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Chapter 09 – Accounting for Receivables

CHAPTER 9

ACCOUNTING FOR RECEIVABLES

Related Assignment Materials

Student Learning Objectives Questions

Quick

Studies* Exercises* Problems*

Beyond the

Numbers

Conceptual objectives:

C1. Describe accounts receivable

and how they occur and are

recorded.

1 9-1, 9-13 9-1, 9-2 9-1, 9-4 9-5, 9-7,

9-8, 9-9

C2. Describe a note receivable, the

computation of its maturity date

and recording of its existence.

9 9-8 9-10 9-5

C3. Explain how receivables can be

converted to cash before

maturity.

9-11 9-14 9-5

Analytical objectives:

A1 Compute accounts receivable

turnover and use it to help

assess financial condition.

9-12 9-15 9-1, 9-2

Procedural objectives:

P1. Apply the direct write-off and

allowance methods to account

for accounts receivable.

2, 3, 5, 6, 8 9-2, 9-3, 9-4 9-3

P2. Apply the allowance method and

estimate uncollectibles based on

sales and accounts receivable.

7,10 9-4, 9-5, 9-6,

9-7

9-4, 9-5,

9-6, 9-7,

9-8, 9-9,

9-16

9-2, 9-3, 9-4 9-2, 9-3,

9-4, 9-6,

9-9

P3. Record the honoring and

dishonoring of a note and

adjustments for interest.

4 9-9, 9-10 9-11, 9-12,

9-13

9-5

*See additional information on next page that pertains to these quick studies, exercises and problems.

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Education.

Chapter 09 – Accounting for Receivables

Additional Information on Related Assignment Material

The Serial Problem for Success Systems continues in this chapter. Problem 9-1A and 9-5A can be

completed with Sage 50 Software. Problem 9-5A and the Serial Problem can be completed with

QuickBooks.

Connect (Available on the instructor’s course-specific website) repeats all numerical Quick Studies, all

Exercises and Problems Set A. Connect provides new numbers each time the Quick Study, Exercise or

Problem is worked. It allows instructors to monitor, promote, and assess student learning. It can be used

in practice, homework, or exam mode

Synopsis of Chapter Revisions

Skai Blue Media: NEW opener with new entrepreneurial assignment

Enhanced 3-step process for estimating allowance for uncollectibles

New T-accounts to enhance learning of receivables

Enhanced infographic on methods to estimate bad debts

New notes on pros/cons of allowance vs direct write-off

Updated receivables analysis using Dell and HP

9-2

Education.

Chapter 09 – Accounting for Receivables

Chapter Outline Notes

I. Accounts Receivable—Amounts due from customers for credit sales.

They occur when a customer uses credit cards issued by third parties

and when a company gives credit directly to customers.

A. Recognizing Accounts Receivable:

1. Sales on credit—Increase (debit) Accounts Receivable for the

full amount of the sale and increase (credit) Sales.

a. The General Ledger continues to keep a single (total)

Accounts Receivable Account. (control account)

b. A supplementary record, called the Accounts Receivable

(subsidiary) Ledger, maintains a separate account

receivable for each customer.

c. A Schedule of Accounts Receivable shows that the sum of

the individual accounts in the subsidiary ledger equals the

balance of the Accounts Receivable account in the general

ledger.

2. Credit card sales (Examples: Visa, MasterCard, American

Express).

a. Advantages: (1) eliminates the company’s need to

evaluate each customer’s credit standing (2) avoids

seller’s risk (3) seller receives cash sooner than when they

grant credit directly (4) more credit options potentially

increase sales.

b. Credit card sales (when cash is received immediately upon

deposit of sales receipt) results in debit to Cash for the

amount of sale less the credit card company charge, debit

to Credit Card Expense for this fee and credit to Sales for

full invoice amount.

c. Credit card sales ((when cash receipt is received some

time after deposit of sales receipt) results in debit to

Accounts Receivable for the amount to be collected, and a

debit to Credit Card expense for the amount of the fee and

credit to Sales for full invoice. Later, when payment is

received, debit Cash and credit Accounts Receivable.

B. Installment Sales and Receivables

Amounts owed by customers from credit sales where payment is

required in periodic amounts over an extended time period.

1. Customer is usually charged interest.

2. Should be classified as current assets even if credit period

exceeds year if the company regularly offers customers such

terms.

C. Valuing Accounts Receivable

Accounts of customers who do not pay are uncollectible accounts,

commonly called bad debts. Two methods are used to account for

uncollectible accounts:

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Education.

Chapter 09 – Accounting for Receivables

Chapter Outline Notes

1. Direct Write-off Method

Records the loss from an uncollectible account receivable

when it is determined to be uncollectible.

a. To write off uncollectible and recognize loss: debit Bad

Debt Expense, credit Accounts Receivable.

b. If a written off account is later collected, this results in a

reversal of the write-off (see above) and a normal

collection of account entry.

c. This method violates the matching (expense recognition)

principle since it frequently results in expense being

charged in a period after that of the credit sale.

d. Materiality constraint states that an amount can be ignored

if its effect on the financial statements is unimportant to

users’ decisions. This constraint permits use of direct

write-off when bad debts expenses are very small in

relation to other financial statement items such as sales

and net income.

2. Allowance Method

Matches the estimated loss from uncollectibles against the

sales they helped produce.

a. At the end of each accounting period, bad debts expense is

estimated and recorded in an adjusting entry.

b. Advantages of method:

i. Satisfies the matching principle because expense is

charged in the period of the corresponding sale.

ii. Reports accounts receivable on balance sheet at the

estimated amount of cash to be collected.

c. To record estimate of bad debt expense, Debit Bad Debt

Expense, credit a contra-asset account called Allowance

for Doubtful Accounts.

d. To write-off an uncollectible: debit Allowance for

Doubtful Accounts, credit Accounts Receivable.

e. Writing off an uncollectible does not change the estimated

amount of cash to be collected (realizable value of

accounts receivable).

f. If a written off account is later recovered (collected) this

results of a reversal of the write off (see d above) and a

normal collection of account entry.

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Education.

Chapter 09 – Accounting for Receivables

Chapter Outline Notes

D. Estimating Bad Debts Expense—two methods:

1. Percent of Sales Method (uses income statement relations to

estimate)—bad debts expense is computed as a percentage of

sales for the period. (% x sales = Bad Debt Expense)

a. Sales figure chosen as base is usually credit sales but it

can be total or net sales if cash sales are small.

b. The estimate is used in the adjusting entry. Note that the

resulting reported allowance account balance is rarely

equal the reported expense because the allowance account

was not likely to be zero prior to adjustment.

2. Percent of Accounts Receivable Method (uses balance sheet

relations to estimate)—desired credit balance in Allowance for

Doubtful Accounts is computed: ( % x Acc/Rec = Desired

balance in Allowance for Doubtful Accounts)

a. As a percentage of outstanding receivables (simplified

approach) or

b. By aging accounts receivable.

c. The amount in the adjustment (Bad Debts Expense) is

calculated by determining the amount necessary to bring

allowance account to a credit balance equivalent to the

estimated uncollectibles.

II. Notes Receivable— Promissory note that is a written promise to pay a

specified amount of money (principal) either on demand or on a

definite future date. Most notes are interest bearing. Promissory notes

are notes payable to the maker (person promising to pay) and notes

receivable to the payee (person to be paid). Interest is the charge for

using money until the due date.

A. Computations for Notes

1. Maturity date is the date the note must be repaid.

2. Amount to be repaid is principal plus interest (maturity value).

3. The period of the note is the time from the note’s date to its

maturity date.

4. Formula for computing annual interest:

Annual Time of note

Principal of xrate of x expressed in = Interest

note interest fraction of year

B. Recognizing Notes Receivable—debit Notes Receivable for

principal or face amount of note. Credit will vary; depends on

reason note is received. Interest is not recorded until earned.

C. Valuing and Settling Notes

1. Recording an honored note—debit Cash for maturity value

(face value and interest), credit Note Receivable for face value

and credit Interest Revenue for the interest amount.

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Education.

Chapter 09 – Accounting for Receivables

Chapter Outline Notes

2. Recording a dishonored note—debit Accounts Receivable for

maturity value (face value + Interest), credit Note Receivable

for face amount and credit Interest Revenue for the interest

amount. If account receivable remains uncollected, it will be

written-off.

3. Recording End-of-Period Interest Adjustment—record accrued

interest by debiting Interest Receivable and crediting Interest

Revenue for accrued interest earned.

4. Collection entry if some interest was accrued requires a debit

to Cash for full amount received, credits to Interest Receivable

(amount previously accrued), Interest Revenue (amount

earned since accrual date) and Notes Receivable (face amount

of note).

III. Disposing of Receivables—Companies can convert receivables to

cash before they are due. Reasons for this include the need for cash or

a desire to not be involved in collection activities.

A. Selling Receivables

1. Buyer, called a factor, charges the seller a factoring fee and

then collects the receivables as they come due.

2. Entry: debit Cash (amount received), and Factoring Fee

Expense (amount charged) and credit Accounts Receivable

(amount sold).

B. Pledging Receivables

1. Company borrows money by pledging its receivables as

security.

2. Borrower retains ownership of the receivables.

3. If borrower defaults, the lender has right to be paid from

receipts on accounts receivable when collected.

4. The pledge should be disclosed in financial statement

footnotes.

5. The loan is recorded as a debit to Cash and a credit to Notes

Payable.

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Education.

Chapter 09 – Accounting for Receivables

Chapter Outline Notes

V. Global View—Compares U.S. GAAP to IFRS

A. Recognition of Receivables: Both have similar asset criteria that

apply to recognition of receivables. Both refer to the realization

principle and earnings process. The criteria are broadly similar but

there are differences.

B. Valuation of Receivables: Both require that receivables be

reported net of estimated uncollectibles and both required that the

expense be recorded the same period as the related revenue

(allowance method).

IV. Decision Analysis—Accounts Receivable Turnover

A. Measures both the quality (likeliness of collecting) and liquidity

(speed of collection) of accounts receivable,

B. Indicates how often, on average, receivables are received and

collected during the period.

C. Calculated by dividing net sales by average accounts receivable.

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Education.

Chapter 09 – Accounting for Receivables

VISUAL # 9-1

METHODS OF ACCOUNTING FOR BAD DEBTS

DIRECT WRITE-OFF METHOD

Accounts for bad debts from an uncollectible account

receivable at the time account is determined to be

uncollectible.

ALLOWANCE METHOD

At the end of each accounting period,

bad debts expense is

estimated and recorded.

Year-end No adjusting entry

Adjusting entry required:

Bad Debt Expense XXX

Allowance for Uncollectible Accounts XXX

(The amount is an estimate based on a percentage of sales or a

percentage of outstanding accounts receivable. If the estimate is based

on sales, the full estimate is used in the adjusting entry. If the estimate

is based on accounts receivable the allowance account balance is

brought to the amount of the estimate.)

When an account is

determined to be

uncollectible

Write-off entry required:

Bad Debts Expense XXX

Accounts Receivable/Customer XXX

(The amount is the balance of the uncollectible account.)

Write-off entry required:

Allowance for Uncollectible Accounts XXX

Accounts Receivable/Customer XXX

(The amount is the balance of the uncollectible account.)

When an account

previously written

off is recovered

1. Reinstate account by reversing write-off:

Accounts Receivable/Customer XXX

Bad Debts Expense XXX

(The amount is the account balance that was written off.)

2. Record collection on account normally:

Cash XXX

Accounts Receivable/Customer XXX

(The amount is the amount collected.)

1. Reinstate account by reversing write-off:

Accounts Receivable/Customer XXX

Allowance for Uncollectible Accounts XXX

(The amount is the account balance that was written off.)

2. Record collection on account normally:

Cash XXX

Accounts Receivable/Customer XXX

(The amount is the amount collected.)

Advantages: Does not require adjusting entry.

Does not require year-end estimating of

uncollectibles.

Matches expense against related revenues.

Reports the net realizable accounts receivable on the balance

sheet (a more accurate reporting of assets).

Disadvantages: Violates matching (expense recognition) principle,

therefore only allowed if qualified under

materiality principle. (Permitted if a business

anticipates an immaterial amount of uncollectibles.)

Requires adjusting entry.

Requires year-end estimating of uncollectibles.

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Chapter 09 – Accounting for Receivables

VISUAL #9-2

PROMISSORY NOTE

(6) $2,000.00 April 15, 2011 (1)

Amount Date

For value received, I promise to pay to the order of

Plexi-Plus Supply Co. (2)

Tobay, New York

(7)

Two thousand and no/100 ——————-Dollars

on June 14, 2011 (3)

plus interest at the annual rate of 9 percent.

(4)

Scott Cooke (5)

for Tobay Surfer Inc.

9-9

Alternate Demonstration Problem

Chapter Nine

At the end of the year, the M. I. Wright Company showed the following

selected account balances:

Sales (all on credit)..…..………………..……………................................$300,000

Accounts Receivable…………..……………..……………......................... 800,000

Allowance for Doubtful Accounts.…………..………........................... 38,000

Required:

1. Assume the company estimates that 1% of all credit sales will not be

collected.

a. Prepare the proper journal entry to recognize the expense

involved.

b. Present the balances in Accounts Receivable and Allowance for

Doubtful Accounts as they would appear on the balance sheet.

Also show the net realizable Accounts Receivable.

2. Assume the company estimates that 5% of its accounts receivable

will never be collected.

a. Prepare the proper journal entry to recognize the expense

involved.

b. Present the balances in Accounts Receivable and Allowance for

Doubtful Accounts as they would appear on the balance sheet.

Also show the net realizable Accounts Receivable.

3. Under assumptions 1 and 2 above, give the proper journal entries for

the following events.

June 3 John Shifty, who owes us $500, informs us that

he is broke and cannot pay. We believe him.

Nov. 9 We learned that John Shifty has won the lottery and

is willing to pay off all his old debts.

Solution: Alternate Demonstration Problem

Chapter Nine

1a. Bad Debts Expense………………………………….. 3,000

Allowance for Doubtful Accounts............. 3,000

($ 300,000 X 1 %)

1b. Accounts Receivable…………..........................$800,000

Less: Allowance for Doubtful Accounts........ 41,000

Estimated Realizable A/R..…………..…………....$759,000

2a. Bad Debts Expense………………………………….. 2,000

Allowance for Doubtful Accounts............. 2,000

($ 800,000 X 5 % less $38,000)

2b. Accounts Receivable…………..........................$800,000

Less: Allowance for Doubtful Accounts........ 40,000

Estimated Realizable A/R..…………..………......$760,000

3. Both assumptions 1 and 2 above represent the allowance method of

accounting for uncollectibles. The only difference is in the approach

to estimating uncollectibles. Therefore the entries to write off and

show subsequent reinstatement would be the same in 1 and 2.

June 3 Allowance for Doubtful Accounts............ 500

Accounts Receivable, John Shifty...... 500

Nov. 9 Accounts Receivable, John Shifty........... 500

Allowance for Doubtful Accounts.…... 500

Note: There would be a closing entry for the Bad Debts Expense

since it is an expense account just like any other expense account.

There would be no closing entry for the Allowance for Doubtful

Accounts since it is not a temporary account. It is a contra-asset

account, contra to Accounts Receivable.