentage of the
principal the maker is charged to borrow money.
• Interest--The cost of borrowing money.
Computing Interest

Principal
(amount)
Computing Interest

Principal Interest
(amount)
X Rate (%)
Computing Interest

Principal Interest Time


(amount)
X Rate (%)
X (years)
Computing Interest

Principal Interest Time


(amount)
X Rate (%)
X (years)

Equals

Interest
Owed
Example: Interest
The Ohio Company signed a 90-day, $5,000 note
payable to the Florida Company in settlement of
existing accounts payable. The interest rate of the
agreement is 14 percent. Calculate the interest
cost.
Example: Interest
The Ohio Company signed a 90-day, $5,000 note
payable to the Florida Company in settlement of
existing accounts payable. The interest rate of the
agreement is 14 percent. Calculate the interest
cost.
Principal x Interest Rate x Time = Interest

$5,000 x 0.14 x 90/365 = $172.60


What journal entries are required for the Ohio
Company? For the Virginia Company?
Journalizing Notes Receivable

The Ohio Company--Maker


Accept Note:
Accounts Payable............ 5,000.00
Note Payable............. 5,000.00

Pay Note Plus Interest:


Note Payable................... 5,000.00
Interest Expense.............. 172.60
Cash.......................... 5,172.60
Journalizing Notes Receivable

The Virginia Company--Payee


Accept Note:
Note Receivable............... 5,000.00
Accounts Receivable.. 5,000.00

Collect Note Plus Interest:


Cash................................. 5,172.60
Note Receivable......... 5,000.00
Interest Revenue........ 172.60
Selling or Factoring Receivables

• Receivables are sold to factoring


companies for cash.
• The factoring companies charge a
percentage of the receivable as a
service cost.
• Factoring allows companies to receive
cash now, instead of waiting to collect
on the receivable.