7-1
Chapter 7
Accounting for Receivables
General Comments for Chapter 7
This chapter focuses on accounting for receivables – both collectible and uncollectible. This
chapter also includes accounting for credit card sales and discount notes. You can begin this
chapter by discussing how customers pay for purchases. Some companies allow customers
to pay on account while other companies accept credit cards as payment. Ask students if all
customers pay their account balances. Discuss how companies might handle situations
where it becomes evident that a customer is not going to pay what is owed. Help students
begin to think about how a company might handle situations where they know some custom-
ers won’t pay their amounts due – it’s just that the company doesn’t know which customers
won’t pay. This is a great time to bring company credit policies into the discussion. If a
company has a very strict credit policy, it might lose sales. On the flip side, if a company has
very flexible credit policies, it might find more customers that won’t pay their amounts due.
If you would like to begin the chapter with a problem-based learning exercise, see the notes
below.
Problem-Based Learning Case: Bad Debts
Instructions: The case appears on the following page in a format you can copy or display.
Distribute copies of the case to the class before providing an explanation of bad debt expens-
es. Ask students to read the case and individually develop answers. After allowing students
time to develop their individual answers, put them into groups to reach consensus on an an-
swer. Also, ask each group to select a spokesperson. Allow groups time to develop answers,
then call on some of the spokespersons to share their solutions. As you respond to the stu-
dent solutions, explain the basic concepts of accounting for bad debts and warranty expenses.
The correct answer is:
Fees revenue
$ 180,000
Bad debts expense
(9,000)
Other operating expenses
(120,000)
Net income
$ 51,000
7-2
Chapter 7 Problem-Based Learning Case:
Bad Debt Expense
Wilson Eye Care earned $180,000 of revenue on account during
2015. Based on past experience Wilson estimated 5% of the credit
sales would never be collected because some customers would be
unable to pay their bills. Wilson incurred $120,000 of other operat-
ing expenses during 2015. Using this information alone, what
amount of net income should Wilson report on its 2015 income
statement?
7-3
Detailed Outline of a Lesson Plan for Chapter 7
I. Explaining how bad debts affect financial statements requires a multicycle ex-
ample. Demonstration Problem 7-1 illustrates accounting for bad debts over two
cycles using the percent of sales method.
A. Start by instructing students to record the first two events under the appropriate
headings using the horizontal financial statements model. The first event involves
recognizing $4,000 of revenue earned on account, and the second event reflects
collecting $3,000 of the accounts receivable created in the first event. By now,
students should be able to record these events with little assistance.
B. Emphasize that the $1,000 balance in accounts receivable represents the total
amount of cash the company would collect if all the customers paid their bills.
Actual collections will likely be less because some customers will be unable to
pay. As a result, expenses are understated and assets are overstated. The compa-
ny can improve reporting accuracy by estimating an amount of credit sales that is
likely to be uncollectible and by deducting that amount from the balance in the re-
ceivables account. The amount of estimated uncollectible accounts is called an
allowance for doubtful accounts. This is the first time students have been intro-
duced to the concept of a contra account. Explain the fact that a contra account
is always associated with another account – accounts receivable in this instance.
If you have introduced debits and credits, you can explain that contra accounts
carry a credit balance when associated with asset accounts, since asset accounts
typically carry a debit balance. Likewise, contract accounts associated with a lia-
bility account would carry a debit balance, since liabilities typically carry credits
balances. Since allowance for doubtful accounts is associated with an asset – ac-
counts receivable – this contra account typically carries a credit balance while the
balance in the associated accounts receivable asset account is typically a debit
balance. If you have not introduced debits and credits, then you can discuss the
fact that the balance in this contra account is negative while the balance in the as-
sociated account is positive. Combining the contra account balance with the as-
sociated asset balance results in what called the net realizable value of receiva-
bles (the amount of cash the company ultimately expects to collect). The focus is
on matching expenses with sales revenues. The amount of bad debts expense to
recognize is determined by estimating the amount of sales expected to ultimately
be uncollectible. Record the event using the horizontal financial statements mod-
el. Point out that recognizing bad debts expense affects the balance sheet and the
income statement, but does not affect cash flow.
C. Events in the second accounting period illustrate accounting for the write-off of
an uncollectible account, the recovery of a previously written-off account receiv-
able, and recognizing bad debts expense for the second year.
7-4
1. The first event in the second year is the write-off of account receivables the
company has determined to be uncollectible. Record the event using the hori-
zontal financial statements model. Emphasize that the write-off does not af-
fect the income statement because the expense was previously recognized in
2015. Also, cash flow and total assets are unaffected. Students often struggle
with the concept of writing off uncollectible receivables when using the al-
lowance method. They think the write off should result in an entry to ex-
pense. You may want to spend some extra time emphasizing that the expense
was recognized in the prior year and was matched to the revenue that was es-
timated to be uncollectible.
2. Have students record Events 2 and 3 on their own. These are familiar events.
Having students record the events rather than doing it for them provides time
for students to think about the first event before they rush into the next seg-
ment of the problem. Take a look around the room with the aim of helping
students who are having difficulty. This strategy keeps students actively in-
volved in their learning. Whenever possible, have students do the work rather
than doing it for them.
3. Events 4 and 5 involve the recovery and collection of a previously written-off
account receivable. Explain reinstating the receivable as a reversal of the pre-
vious write-off. The collection is no different than any other collection of a
receivable and is usually easy for students to understand.
4. Estimate the amount of bad debts expense to recognize in Event No. 6. Note
that the expense is the same as it was the previous year except the percentage
has been reduced to reflect the first year’s experience. This would be a good
time to discuss how bad debt expenses are estimated. Discuss the two differ-
ent methods of calculating bad debt expense (called uncollectible accounts
expense in the textbook). One method is the percentage of revenue method (an
income statement focus), and the other is the aging of accounts receivable
method (a balance sheet approach).
When you record the event using the horizontal financial statements model,
stress that expense recognition comes at the end of the accounting cycle through
an adjusting entry. It affects the balance sheet by reducing the net realizable val-
ue of receivables and affects stockholders’ equity by reducing retained earnings.
The expense affects the balance sheet but not cash flow. These are critical points.
Do not let them become obscured by complications arising from computing the
amount of expense to recognize.
D. Record the events in T-accounts, close the revenue and expense accounts, and
compare the T-account balances with the balances in the statements model.
E. Point out that this Demonstration Problem highlighted accounting for uncollecti-
ble accounts using the allowance method. Point out that the creation of an ac-
count called allowance for doubtful accounts illustrates the fact that this company
uses the allowance method. The allowance method is the one required by gener-
7-5
ally accepted accounting principles. The direct write-off method is only allowed
if the uncollectible accounts are an immaterial amount. Then discuss how a com-
pany would handle bad debts if the direct write off method were used. In this
method, no allowance for doubtful accounts would be established. Only when ac-
counts are written off would bad debt expense be recorded. This would be a good
time to ask students if they thought the direct write off method properly matched
revenues earned with expenses incurred to earn those revenues. It would also be a
good time to ask students what kinds of companies should use the allowance
method and what kinds could appropriately use the direct write off method.
II. Use Demonstration Problem 7-2 to introduce accounting for credit card sales.
Point out that the full amount of the sale is shown as revenue and that the charge for
the use of the credit card is an expense. Also help the students see that the cash flow
impact of credit card sales differs from the manner in which revenue and expense are
recorded.
III. Use Demonstration Problem 7-3 to introduce accounting for notes receivable.
The problem covers two cycles. The note has a one-year term. Date of issue, accrual
of interest, and repayment of principal at maturity are covered. Before demonstrating
how to record the transactions, explain that notes receivable are just like accounts re-
ceivable but they are for a longer period of time. You can remind students of the in-
terest payable discussions in Chapter 2 and relate that information to the interest rev-
enue accrued on notes receivable. Now begin Demonstration Problem 7-3. Discuss
the manner in which interest receivable would be computed. Record the 2015 events
in T-accounts. Close the revenue and expense accounts for 2015. After recording the
2015 transactions in T-accounts, use the horizontal financial statements model to
show how each event will affect the financial statements. Finally, record the 2016
transactions in T-accounts. Emphasize that the interest receivable balance from 2015
carried forward as the beginning balance in 2016. After interest receivable is record-
ed in 2016, the interest receivable balance reflects the full year of interest that will be
received on the note maturity date.
IV. Time considerations and homework assignments. Plan to spend approximately
two hours of class time on this chapter. Accounting for bad debts requires the majori-
ty of this time. Students seem to struggle with this concept, especially when the al-
lowance method is used, because of the different ways to calculate the uncollectible
accounts expense. Use Demonstration Problem 7-1 to illustrate the basic concepts
and then assign Exercises 7-4 A or B or 7-6 A or B as homework. We recommend
that you help your students start these problems in class. Accounting for bad debts is
a difficult subject for most students and many of them will need your assistance.
Work as far into the problems as class time permits. Reserve approximately one-half
hour to cover accounting for credit card sales and notes receivable. Use Exercise 7-
14 A or B to reinforce students’ understanding of how credit card sales affect finan-
cial statements and Exercise 7-11 A or B to reinforce accounting for notes receivable
7-6
concepts. Exercise 7-15 A or B is an excellent comprehensive assignment that brings
together all the concepts covered in chapters 1 – 7.
7-7
Demonstration Problem 7-1 – Accounting for Bad Debts
The Solo Company was started on January 1, 2015. The following events occurred during
2015 and 2016.
2015
1. Provided $4,000 of services on account.
2. Collected $3,000 cash from accounts receivable.
3. Estimated uncollectible accounts expense to be 1.5% of 2015 credit sales.
2016
1. Wrote off $40 of accounts receivable that were deemed uncollectible.
2. Provided $6,500 of services on account.
3. Collected $5,400 cash from accounts receivable.
4. Received $5 from a bad debt that had been previously written off. Reinstated the ac-
count.
5. Recorded the $5 cash received from the receivable reinstated in Event No. 4.
6. Estimated uncollectible accounts expense to be 1% of 2016 credit sales.
Required
a. Record the events in T-accounts, including closing the revenue and expense accounts to
retained earnings.
b. Record the events using the horizontal financial statements model under the titles of the
affected accounts. Record a zero under each heading not affected by a given event.
Compare the final balances in the T-accounts from Part a with the ending balances in the
horizontal financial statements model.
Demonstration Problem 7-2 – Credit Card Sales
Versa Training Services provides instruction on how to pass the CPA examination. The fol-
lowing events pertain to a new course that was recently established by Versa.
1. Versa accepted credit card payments for $8,000 of instructional services it provided to
CPA exam candidates. The credit card company charged Versa a 5% service fee.
2. Versa collected the receivable due from the credit card company.
Required
a. Record the events in T-accounts, including closing the revenue and expense accounts to
retained earnings
b. Record the events using the horizontal financial statements model under the titles of the
affected accounts. Record a zero under each heading not affected by the event. Compare
7-8
the final balances in the T-accounts from Part a with the ending balances in the horizon-
tal financial statements model.
Demonstration Problem 7-3 – Notes Receivable
Money Lenders experienced the following accounting events in its first year of operation.
1. The company was started on January 1, 2015 when it received $50,000 in cash for the
sale of common stock.
2. Paid $4,200 cash for operating expenses.
3. Recognized $7,300 of cash service revenue.
4. Loaned $10,000 cash to Needy Company on July 1, 2015. Needy Company signed a
one-year note and agreed to pay 5% interest. Money Lenders recognized accrued inter-
est receivable at December 31, 2015.
Accounting events affecting 2016 were as follows:
1. On July 1, 2016 Needy Company repaid the note and interest. Money Lenders recog-
nized the accrued interest receivable just prior to this payment.
2. Recognized $9,500 of cash service revenue.
3. Paid $6,400 cash for operating expenses.
Required
a. Record the events for 2015 and 2016 in T-accounts.
b. Record the events for 2015 and 2016 using the horizontal financial statements model.
7-9
Demonstration Problem 7-1 Solution, part a. T-accounts, 2015
Ledger T-Accounts
Cash
Liabilities
Retained Earnings
(2) 3,000
3,940 cl.
Bal. 3,000
3,940 Bal.
Accounts Receivable
Services Revenue
(1) 4,000
3,000 (2)
cl. 4,000
4,000 (1)
Bal. 1,000
Allow. for Doubt. Accts.
Uncollect. Accts.
Expense
60 (3)
(3) 60
60 cl.
60 Bal.
Demonstration Problem 7-1 Solution, part b. Statements Model, 2015
Event
Assets
=
Liab.
+
Equity
Rev.
–
Exp.
=
Net Inc.
Cash Flow
No.
Cash
+
Accts. Rec.
+
(Allow.)
=
Ret. Earn.
Beg. bal.
0
+
0
+
0
=
0
+
0
0
–
0
=
0
0
1.
0
+
4,000
+
0
=
0
+
4,000
4,000
–
0
=
4,000
0
2.
3,000
+
(3,000)
+
0
=
0
+
0
0
–
0
=
0
3,000 OA
3.
0
+
0
+
(60)
=
0
+
(60)
0
–
60
=
(60)
0
Totals
3,000
+
1,000
+
(60)
=
0
+
3,940
4,000
–
60
=
3,940
3,000 NC
7-10
Demonstration Problem 7-1 Solution, part a. T-accounts, 2016
Ledger T-Accounts
Cash
Liabilities
Retained Earnings
Bal. 3,000
3,940Bal.
(3) 5,400
6,435 cl
(5) 5
10,375
Bal. 8,405
Accounts Receivable
Services Revenue
Bal. 1,000
40 (1)
cl. 6,500
6,500 (2)
(2) 6,500
5,400 (3)
(4) 5
5 (5)
Bal. 2,060
Allow. for Doubt. Accts.
Uncollect. Accts.
Expense
(1) 40
60 Bal.
(6) 65
65 cl
5 (4)
65 (6)
90 Bal.
Demonstration Problem 7-1 Solution, part b. Statements Model, 2016
Event
Assets
=
Liab.
+
Equity
Rev.
–
Exp.
=
Net Inc.
Cash Flow
No.
Cash
+
Accts. Rec.
+
(Allow.)
=
Ret. Earn.
Beg. bal.
3,000
+
1,000
+
(60)
=
0
+
3,940
0
–
0
=
0
0
1.
0
+
(40)
+
40
=
0
+
0
0
–
0
=
0
0
2.
0
+
6,500
+
0
=
0
+
6,500
6,500
–
0
=
6,500
0
3.
5,400
+
(5,400)
+
0
=
0
+
0
0
–
0
=
0
5,400 OA
4.
0
+
5
+
(5)
=
0
+
0
0
–
0
=
0
0
5.
5
+
(5)
+
0
=
0
+
0
0
–
0
=
0
5 OA
6.
0
+
0
+
(65)
=
0
+
(65)
0
–
65
=
(65)
0
Totals
8,405
+
2,060
+
(90)
=
0
+
10,375
6,500
–
65
=
6,435
5,405 NC
Copyright © McGraw-Hill Education. Permission required for reproduction or display.
7-11
Demonstration Problem 7-2 Solution, part a. T-accounts
Ledger T-Accounts
Cash
Retained Earnings
(2) 7,600
7,600 cl
Bal. 7,600
7,600Bal.
Accounts Receivable
Service Revenue
(1) 7,600
7,600 (2)
cl. 8,000
8,000 (1)
Credit Card Expense
(1) 400
400 cl
Demonstration Problem 7-2 Solution, part b. Statements Model
Event
Assets
=
Liab.
+
Equity
Rev.
–
Exp.
=
Net Inc.
Cash Flow
No.
Cash
+
Accts. Rec.
=
W. Pay
Ret. Earn.
Beg. bal.
0
+
0
=
0
+
0
0
–
0
=
0
0
1.
0
+
7,600
=
0
+
7,600
8,000
–
400
=
7,600
0
2.
7,600
+
(7,600)
=
0
+
0
0
–
0
=
0
7,600 OA
Totals
7,600
+
0
=
0
+
7,600
8,000
–
400
=
7,600
7,600