Chapter 05 – Receivables and Sales
5-1
Chapter 5
Receivables and Sales
INSTRUCTOR’S MANUAL
Authors’ Perspectives
PART A: Recognizing Accounts Receivable
LO5-2 Calculate net revenues using returns, allowances, and discounts.
Credit Sales – Students need to understand the two critical components of revenue recognition:
1. When? At the time goods and services are provided to customers.
2. How much? For the amount the company is entitled to receive from customers.
Net Revenues – To address the second component of revenue recognition—How much?—
students are introduced to the concept of net revenues. The amount the company is entitled to
receive from customers is reduced by discounts, returns, and allowances. These amounts are
subtracted from total revenues to obtain net revenues.
Instructors might want to emphasize the concept of “entitled to receive” separately from
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PART B: Estimating Uncollectible Accounts
LO5-3 Establish an allowance for uncollectible accounts.
LO5-4 Write off accounts receivable as uncollectible.
To help students understand how to apply the allowance method, Part B uses a two-year example
to demonstrate the following steps:
1. Establish – At the end of the initial year, establish an allowance by estimating future
uncollectible accounts (LO5-3).
Setting up the timeline in these steps helps students to understand why the adjusting entry for
uncollectible account involves a different calculation in the initial year (step 1) versus the
subsequent year (step 3). It also emphasizes that we are estimating bad debts (step 1) before they
actually occur (step 2).
Establish the allowance – By this point in Chapter 5, most students are familiar with the
concept of accounts receivable being an asset. However, they probably are not aware that
The two accounts used in the adjusting entry require careful discussion.
1. Students sometimes misclassify Allowance for Uncollectible Accounts as a liability
(because they both have normal credit balances). We can emphasize that the issue involved isn’t
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The allowance method is covered using the percentage-of-receivables method. GAAP requires
accounts receivable to be reported at the net amount expected to be collected. This is why the
percentage-of-receivables method (balance sheet method) is preferred in practice over the
percentage-of-credit-sales method (income statement method). Companies sometimes use the
percentage-of-credit-sales method for quarterly estimation. To allow for flexibility in coverage,
the percentage-of-credit-sales method is discussed in the appendix.
Write off accounts receivable – This is not an easy concept for some students. Many think that
an actual write-off should be recorded as an expense. This is a natural tendency, given the bad
news of an actual bad debt has just be realized. The discussion in the book helps to dispel this
Adjusting the allowance in subsequent years – By the end of the subsequent year, students
will now see that estimated uncollectibles are not the same as actual uncollectibles. This
difference creates an ending balance in Allowance for Uncollectible Accounts. We can explain
that the ending balance is a credit if we overestimated bad debts, or a debit if we underestimated
bad debts.
Next, we explain that one of the purposes of adjusting entries is to properly state assets. The
balance of Accounts Receivable is correct, but the balance of its contra-asset—Allowance for
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PART C: Notes Receivable and Interest
LO5-7 Account for notes receivable and interest revenue.
Students are reminded that accounting for notes receivable is similar to accounts receivable,
except for interest collection, which usually accompanies notes receivable. Many students may
not be familiar with a note receivable.
ANALYSIS
LO5-8 Calculate key ratios investors use to monitor a company’s effectiveness in managing
receivables.
Receivables Analysis – The analysis section discusses the receivables turnover ratio and the
average collection period to help students understand how decision makers use receivables
APPENDIX
LO5-9 Estimate uncollectible accounts using the percentage-of-credit-sales method.
Percentage-of-Credit-Sales Method – For those interested in comparing the balance sheet
Chapter 05 – Receivables and Sales
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Self-Study Materials
■ Let’s Review—Credit sales and sales discounts (p. 233).
■ Let’s Review—Estimating uncollectible accounts using the aging method (p. 244).
Chapter 05 – Receivables and Sales
Key Points by Learning Objective
Throughout the chapter, Key Points provide quick synopses of the critical pieces of information
LO5-1 Recognize accounts receivable at the time of credit sales.
Companies record an asset (accounts receivable) and revenue when they sell goods or services to
LO5-2 Calculate net revenues using returns, allowances, and discounts.
Sales returns, sales allowances, and sales discounts are contra revenue accounts. We subtract the
balances in these accounts from total revenues when calculating net revenues.
LO5-3 Establish an allowance for uncollectible accounts.
Customers’ accounts that we no longer consider collectible are referred to as uncollectible
accounts, or bad debts.
LO5-4 Write off accounts receivable as uncollectible.
Writing off a customer’s account as uncollectible reduces the balance of accounts receivable but
LO5-5 Adjust the allowance for uncollectible accounts in subsequent years.
Using the aging method to estimate uncollectible accounts is more accurate than applying a
single percentage to all accounts receivable. The aging method recognizes that the longer
Chapter 05 – Receivables and Sales
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LO5-6 Contrast the allowance method and direct write-off method when accounting for
uncollectible accounts.
The direct write-off method waits to reduce accounts receivable and record bad debt expense
LO5-7 Account for notes receivable and interest revenue.
Notes receivable are similar to accounts receivable except that notes receivable are formal credit
arrangements made with a written debt instrument, or note.
Analysis
LO5-8 Calculate key ratios investors use to monitor a company’s effectiveness in managing
receivables.
Appendix
LO5-9 Estimate uncollectible accounts using the percentage-of-credit-sales method.
When applying the percentage-of-credit-sales method, we adjust the allowance for uncollectible
Chapter 05 – Receivables and Sales
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Questions
Learning
Objective(s)
Topic
Time
(Min.)
1
LO5-1
Describe recording of a credit sale
5
2
LO5-1
and a nontrade receivable
3
LO5-2
Explain the difference between a trade discount and
a sales discount
5
4
LO5-2
Explain the accounting treatment for sales returns
and allowances
5
5
LO5-2
Provide an example of revenue earned at one point
or over time
5
6
LO5-3
Explain how companies account for uncollectible
5
Explain the difference between a trade receivable
5
accounts receivable
7
LO5-3
Understand the purposes of estimating future
uncollectible accounts
5
8
LO5-3
Relate accounting for uncollectible accounts to the
proper recognition of assets
5
9
LO5-3
Identify the financial statement effects of
accounting for uncollectible accounts
5
10
LO5-3
Explain net accounts receivable
5
11
LO5-4
Describe the entry to write off an account
5
12
LO5-4
Explain a debit balance in the allowance for
uncollectible accounts
5
13
LO5-4
Explain a credit balance in the allowance for
uncollectible accounts
5
14
LO5-5
Explain the age of accounts receivable
5
15
LO5-5
Describe the year-end adjustment for the allowance
5
for uncollectible accounts
16
LO5-6
Discuss the differences between the allowance
method and direct write-off method
5
17
LO5-7
Describe notes receivable
5
18
LO5-7
Explain terms related to notes receivable
5
19
LO5-7
Understand interest calculation on a note receivable
5
20
LO5-7
Describe the entry to accrue interest revenue
5
21
LO5-8
Explain the receivables turnover ratio
5
22
LO5-8
Identify the average collection period
5
LO5-8
Discuss the benefits of effectively managing
receivables
5
24
LO5-9
Discuss the use of the percentage-of-credit-sales
method
5
statement method of accounting for uncollectible
accounts
Chapter 05 – Receivables and Sales
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Brief
Exercises
Learning
Objective(s)
Topic
Time
(Min.)
BE5-1
LO5-2
Record accounts receivable and trade discount
5
BE5-2
LO5-2
Calculate net sales
5
BE5-3
LO5-3
Establish an allowance for uncollectible accounts
5
BE5-4
LO5-4
Record the write-off of uncollectible accounts
5
BE5-5
LO5-4
Record collection of account previously written off
5
BE5-6
LO5-5
Record the adjustment for uncollectible accounts
5
BE5-7
LO5-5
Record the adjustment for uncollectible accounts
5
BE5-8
LO5-5
Record the adjustment for uncollectible accounts
BE5-9
LO5-5
Record the adjustment for uncollectible accounts
5
BE5-10
LO5-5
Calculate uncollectible accounts using the aging
method
BE5-11
LO5-5
Calculate uncollectible accounts using the aging
method
10
BE5-12
LO5-6
Use the direct write-off method to account for
uncollectible accounts
10
BE5-13
LO5-6
Use the direct write-off method to account for
uncollectible accounts
10
BE5-14
LO5-6
uncollectible accounts
LO5-7
Calculate amounts related to interest
LO5-7
Calculate interest revenue on notes receivable
5
LO5-9
Use the percentage-of-credit-sales method to adjust
for uncollectible accounts
BE5-18
LO5-9
Use the percentage-of-credit-sales method to adjust
for uncollectible accounts
Use the direct write-off method to account for
10
Chapter 05 – Receivables and Sales
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Exercises
Learning
Objective(s)
Topic
Time
(Min.)
E5-1
LO5-1
Record credit sale
5
E5-2
LO5-2
Record cash sales with a trade discount
5
E5-3
LO5-1, 5-2
Record credit sale and cash collection with a sales
discount
5
E5-4
Record credit sale and cash collection
5
E5-5
Record credit purchase and cash payment
5
E5-6
Record credit sales with a sales allowance
E5-7
LO5-3, 5-4
Establish an allowance for uncollectible accounts
and write off accounts receivable
10
E5-8
LO5-5
Record the adjustment for uncollectible accounts
and calculate net accounts receivable
10
E5-9
LO5-5
Record the adjustment for uncollectible accounts
and calculate net accounts receivable
10
E5-10
LO5-5
Record the adjustment for uncollectible accounts
using the aging method
10
E5-11
LO5-5
Record the adjustment for uncollectible accounts
using the aging method
10
E5-12
LO5-3, 5-4, 5-5
Identify the financial statement effects of
transactions related to accounts receivable and
allowance for uncollectible accounts
10
off method
LO5-7
Record notes receivable
5
LO5-7
Record notes receivable and interest revenue
5
LO5-7
Record notes payable and interest expense
5
LO5-7
Record notes receivable and interest revenue
LO5-8
Calculate receivables ratios
LO5-9
Compare the percentage-of-receivables method and
the percentage-of-credit-sales method
10
LO5-9
Compare the percentage-of-receivables method and
the percentage-of-credit-sales method
10
Chapter 05 – Receivables and Sales
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Problems
Learning
Objective(s)
Topic
Time
(Min.)
P5-1A
LO5-1
Calculate the amount of revenue to recognize
10
P5-2A
LO5-1, 5-2
Record transactions related to credit sales and contra
revenues
20
P5-3A
LO5-3, 5-4, 5-5
Record transactions related to accounts receivable
25
P5-4A
Record transactions related to uncollectible accounts
15
LO5-3, 5-6
Compare the direct write-off method to the
allowance method
20
LO5-5
income
20
P5-7A
Overestimate future uncollectible accounts
20
P5-8A
LO5-7
Record long-term notes receivable and interest
revenue
10
P5-9A
LO5-8
Calculate and analyze ratios
15
P5-1B
LO5-1
Calculate the amount of revenue to recognize
10
P5-2B
LO5-1, 5-2
Record transactions related to credit sales and contra
revenues
20
P5-3B
LO5-3, 5-4, 5-5
Record transactions related to accounts receivable
25
P5-4B
Record transactions related to uncollectible accounts
15
LO5-3, 5-6
Compare the direct write-off method to the
allowance method
20
understate income
P5-7B
Underestimate future uncollectible accounts
20
P5-8B
LO5-7
Record long-term notes receivable and interest
revenue
10
P5-9B
LO5-8
Calculate and analyze ratios
15
Additional
Perspectives
Topic
AP5-1
Continuing Problem: Great Adventures
AP5-2
Financial Analysis: American Eagle Outfitters, Inc.
Financial Analysis: The Buckle, Inc.
Comparative Analysis: American Eagle Outfitters, Inc. vs. The
Buckle, Inc.
Ethics
Internet Research
Written Communication
AP5-8
Earnings Management
Chapter 05 – Receivables and Sales
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Alternate Let’s Review
Problem #1
Mercy Care normally charges $200 for an annual physical exam. Currently, the company is
offering a $50 discount to expectant mothers. In addition, Mercy offers terms 2/10, n/30 to all
Required:
1. On what date should Mercy record patient revenue?
2. Record service revenue for Mercy.
Solution:
1. June 21 – the date the service is provided.
2.
June 21
Debit
Credit
3.
June 27
Debit
Credit
4.
Accounts Receivable
Credit sale from #2
150
Chapter 05 – Receivables and Sales
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Problem #2
1. Record the write-off of $50,000 of accounts receivable during the year.
2. Estimate the allowance for future uncollectible accounts using the following ages and
Solution:
1.
Debit
Credit
2.
Age Group
Amount
Receivable
Estimated
Percent
Uncollectible
Estimated
Amount
Uncollectible
Not yet due
$400,000
1-45 days past due
More than 45 days past due
$525,000
3.
Allowance for Uncollectible Accounts
60,000
Beginning balance
50,000
Write-offs
4.
Chapter 05 – Receivables and Sales
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December 31
Debit
Credit
Bad Debt Expense . . . . . . . . . . . . . . . . . .. . . . . . .
35,000
Allowance for Uncollectible Accounts. . . .
5.
Compassion Clinic
Partial Balance Sheet
December 31
Assets
Current assets:
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Problem #3
Northwest Hospital has a policy of loaning any employee up to $5,000 for a period of up to 12
months at a fixed interest rate of 12%. Clark Lewis has worked for Northwest for more than 10
years and wishes to take his family on a winter vacation to the Pacific Coast. On November 1,
2021, he borrows $5,000 from Northwest by issuing a note to be repaid in six months.
Required:
1. Record the acceptance of the note receivable by Northwest Hospital.
2. Record Northwest Hospital’s year-end adjusting entry to accrue interest revenue.
3. Record the collection of the note with interest from Clark Lewis on May 1, 2022.
Solution:
1.
November 1, 2021
Debit
Credit
Notes Receivable. . . . . . . . . . . . . . . . . . . . . . . . . . .
5,000
December 31, 2021
Debit
Credit
Interest Receivable. . . . . . . . . . . . . . . . . . . . . . . . .
May 1, 2022
Debit
Credit
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Common Mistakes
Common Mistakes made by students are highlighted in each of the chapters. With greater
awareness of the potential pitfalls, students can avoid making the same mistakes and gain a
deeper understanding of the chapter material.
Common Mistake
Common Mistake
Because Allowance for Uncollectible Accounts has a normal credit balance, students sometimes
Students sometimes misclassify contra revenue accounts—sales returns and sales allowances—
as expenses. Like expenses, contra revenues have normal debit balances and reduce the reported
Common Mistake
Common Mistake
Students often mistakenly record bad debt expense when they write off an uncollectible account.
Chapter 05 – Receivables and Sales
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Decision Points and Decision Maker’s Perspective
Decision Points and Decision Maker’s Perspectives are provided throughout each chapter to give
insight into how measurement and communication of financial accounting information help
decision makers.
Decision Points
Question
Accounting Information
Analysis
satisfaction?
not satisfied with the company’s
products or services.
Question
Accounting Information
Analysis
credit sales policies
too lenient?
the allowance for
uncollectible accounts
uncollectible accounts to total
accounts receivable could be an
indication that the company extends
too much credit to high-risk
customers.
Does a company have
a recurring problem
Total sales and sales returns
and allowances
If sales returns and allowances are
routinely high relative to total sales,
Question
Accounting Information
Analysis
How likely is it that
the company’s
accounts receivable
will be collected?
Notes to the financial
statements detailing the
age of individual accounts
receivable
Older accounts are less likely to be
collected.
Question
Accounting Information
Analysis
Is the company
effectively managing
Receivables turnover ratio and
average collection period
A high receivables turnover ratio (or
low average collection period)
effective.
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Decision Maker’s Perspective
Managing Bad Debt Estimates
While the allowance method is conceptually superior to the direct write-off method and more
accurately reports assets, it does have one disadvantage. This disadvantage arises from the fact
that reported amounts under the allowance method represent management estimates. If so
HealthSouth Corporation appears to have used estimates of uncollectible accounts to
manipulate earnings. In the early 1990s, HealthSouth reported large amounts of bad debt
expense, building large reserves in the allowance account. Then in the mid-1990s, as additional
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Ethical Dilemma
Philip Stanton, the executive manager of Thomson Pharmaceutical, receives a bonus if the
company’s net income in the current year exceeds net income in the past year. By the end of
2021, it appears that net income for 2021 will easily exceed net income for 2017. Philip has
asked Mary Beth Williams, the company’s controller, to try to reduce this year’s income and
Key Issues
• Increasing the bad debt estimate from 10% to 15% of accounts receivable increases bad
debt expense in the current year, reducing net income. If 10% ends up being the correct
Option 1: Record the estimate of bad debts for 10% of accounts receivable
• An assumption of financial reporting is that accountants present financial information
Option 2: Record the estimate of bad debts for 15% of accounts receivable
• In the long run, it is likely that the bad debt expense will smooth itself out, so a temporary
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• Ultimately, Mary Beth should not feel responsible for this decision to change the
percentage. Her boss is advising her on what to do, so is it worth her job to
oppose/confront him on this decision?
• We have extra profits this year, so why not hang onto them? We may need some in future