ACCOUNTING FOR ACCOUNTING FOR RECEIVABLESRECEIVABLES

CHAPTERCHAPTER

99

• The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash.

• Three major classes of receivables are:

i. Accounts Receivable (due 30 days)

ii. Notes Receivable (due 30-90 days)

iii. Other Receivables

RECEIVABLESRECEIVABLESRECEIVABLESRECEIVABLES

The three primary accounting problems associated with accounts receivable are:

1. Recognizing accounts receivable.

2. Valuing accounts receivable.

3. Disposing of accounts receivable.

ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLEACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

Date Particulars Debit CreditJuly 1

When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.

Accounts Receivable – Adorable Junior 1,000

Sales 1,000

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

Date Particulars Debit CreditJuly 5

When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited.

Sales Returns and Allowances 100Accounts Receivable 100

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

Date Particulars Debit CreditJuly 31 Cash ($1,000 – $100) 900

900Accounts Receivable

When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

1. RECOGNIZING 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

Date Particulars Debit CreditJuly 31 Accounts Receivable (18% or 1.5% per month on

$900)13.50

13.50Interest Revenue

When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited.

• To ensure that receivables are not overstated, they are stated at their net realizable value.

• Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect.

2. VALUING 2. VALUING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE2. VALUING 2. VALUING ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

• Two methods of accounting for

uncollectible accounts are:

1. Allowance method

2. Direct write-off method

2. VALUING2. VALUING

ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

2. VALUING2. VALUING

ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

• Under the direct write-off method, no entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts Expense.

• No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet.

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD

Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.

Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.

Date Particulars Debit CreditJan. 12 Bad Debt Expense 200

200Accounts Receivable – E. Schaefer

Why is this a selling operating expense?

• The allowance method is required when bad debts are deemed to be material in amount.

• Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred.

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

(2 Steps)(2 Steps)

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

(2 Steps)(2 Steps)

Why?

Achtung !

Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.

Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

Step 1Step 1

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

Step 1Step 1

Date Particulars Debit CreditDec. 31 Bad Debts Expense 24,000

24,000Allowance for Doubtful Accounts

ADORABLE JUNIOR GARMET

Balance Sheet (partial)

Current assets Cash $ 14,800

Accounts receivable $200,000Less: Allowance for doubtful accounts 24,000 176,000

Net Realizable Value

Why not just show the Net Realizable Value,

and omit the rest?

Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.

Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

Step 2Step 2

THE ALLOWANCE METHODTHE ALLOWANCE METHOD

Step 2Step 2

Date Particulars Debit CreditMar. 1 Allowance for Doubtful Accounts 500

500Accounts Receivable - Nadeau

When there is recovery of an account that has been written off:

1. Reverse the entry made to write off the account

When there is recovery of an account that has been written off:

1. Reverse the entry made to write off the account

THE ALLOWANCE METHODTHE ALLOWANCE METHODTHE ALLOWANCE METHODTHE ALLOWANCE METHOD

Date Particulars Debit CreditJuly 1

2. Record the collection in the usual manner.

2. Record the collection in the usual manner.Date Particulars Debit Credit

July 1

Accounts Receivable – Nadeau 500Allowance for Doubtful Accounts 500

Cash 500Accounts Receivable 500

• Companies use either of two methods in the estimation of uncollectible accounts:

A. Percentage of salesB. Percentage of aged receivables

• Both bases are GAAP; the choice is a management decision.

BASES USED FOR THE BASES USED FOR THE ALLOWANCE METHODALLOWANCE METHODBASES USED FOR THE BASES USED FOR THE ALLOWANCE METHODALLOWANCE METHOD

Achtung !

• In the percentage of sales basis, management establishes what amount of net CREDIT sales are expected to be uncollectible (usually from past experience).

• Bad Debt Expense is then determined by applying the percentage to the sales base of the current period. The TOTAL amount is charged to Bad Debt. Observe…

A. PERCENTAGE OF SALES BASISA. PERCENTAGE OF SALES BASISA. PERCENTAGE OF SALES BASISA. PERCENTAGE OF SALES BASIS

• This basis better matches expenses with revenues.Date Particulars Debit Credit

Dec. 31 Bad Debt Expense 3,000Allowance for Doubtful Accounts 3,000

• Under this method, management estimates what the TOTAL value of bad debt currently is by applying a percentage to the actual, existing accounts receivable balances at the end of the period.

• This percentage can be applied to1. The total receivable balance, or2. To accounts receivable balances grouped by

age. (see pg 429)

B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED RECEIVABLES BASISRECEIVABLES BASIS

B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED RECEIVABLES BASISRECEIVABLES BASIS

• The amount of the adjusting entry is the difference between the required balance in the allowance account, and the current balance.

• This basis produces the better estimate of net realizable value of receivables. Observe…

B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED RECEIVABLES BASIS (cont.)RECEIVABLES BASIS (cont.)B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED

RECEIVABLES BASIS (cont.)RECEIVABLES BASIS (cont.)

Desired Balance

B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED RECEIVABLES BASIS (cont.)RECEIVABLES BASIS (cont.)B. PERCENTAGE OF AGED B. PERCENTAGE OF AGED

RECEIVABLES BASIS (cont.)RECEIVABLES BASIS (cont.)

• So, if the balance in the Allowance account is already $2,200, then the adjusting entry to bring the Allowance up to the present estimated of Net Realizable Receivables is…

Date Particulars Debit CreditDec. 31 Bad Debt Expense ($3,245 - $2,200) 1,045

Allowance for Doubtful Accounts 1,045

Do the following starting on page 445:

BE9-1 to 6

E9-2

E9-3

P9-2A

P9-3A

To accelerate the receipt of cash from receivables, owners frequently:

1. sell to a factor, such as a finance company or a bank, and

2. make credit card sales.

3. DISPOSING OF 3. DISPOSING OF ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

3. DISPOSING OF 3. DISPOSING OF ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

• A factor buys receivables from businesses for a fee and collects the payments directly from customers.

• Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit.

• Retailers can receive cash more quickly from the credit card issuer.

3. DISPOSING OF 3. DISPOSING OF ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

3. DISPOSING OF 3. DISPOSING OF ACCOUNTS RECEIVABLE (cont.)ACCOUNTS RECEIVABLE (cont.)

• Three parties are involved when credit cards are used in making retail sales:

1. the credit card issuer,

2. the retailer, and

3. the customer.

• The retailer pays the credit card issuer a percentage fee of the invoice price for its services.

CREDIT CARD SALESCREDIT CARD SALESCREDIT CARD SALESCREDIT CARD SALES

BANK CARD SALESBANK CARD SALESBANK CARD SALESBANK CARD SALES

• Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.

• These cards are issued by banks.

• Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.

BANK CARD SALESBANK CARD SALESBANK CARD SALESBANK CARD SALES

• We purchase a CDs for our restaurant from Karen Kerr Music Co. for $1,000 using our Royal Bank VISA card.

• The service fee that the Royal charges is 3.5 percent.

• We purchase a CDs for our restaurant from Karen Kerr Music Co. for $1,000 using our Royal Bank VISA card.

• The service fee that the Royal charges is 3.5 percent.

Date Particulars Debit CreditJuly 31

What other account does this resemble?

Credit Card Expense ($1,000 x 3.5%) 35Sales 1,000

Cash 965

• A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

• The party making the promise is the maker.

• The party to whom payment is made is called the payee.

NOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLE

• Interest rate• The cost of borrowing others’ money. It is an

expense, not the repayment of debt

• Face Value• The price of a note or bond, written on the actual

contract (note)

• Term• The length of the note or bond before it is due

• Maturity• When the note/bond’s face value is due, along

with any outstanding interest

IMPORTANT TERMSIMPORTANT TERMSIMPORTANT TERMSIMPORTANT TERMS

• Interest is always calculated as follows:

IMPORTANT TERMSIMPORTANT TERMSIMPORTANT TERMSIMPORTANT TERMS

InterestExpense

FaceValue

InterestRate

X=

• We now will look at the following three procedures for dealing with notes:– Acquisition– Adjustment/valuation– Disposal/termination

• Note: these three steps are similar to many things we will look at this semester. Best to look for trends and processes.

NOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLE

RECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLEAcquisitionAcquisition

RECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLEAcquisitionAcquisition

Wilma Company receives a $1,000, 6% promissory note, due in two months (July 1) from Brent Company to settle an open account.

Wilma Company receives a $1,000, 6% promissory note, due in two months (July 1) from Brent Company to settle an open account.

Date Particulars Debit CreditMay 1 Notes Receivable 1,000

1,000Accounts Receivable – Brent Company

• Like accounts receivable, short-term notes receivable are reported at their net realizable value.

• The notes receivable allowance account is Allowance for Doubtful Notes.

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLE

Date Particulars Debit CreditMay 31 Interest Receivable 5

5Interest Revenue

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEAdjustment/ValuationAdjustment/Valuation

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEAdjustment/ValuationAdjustment/Valuation

• If Wilma company adjusts monthly, the journal entry will look like this:

• If they do not, not entry will be recorded until the note matures and pays interest.

Date Particulars Debit Credit

May 31 Cash 1,0105Interest Receivable

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEDisposal/TerminationDisposal/Termination

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEDisposal/TerminationDisposal/Termination

• If Wilma company adjusts monthly, the journal entry will look like this:

5Interest Revenue1,000Notes Receivable

Date Particulars Debit Credit

May 31 Cash 1,01010Interest Receivable

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEDisposal/TerminationDisposal/Termination

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEDisposal/TerminationDisposal/Termination

• If Wilma company does NOT adjust monthly, the journal entry will look like this:

1,000Notes Receivable

DISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLE

• 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.

• 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.

Date Particulars Debit CreditSept. 30 Accounts Receivabl 1,010

1,000Notes Receivable10Interest Revenue

BALANCE SHEET PRESENTATION BALANCE SHEET PRESENTATION OF RECEIVABLESOF RECEIVABLES

BALANCE SHEET PRESENTATION BALANCE SHEET PRESENTATION OF RECEIVABLESOF RECEIVABLES

• Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

• Why?

USING THE INFORMATION IN THE USING THE INFORMATION IN THE FINANCIAL STATEMENTSFINANCIAL STATEMENTS

• Financial ratios are calculated to evaluate the short-term liquidity of a company.

• Recall these ratios: 1. current ratio,2. acid test (quick) ratio,3. receivables turnover, and the4. A/R collection period (in days).

Do the following starting on page 449:

BE9-7 to 12

P9-8A

P9-10A