Chapter 8Chapter 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 ReceivableAssume 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

Credit Sale: Accounts Receivable 1,000

Sales Revenue 1,000

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

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

Sales Revenue......... 1,000

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

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

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 MethodDirect Method

Or:

•AllowanceAllowance MethodMethod

EXAMPLE:EXAMPLE:If We Have $100,000 in A/RIf We Have $100,000 in A/R

• All invoices are presumed to be good . . .• (Valued at $100,000)

They would be represented by a stack of invoices

InvoiceABC Inc. $

Direct MethodDirect MethodUnder the

• until we discover someone can’t pay the amount owed.

Direct MethodDirect Method

• When an invoice is discovered to be uncollectible — it must be removed from A/R.

• That is it must be expensed or written off.

InvoiceABC Inc. $

Direct MethodDirect Method

Journal Entry to record Bad Debt:

InvoiceABC Inc. $

Dr. Cr.Bad Debt Expense 500

Accounts Receivable 500

Direct MethodDirect 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 MethodDirect Method

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

InvoiceABC Inc. $

1. Accounts Receivable is overstated.

2. Bad debt expense is understated! It is not recorded in the same period the sale

was made.

• Requires expenses be recorded in the same period the corresponding revenue is recognized.

Direct Method is in conflict with the Direct Method is in conflict with the Matching PrincipleMatching Principle

Not accepted under GAAP Not accepted under GAAP

The Matching Principle

Under the

Allowance MethodAllowance Method

• We presume some invoices will not be good . . .

• We just don’t know which ones.

InvoiceABC Inc. $ If We Have $100,000 If We Have $100,000

in A/Rin A/R

Allowance MethodAllowance Method

ESTIMATE the amount, ESTIMATE the amount, but don’t remove any but don’t remove any invoices from A/Rinvoices from A/R

How do we write off an unknown How do we write off an unknown amount of Accounts Receivable?amount of Accounts Receivable?

• An estimate can be based on:a) Size of the receivablesb) Age of the receivablesc) Past loss experienced) All of the above

Allowance MethodAllowance Method

• An estimate can be based on:a) Size of the receivablesb) Age of the receivablesc) Past loss experienced) All of the above

Allowance MethodAllowance 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 MethodAllowance Method

Dr. Cr.

Bad Debt Expense 2000Allowance for Doubtful Accounts 2000

To record estimated bad debts

Allowance MethodAllowance Method

Balance Sheet Presentation

Assets: Cash 20,000 Accounts Receivable 100,000 Supplies 2,500 PP&E 3,000,000 Total Assets 3,120,500

The Allowance for Doubtful

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!

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)

Allowance MethodAllowance Method

Dr. Cr.Bad Debt Expense 2000

Accounts Receivable 500

Allowance Method

Allowance for DA 2000

Allowance for DA 500May 5

Dec 31

Direct vs. Allowance Methods

Dr. Cr.Bad Debt Expense 500

Accounts Receivable 500

Direct Method

May 5

The difference The difference isis

TIMINGTIMING

(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 $99,500Less Allowance for Less Allowance for Doubtful Accounts 2,000 Doubtful Accounts 1,500Net Receivables $ 98,000 Net Receivables $98,000

Allowance MethodAllowance 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.

Allowance MethodAllowance Method

Reversing Written-Off Receivables

Reverse Write Off: Accounts Receivable 500 Allowance for Doubtful Accounts 500 To reinstate a written-off receivable.

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.

Reversing Written-Off Receivables

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 ExpenseThe 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.

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 Expense

350 Balance

Expense 2,701 2,701 Expense

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

Allowance for Doubtful Accounts

Example: Bad Debt Expense

Bad Debt Expense 2,701 Allowance for Doubtful Accounts 2,701To adjust the Allowance account to desired balance.

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 Expense

350 Balance

Expense 2,701 2,701 Expense

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

Allowance for Doubtful Accounts

Example: 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.

Example 2: Bad Debt Expense

Percentage Estimated to be

Age Balance Uncollectible AmountCurrent.............. $10,000 1.5 $ 1501-30 days.......... 4,000 4.0 16031-90 days........ 2,100 20.0 420Over 90 days..... 1,000 40.0 400

$17,000 $1,130

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 AccountExpense

Allowance for Doubtful Accounts

150 Balance

Expense 980 980 Expense End. Bal. 1,130 End. Bal.

Example 2: Bad Debt Expense

980

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 AccountExpense

Allowance for Doubtful Accounts

150 Balance

Expense 980 980 Expense

End. Bal. 980 1,130 End. Bal.

Uncollectible Account Expense 980 Allowance for Doubtful Accounts 980To adjust the Allowance account to desired balance.

Example 2: Bad Debt Expense

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.

Accounting for Uncollectible Receivables (Percentage of Credit Sales)

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.

• 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.

Assessing Management of 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.

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 = 4.0Average Accounts Receivable $ 37,500

Example

Number of Days in Receivables:

Number of Days 365 = 91.25Accounts Receivable Turnover 4.0

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

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.

• 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--AnnualizedAnnualized percentage of the

principal the maker is charged to borrow money.• Interest--The cost of borrowing money.

Notes Receivable -- Components

Computing Interest

Principal Principal (amount)(amount)

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)X

Computing Interest

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)

Time Time (years)(years)X X

Computing Interest

Principal Principal (amount)(amount)

Interest Interest Rate (%)Rate (%)

Time Time (years)(years)

Interest Interest OwedOwed

X X

Equals

Computing Interest

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.

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

Example: Interest

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

The Ohio Company--Maker

Journalizing Notes Receivable

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

The Virginia Company--Payee

Journalizing Notes Receivable

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.