ACCOUNTING FOR RECEIVABLES

CHAPTER

9

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

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• Three major classes of receivables are:

i. Accounts Receivable (due 30 days)

ii. Notes Receivable (due 30-90 days)

iii. Other Receivables

RECEIVABLES

The three primary accounting problems associated with accounts receivable are:

1. Recognizing accounts receivable.

2. Valuing accounts receivable.

3. Disposing of accounts receivable.

ACCOUNTS RECEIVABLE

1. RECOGNIZING ACCOUNTS RECEIVABLE

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 ACCOUNTS RECEIVABLE (cont.)

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

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Sales Returns and Allowances 100

Accounts Receivable 100

1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)

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

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1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)

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.

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• 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 ACCOUNTS RECEIVABLE

• Two methods of accounting for uncollectible accounts are:

1. Allowance method

2. Direct write-off method

2. VALUING

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.

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• 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 METHOD

DIRECT 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.

• 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 METHOD

(2 Steps)

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.

THE ALLOWANCE METHOD

Step 1

ADORABLE JUNIOR GARMET

Balance Sheet (partial)

Current assets

Cash $ 14,800

Accounts receivable $200,000

Less: Allowance for doubtful accounts (24,000) 176,000

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 METHOD

Step 2

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

• Reverse the entry made to write off the account

THE ALLOWANCE METHOD

• Record the collection in the usual manner.

Accounts Receivable – Nadeau 500

Allowance for Doubtful Accounts 500

Cash 500

Accounts Receivable 500

• Companies use either of two methods in the estimation of uncollectible accounts:
• Percentage of sales
• Percentage of aged receivables

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

BASES USED FOR THE ALLOWANCE METHOD

• 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…

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A. PERCENTAGE OF SALES BASIS

• This basis better matches expenses with revenues.

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Bad Debt Expense 3,000

Allowance 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.

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• This percentage can be applied to
• The total receivable balance, or
• To accounts receivable balances grouped by age.

B. PERCENTAGE OF AGED RECEIVABLES BASIS

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

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

B. PERCENTAGE OF AGED RECEIVABLES BASIS (cont.)

Desired Balance

B. PERCENTAGE OF AGED 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…

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 ACCOUNTS 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.

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3. DISPOSING OF 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 SALES

BANK 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 SALES

• Karen Kerr buys items for their restaurant from us for $1,000 using their Royal Bank VISA card.
• The service fee that the Royal charges is 3.5 percent.

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

Sales 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 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 TERMS

• Interest paid in cash is always calculated as follows:

IMPORTANT TERMS

Interest

Paid

Face

Value

Interest

Rate

(for time period)

X

=

• We now will look at the following three procedures for dealing with notes:
• Acquiring
• Adjusting
• Disposing

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

NOTES RECEIVABLE

RECOGNIZING NOTES RECEIVABLE

Acquisition

Wilma Company receives a $1,000, 6% promissory note, due in two months (June 30) from Brent Company to settle an open account.

• 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 RECEIVABLE

VALUING NOTES RECEIVABLE

Adjustment/Valuation

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

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• If they do not, no entry will be recorded until the note matures and pays interest.

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VALUING NOTES RECEIVABLE

Disposal/Termination

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

VALUING NOTES RECEIVABLE

Disposal/Termination

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

DISHONOUR 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.

Do the following starting on page 449:

BE9-7, 8, 10 and 12

P9-8A

P9-10A