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978-0078025754 Chapter 7 Lecture Note

March 26, 2020
CHAPTER 7
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
7-1, 7-13
7-1, 7-2
7-1, 7-4
7-5, 7-7,
7-8, 7-9
C2. Describe a note receivable, the
computation of its maturity date
and recording of its existence.
9
7-8
7-10
7-5
C3. Explain how receivables can be
converted to cash before
maturity.
7-11
7-14
7-5
Analytical objectives:
A1 Compute accounts receivable
turnover and use it to help
assess financial condition.
7-12
7-15
7-1, 7-2
Procedural objectives:
P1. Apply the direct write-off and
allowance methods to account
for accounts receivable.
2, 3, 5, 6, 8
7-2, 7-3, 7-4
7-3
P2. Apply the allowance method
and estimate uncollectibles
based on sales and accounts
receivable.
7,10
7-4, 7-5, 7-6,
7-7
7-4, 7-5,
7-6, 7-7,
7-8, 7-9,
7-16
7-2, 7-3, 7-4
7-2, 7-3,
7-4, 7-6,
7-9
P3. Record the honoring and
dishonoring of a note and
adjustments for interest.
4
7-9, 7-10
7-11, 7-12,
7-13
7-5
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
The Serial Problem for Success Systems continues in this chapter. Problem 7-1A and 7-5A can be
completed with Sage 50 Software. Problem 7-5A 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
Chapter Outline
Notes
I. Accounts ReceivableAmounts 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 creditIncrease (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:
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.
Chapter Outline
Notes
D. Estimating Bad Debts Expensetwo 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.
a. 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 x rate of x expressed in = Interest
note interest fraction of year
B. Recognizing Notes Receivabledebit 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 notedebit Cash for maturity value
(face value and interest), credit Note Receivable for face value
and credit Interest Revenue for the interest amount.
Chapter Outline
Notes
2. Recording a dishonored notedebit 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 Adjustmentrecord
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 ReceivablesCompanies 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.
Chapter Outline
Notes
V. Global ViewCompares 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 AnalysisAccounts Receivable Turnover
C. Measures both the quality (likeliness of collecting) and liquidity
(speed of collection) of accounts receivable,
D. Indicates how often, on average, receivables are received and
collected during the period.
E. Calculated by dividing net sales by average accounts receivable.
VISUAL # 7-1
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.
VISUAL #7-2
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.
Copyright © 2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
Alternate Demonstration Problem
Chapter 7
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 r ealizable 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 r ealizable 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 $500, informs us that
he is broke and cannot pay. We believe him.
Nov. 9 We learned that John Shifty has won the lottery and
is willing to pay off all his old debts.
Solution: Alternate Demonstration Problem
Chapter 7
1a. Bad Debts Expense .......................................... 3,000
Allowance for Doubtful Accounts .............. 3,000
($ 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.

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