Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 9
Receivables
Learning Objectives
1. Dene receivables, and explain the allowance method for valuation of receivables as an
application of accrual accounting.
2. Apply the allowance method of accounting for uncollectible accounts.
3. Make common calculations for notes receivable.
4. Show how to evaluate the level of receivables, and identify alternative means of
nancing receivables.
Section 1: Concepts
Concepts
Accrual accounting (matching principle)
Valuation
Disclosure
Lecture Outline
I. Accounts receivable and notes receivable are short-term nancial assets.
II. A note receivable is a promissory note and is an unconditional promise to pay a sum of
money on demand or on a certain date.
A. The maker of the note records Notes Payable.
B. The payee of the note records Notes Receivable.
III. There are two methods of accounting for uncollectible accounts.
A. Journalize the write-o1 of an account under the direct charge-o1 method.
B. Journalize the year-end adjustment for uncollectible accounts under the allowance
method.
IIV. Illustrate the balance sheet presentation of Allowance for Uncollectible Accounts.
Summary
The most common receivables are accounts receivable and notes receivable. Accounts
receivable are classied as current assets and represent payments due from credit
customers. Wholesalers and retailers usually allow customers to pay for merchandise over
time (i.e., they extend credit) because many customers cannot or will not make full payment
immediately. This type of credit, often called trade credit, makes expensive items
a1ordable and increases sales for the merchant. Most companies that sell on credit have
credit departments whose responsibility it is to approve or refuse credit to individuals or
companies. In some retail businesses, installment accounts receivable are common. Under
these terms, the buyer is allowed to make a series of payments over an extended period.
These receivables are considered current assets if the terms are the industry norm.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 2
Uncollectible accounts (also called bad debts), the accounting term for nonpayment by
customers, are an expense of selling on credit. The matching principle requires that the
expense be recorded in the same period as the related sale. Because the amount of
uncollectible accounts can only be estimated, this process may be subject to manipulation
via unethical and questionable practices.
Under the direct charge-o method, an expense is recorded when a specic customer’s
account is written o1. However, this violates the matching principle, which requires that the
expense be recorded in the same period as the related sale.
A promissory note is an unconditional promise to pay a denite sum of money on demand
or at a future date. The person who signs the note and thereby promises to pay is called the
maker of the note. The person to whom money is owed is called the payee. The payee
records long- or short-term notes receivable; the maker records long- or short-term notes
payable.
Generally accepted accounting principles require use of the allowance method, in which
losses from bad debts appear on the same income statement as the corresponding sales.
Since at the time of sale the company does not know whether the customer eventually will
pay, an estimate of uncollectible accounts must be made at the end of the accounting
period. An adjusting entry is then made debiting Uncollectible Accounts Expense and
crediting Allowance for Uncollectible Accounts for the estimated amount. Uncollectible
Accounts Expense is closed out in a manner similar to other expenses and appears on the
income statement.
Any interest accrued on notes receivable is included on the balance sheet as interest
receivable in the current assets section. Allowance for Uncollectible Accounts is a
contra-asset account to Accounts Receivable that reduces Accounts Receivable on the
balance sheet to the amount estimated to be collectible.
Relevant Examples and Exhibits
Exhibit 1 Accounts Receivable as a Percentage of Total Assets for Selected Industries
Exhibit 2 A Promissory Note
Teaching Strategy
It is important the students have an understanding of why receivables are important to the
operation of a business and that this arrangement is an extension of credit to their
customers. Explain to students that just like they may have friends who may not pay them
money that is owed to them businesses have the same issue. This will allow the student to
clearly understand why the allowance method is necessary and how the allowance helps
company estimate the actual amount of money that they expect to collect from their
accounts receivables.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 3
Section 2: Accounting Applications
Accounting Applications
Estimate uncollectible accounts and uncollectible accounts expense using
oPercentage of net sales method
oAccounts receivable aging method
Write o1 uncollectible accounts
Make common calculations for notes receivable
Lecture Outline
I. There are two methods of accounting for uncollectible accounts.
A. Estimate uncollectible accounts using the percentage of net sales method. Any
previous balance in Allowance for Uncollectible Accounts is irrelevant in making
the adjusting entry.
B. Journalize the year-end adjustment for uncollectible accounts under the allowance
method.
1. Estimate uncollectible accounts using the accounts receivable aging method.
Any previous balance in Allowance for Uncollectible Accounts is relevant in
making the adjusting entry.
2. Explain an aging of accounts receivable.
C. Compare the two methods.
D. Journalize the write-o1 of a specic account under the allowance method. The net
realizable value of Accounts Receivable is unchanged.
E. Journalize the recovery of accounts receivable written o1 under the allowance
method.
II. There are ve common calculations for notes receivable.
A. Determine the maturity date of a note if it is not specically stated.
B. Calculate the duration of a note if it is not specically stated.
C. Interest equals principal × rate of interest × time (length of note).
D. The maturity value equals principal plus interest.
E. The interest on a note accrues by a small amount each date of the note’s duration.
III. When the maker of a note does not pay the note at maturity, it is said to be a
dishonored note.
IV. The estimation of uncollectible credit sales and the interest income on notes receivable
a1ect both the balance sheet (net accounts receivable and interest receivable) and the
income statement (uncollectible accounts expense and interest revenue).
Summary
The two most common methods for estimating uncollectible accounts are the percentage of
net sales method and the accounts receivable aging method. Under the percentage of net
sales method, the estimated percentage for uncollectible accounts is multiplied by net
sales for the period. The resulting gure is then used in the adjusting entry. Any previous
balance in Allowance for Uncollectible Accounts represents amounts from previous years
that have not yet been written o1 and is irrelevant in making the adjusting entry.
Under the accounts receivable aging method, customer accounts are placed into a “not
yet due” category or into one of several “past due” categories (called the aging of
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 4
accounts receivable). The amounts in each category are totaled; each total is then
multiplied by a di1erent percentage for estimated bad debts. The sum of these products
represents estimated bad debts on ending Accounts Receivable. Again, the debit is to
Uncollectible Accounts Expense and the credit is to Allowance for Uncollectible Accounts.
Under the aging method, however, the entry is for the amount that brings Allowance for
Uncollectible Accounts to the computed gure.
When it becomes clear that a specic account will not be collected, it should be written o1
by a debit to Allowance for Uncollectible Accounts and a credit to Accounts Receivable. The
debit is not made to Uncollectible Accounts Expense. After an account has been written o1,
Accounts Receivable and Allowance for Uncollectible Accounts decrease by the same
amount, but the net gure for expected receivables stays the same.
When a customer whose account has been written o1 pays in full or in part, two entries
must be made. First, the customer’s receivable is reinstated by a debit to Accounts
Receivable and a credit to Allowance for Uncollectible Accounts. Second, Cash is debited and
Accounts Receivable is credited for each collection.
The following journal entries are introduced in this section:
Uncollectible Accounts Expense XX (amount estimated)
Allowance for Uncollectible Accounts XX (amount
estimated)
To record uncollectible accounts expense at a
percent of net sales
Uncollectible Accounts Expense XX (amount estimated)
Allowance for Uncollectible Accounts XX (amount
estimated)
To bring the allowance for uncollectible accounts to
the level of estimated losses
Allowance for Uncollectible Accounts XX (defaulted amount)
Accounts Receivable XX (defaulted amount)
Write-o1 of account
Several calculations are common to promissory notes, including maturity date, duration of
note, interest, maturity value, and accrued interest. The maturity date and duration of
note must be either stated on the promissory note or determinable from the information on
the note.
To the borrower, interest is the cost of borrowing money. To the lender, it is the reward for
lending money. The principal is the amount of money borrowed or loaned. The rate of
interest is the annual charge for borrowing money, expressed as a percentage. A note may
be either interest-bearing or non-interest-bearing.
Interest (not interest rate) is a dollar gure. It is computed as follows:
Interest = Principal × Rate of Interest × Time (length of note)
For example, interest on $800 at 5 percent for 90 days is $9.86, which is computed by
solving
$800 × (5 ÷ 100) × (90 ÷ 365). If the length of the note were expressed in months, then the
number of months divided by 12 would constitute the time.
The maturity value of an interest-bearing note is the face value of the note (principal) plus
interest. For a non-interest-bearing note, maturity value is equal to the face amount (which,
however, includes implied interest).
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 5
End-of-period adjustments must be made for notes that apply to both the current and future
periods. In this way, interest can be divided correctly among the periods.
A dishonored note is one that is not paid at the maturity date. The payee debits Accounts
Receivable for the principal plus interest and credits Notes Receivable and Interest Income.
The estimation of uncollectible credit sales a1ects both the balance sheet (net accounts
receivable) and the income statement (uncollectible accounts expense). Accrued interest on
notes receivable a1ects the balance sheet (interest receivable) and the income statement
(interest revenue).
Relevant Examples and Exhibits
Exhibit 3 Analysis of Accounts Receivable by Age
Exhibit 4 Two Methods of Estimating Uncollectible Accounts
Exhibit 5 Valuation of Accounts Receivable on the Balance Sheet Impacts Net Sales
on the Income Statement
Teaching Strategy
Tying anticipated uncollectible accounts to the matching principle builds the foundation for
understanding the journal entry that sets up the Allowance for Uncollectible Accounts to
correspond to the period’s sales. Refer to the illustration in the text that shows the use of
that account to present more accurately the value of Accounts Receivable. Review the
denition of a contra-asset account if necessary.
Students often have diLculty understanding the necessity for calculating the anticipated
uncollectible accounts expense. Through calculation and demonstrations, the rationale does
become clear.
The percentage of net sales method is straightforward and easily mastered.
Aging of accounts receivable poses some diLculty for students. A discussion of the
relationship between older accounts and their resulting collectibility is helpful before the
required calculations are introduced. After such a discussion, refer to Exhibit 3, which
identies a company’s historical experience and the resulting calculation of anticipated
uncollectible accounts expense.
The journal entries required for this section of the text are confusing to students. T accounts
are helpful in demonstrating the journal entries and the sequence of events in the ledger
accounts. Demonstrate a full sequence, from the establishment of the allowance account
through actual occurrences of uncollectibility and the end-of-period adjustment when there
is either a debit or a credit balance in the allowance account prior to adjustment. Complete
the demonstration for each of the two methods of accounting for uncollectible accounts.
Take time to allow for a clear understanding of the di1erences between the two methods.
Address the issue of collecting on accounts previously written o1. Point out that the
account, which was once considered uncollectible and charged to the allowance account,
has to be reinstated and the allowance account and accounts receivable account adjusted.
Short Exercises 3 through 5 and Exercises 2A through 7A are appropriate for classroom
presentation.
Take the time to dene each element of the calculation for interest on a note and maturity
value of a note. Each calculation, as well as its place in the sequence of events involved in
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 6
accounting for notes receivable, must be understood. Use Short Exercises 6 through 8,
Exercises 8A through11A, and Problem 8 to illustrate these calculations.
Section 3: Business Applications
Business Applications
Receivables turnover
Days’ sales uncollected
Financing receivables
oFactoring of accounts receivable
oSecuritization of accounts receivable
oDiscounting of accounts receivable
Ethics
Lecture Outline
I. The following measures of the e1ectiveness of credit policies should be compared with
industry averages.
A. Receivable turnover (net credit sales divided by average net accounts receivable)
B. Days’ sales uncollected (365 days divided by the receivable turnover)
II. Some companies nance receivables to maintain nancial Nexibility.
A. Establish a nance company
B. Pledge accounts receivable
C. Factor (sell) accounts receivable
1. “Without recourse” (e.g., Visa, MasterCard, American Express) means that the
factor bears the risk of loss.
2. “With recourse” means that the seller bears the risk of loss.
a. A contingent liability is a potential liability that may develop into a real
liability depending upon a future occurrence.
D. Through securitization, group receivables in batches and sell them at a discount to
companies and investors
E. Discount (sell) notes receivable
V. Deliberately overstating or understating earnings as a result of misrepresenting the
level of uncollectible accounts is a serious ethical violation.
Summary
The receivable turnover and days’ sales uncollected are commonly used to measure the
e1ectiveness of a company’s credit policies. The receivable turnover is computed by
dividing net credit sales by average net accounts receivable. It shows how many times, on
average, receivables were collected during the period. The days’ sales uncollected is
computed by dividing 365 days by the receivable turnover. It shows how many days, on
average, accounts receivable are outstanding. These ratios vary considerably from industry
to industry.
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 7
Occasionally, companies cannot a1ord to wait until their receivables are collected.
Accordingly, there are ways to obtain cash before collection from customers occurs. Some
companies establish nance companies. Others pledge their accounts receivable as
collateral on a loan. Or a company may sell its accounts receivable for cash to a bank or
nance company (known as the factor), in a process called factoring. If this is done
without recourse, the factor bears any losses from uncollectible accounts. Credit cards are
an example of factoring without recourse. Factoring with recourse means that the seller
bears the risk. This risk is disclosed in the nancial statements as a contingent liability, a
potential liability that can develop into a real liability depending on a future event. Another
possible means for a company to obtain cash is through securitization, whereby the
company groups its receivables in batches and sells them at a discount to companies and
investors. Discounting, or selling, notes receivable is yet another way companies maintain
liquidity.
Uncollectible accounts (also called bad debts), the accounting term for nonpayment by
customers, are an expense of selling on credit. The matching principle requires that the
expense be recorded in the same period as the related sale. Because the amount of
uncollectible accounts can only be estimated, this process may be subject to manipulation
via unethical and questionable practices.
Relevant Examples and Exhibits
Ratio: Receivables Turnover
Ratio: Days’ Sales Uncollected
Exhibit 6 How Factoring Works
Teaching Strategy
Review the denition of liquidity and discuss its importance to the operations of a rm.
Emphasize the signicance of the ratios presented and how management uses them. Point
out that ratios can vary considerably by company and by industry and that they should be
compared with prior periods and similar companies in the same industry.
Students have had experience with the credit policies of companies with which they have
dealt. A class discussion on this topic helps students recognize how credit policies t into the
overall accounting system.
Dene contingent liability and give other examples. It is an important concept that students
will encounter again.
Short Exercise 10 and Exercise 13A are appropriate for classroom work. Cases 3, 4, and 6
apply to concepts from this section. Use those that are of interest to your students to
reinforce key points.
Student Engagement Tactics
1. Assign Case 7 as advance reading for class. Ask for two volunteers to participate in
the role-play and tell them you will provide specic guidance on preparing for the
role-play. This may include the following:
Owner (Ms. Caldwell):
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
Chapter 9: Receivables Instructor’s Manual, p. 8
Ms. Caldwell believes that lowering the estimate of uncollectible accounts expense is
the best way to ensure increased earnings during a year when earnings are actually
down. This action will improve reported net income for the current year. With higher
sales and earnings expected next period, the nancial community will not be
alarmed. Historically, this company has been protable even in economic downturns.
She believes that the community can absorb many laid-o1 employees into its work
force. Owner’s personality traits: optimistic (does not focus on bad news), does not
like to be challenged by bankers or anyone else.
Controller:
The controller believes that underestimating uncollectible accounts would be a
violation of conservatism by overstating assets and income. The controller knows
that how much and which accounts are uncollectible is eventually known with
certainty. Cash Nows are adversely a1ected if collections are not made and
repossessions are necessary. Bankers look carefully when sales are down but
earnings are up. While the nancials for the current year may fool lenders in the
short run, the lack of candor about uncollectibles could hurt the company in the long
run because the company’s credibility with its lenders could be jeopardized, possibly
resulting in higher nancing costs or, worse, the lenders preferring to no longer make
loans to Caldwell Interiors. Suggest generating a report of current receivables from all
the insurance company employees with a schedule of who is currently delinquent.
Assess the potential impact of layo1s on receivables. Controller’s personality traits:
persuasive, careful not to o1end the boss, thoughtful.
2. Introduce the role-play. Relate to the class objectives to support varied learning styles
and to enhance communication skills. Distribute assessment questionnaire. (Sample
questions follow in the assessment section.) Allow time to read and ask students
what questions they have about this information. Students/observers of the role-play
enactment must listen carefully to points made. Tell students this activity will be
graded. Quiet students as the role-play begins, if necessary. The instructor should
stay out of sight during the role-play but end the role-play if players can’t seem to
quit and if key points have already been made.
3. After enacting the role-play, follow up with evaluation and debrieng. As a part of the
debrieng, stand next to the role-players. Ask the controller what his or her feelings
are toward Ms. Caldwell and whether he or she continues to have any ethical
concerns. Ask Ms. Caldwell what her feelings are toward the controller and whether
she has any ethical concerns about this situation. Allow students/observers to ask
role-players questions.
4. Ask the following questions on a short questionnaire: What ethical dilemma does the
role-play present? What reasons did the owner give for his position? What reasons did
the controller give for his or her position? As a lender, how important is it to be
accurate in estimating losses from uncollectibles?
5. The questionnaire requires students to practice their listening and writing skills. If
e1ective presentation skills have been introduced in your class, the questionnaire
could include questions that provide feedback to each role-player. Did the owner
speak clearly, make points e1ectively, and use good eye contact with the controller?
Did the controller use gestures e1ectively and appear condent?
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
