Chapter 05 – Receivables and Sales
5-1
Chapter 5
Receivables and Sales
INSTRUCTOR’S MANUAL
Learning Objectives
LO5-1 Recognize accounts receivable.
LO5-2 Calculate net revenues using discounts, returns, and allowances.
LO5-3 Record an allowance for future uncollectible accounts.
LO5-4 Use the aging method to estimate future uncollectible accounts.
LO5-5 Apply the procedure to write off accounts receivable as uncollectible.
LO5-6 Contrast the allowance method and direct write-off method when accounting
for uncollectible accounts.
LO5-7 Account for notes receivable and interest revenue.
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.
Chapter 05 – Receivables and Sales
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Teaching Suggestions
Chapter 5 uses a hospital theme because of the high amounts of receivables and uncollectible
accounts in the industry.
Part A begins with the concept of credit sales (or sales on account). Students should become
familiar with the idea that selling products or services on account results in revenue being
recorded even though no cash is yet received. Credit sales also create the right to collect cash
from customers, or an asset, referred to as accounts receivable. Related to credit sales, students
are introduced to recording sales discounts. Other sales-related activities are also covered (trade
discounts, sales returns, and sales allowances).
Part B addresses the main issue of the chapter, allowance for uncollectible accounts. Students
are asked to focus on the concept that accounts receivable are recorded at their net realizable
value. Consistent with this, the allowance method is covered using the percentage-of-receivables
method. It’s useful for the instructor to focus on the fact that at the time of estimating
uncollectible accounts, assets are reduced (through the allowance account) and expenses are
recorded. When the actual bad debts occur, the accounting equation remains unaffected because
the negative effects of bad debts have already been recorded. This is illustrated by walking
students through writing off an actual bad debt and then subsequently collecting on an account
previously written off. Students are also introduced to the aging method, which explains that the
collectability of a receivable is inherently linked to its age (or number of days past due).
Part C deals with notes receivable. Students are reminded that accounting for notes
receivable is similar to accounts receivable, except for interest collection, which usually
accompanies notes receivable.
The analysis section discusses the receivables turnover ratio and the average collection
period to help students understand how decision makers use receivables information. The
analysis is performed for Tenet Healthcare and LifePoint Hospitals. The analysis demonstrates
that the lower profit performance of Tenet may be linked to the company’s higher uncollectible
accounts.
For those interested in comparing the balance sheet method (percentage-of-receivables) to
the income statement method (percentage-of-credit-sales), the appendix provides an analysis.
Understanding this comparison may be helpful from a conceptual understanding that accounting
choices have real effects on amounts reported in the financial statements. However, students are
reminded that the percentage-of-credit-sales method is allowed only if the ending balance of the
allowance account is not materially different than that under the percentage-of-receivables
method. Accounts receivable must be recorded at their net realizable value, which is a balance
sheet focus.
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
Explain the difference between a trade receivable
and a nontrade receivable
5
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
accounts receivable
5
7
LO5-3
Understand the purposes of estimating future
uncollectible accounts
5
8
LO5-3
Relate accounting for uncollectible accounts to the
matching principle
5
9
LO5-3
Identify the financial statement effects of
accounting for uncollectible accounts
5
10
LO5-3
Describe the year-end adjustment for the allowance
for uncollectible accounts
5
11
LO5-3
Explain a debit balance in the allowance for
uncollectible accounts
5
12
LO5-3
Explain net realizable value
5
13
LO5-4
Explain the age of accounts receivable
5
14
LO5-5
Describe the entry to write off an account
5
15
LO5-5
Explain a credit balance in the allowance for
uncollectible accounts
5
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
23
LO5-8
Discuss the benefits of effectively managing
receivables
5
24
LO5-9
Discuss the use of the percentage-of-credit-sales
method
5
25
LO5-9
Explain the balance sheet method and income
statement method of accounting for uncollectible
accounts
5
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
Record the adjustment for uncollectible accounts
BE5-4
LO5-3
Record the adjustment for uncollectible accounts
5
BE5-5
LO5-3
Record the adjustment for uncollectible accounts
5
BE5-6
LO5-3
Record the adjustment for uncollectible accounts
BE5-7
LO5-3
Record the adjustment for uncollectible accounts
10
BE5-8
LO5-4
Calculate uncollectible accounts using the aging
method
5
BE5-9
LO5-4
Calculate uncollectible accounts using the aging
method
5
BE5-10
LO5-5
Record the write-off of uncollectible accounts
5
BE5-11
LO5-5
Record collection of account previously written off
5
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
Use the direct write-off method to account for
uncollectible accounts
10
BE5-15
LO5-7
Calculate amounts related to interest
10
BE5-16
LO5-7
Calculate interest revenue on notes receivable
5
BE5-17
LO5-9
Use the percentage-of-credit-sales method to adjust
for uncollectible accounts
5
BE5-18
LO5-9
Use the percentage-of–credit-sales method to adjust
for uncollectible accounts
5
BE5-19
LO5-1, 5-2,
5-3, 5-4, 5-5,
5-6, 5-7
Define terms related to receivables
15
Chapter 05 – Receivables and Sales
5-5
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
LO5-1, 5-2
Record credit sale and cash collection
5
E5-5
LO5-1, 5-2
Record credit purchase and cash payment
5
E5-6
LO5-1, 5-2
Record credit sales with a sales allowance
10
E5-7
LO5-3
Record the adjustment for uncollectible accounts
and calculate net realizable value
10
E5-8
LO5-3
Record the adjustment for uncollectible accounts
and calculate net realizable value
10
E5-9
LO5-3
Record the adjustment for uncollectible accounts
and calculate net realizable value
10
E5-10
LO5-4
Record the adjustment for uncollectible accounts
using the aging method
10
E5-11
LO5-4
Record the adjustment for uncollectible accounts
using the aging method
10
E5-12
LO5-3, 5-5
Identify the financial statement effects of
transactions related to accounts receivable and
allowance for uncollectible accounts
10
E5-13
LO5-6
Compare the allowance method and the direct write-
off method
20
E5-14
LO5-7
Record notes receivable
5
E5-15
LO5-7
Record notes receivable and interest revenue
5
E5-16
LO5-7
Record notes payable and interest expense
5
E5-17
LO5-7
Record notes receivable and interest revenue
10
E5-18
LO5-8
Calculate receivables ratios
10
E5-19
LO5-9
Compare the percentage-of-receivables method and
the percentage-of-credit-sales method
10
E5-20
LO5-9
Compare the percentage-of-receivables method and
the percentage-of-credit-sales method
10
E5-21
LO5-1, 5-3,
5-4, 5-5, 5-7,
5-8
Complete the accounting cycle using receivable
transactions
60
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, 5-5
Record transactions related to accounts receivable
25
P5-4A
LO5-4, 5-5
Record transactions related to uncollectible accounts
15
P5-5A
LO5-3, 5-6
Compare the direct write-off method to the
allowance method
20
P5-6A
LO5-3
Use estimates of uncollectible accounts to overstate
income
20
P5-7A
LO5-3, 5-5
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, 5-5
Record transactions related to accounts receivable
25
P5-4B
LO5-4, 5-5
Record transactions related to uncollectible accounts
15
P5-5B
LO5-3, 5-6
Compare the direct write-off method to the
allowance method
20
P5-6B
LO5-3
Use estimates of uncollectible accounts to
understate income
20
P5-7B
LO5-3, 5-5
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
Time
(Min.)
AP5-1
Continuing Problem: Great Adventures
30
AP5-2
Financial Analysis: American Eagle Outfitters, Inc.
15
AP5-3
Financial Analysis: The Buckle, Inc.
15
AP5-4
Comparative Analysis: American Eagle Outfitters, Inc. vs. The
Buckle, Inc.
10
AP5-5
Ethics
20
AP5-6
Internet Research
30
AP5-7
Written Communication
25
AP5-8
Earnings Management
20
Chapter 05 – Receivables and Sales
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Chapter Quiz Questions
The following multiple-choice questions are 10 unique quiz questions that correspond to the 10
questions at the end of each chapter. Each question covers the same learning objective but with a
little different twist. The correct answer is highlighted in bold for each item.
LO5-1
1. Which of the following transactions would result in an account receivable?
LO5-2
2. On August 4, Sanders provides services to Frederickson for $5,000, terms 3/10, n/30.
Frederickson pays for the services on August 12. What amount would Sanders record as
revenue on August 4?
LO5-2
3. Refer to the information in the previous question. What is the amount of net revenues (total
revenue minus sales discounts) as of August 12?
LO5-3
4. Suppose the balance of the allowance for uncollectible accounts at the end of the current year
is $800 (debit) before any adjustment. The company estimates future uncollectible accounts
to be $5,600. At what amount would bad debt expense be reported in the current year’s
income statement?
5-8
LO5-3
5. Suppose the balance of the allowance for uncollectible accounts at the end of the current year
is $800 (credit) before any adjustment entry. The company estimates future uncollectible
accounts to be $5,600. At what amount would bad debt expense be reported in the current
year’s income statement?
a. $800
LO5-4
6. Nija Incorporated reports the following aging schedule of its accounts receivable with the
estimated percent uncollectible. What is the total estimate of uncollectible accounts using the
aging method?
Age Group
Amount
Receivable
Estimated
Percent
Uncollectible
0-60 days
$40,000
1%
61-90 days
15,000
20%
More than 90 days past due
5,000
60%
Total
$60,000
a. $400
LO5-5
7. The effect of writing off a specific account receivable is:
LO5-6
8. Under the direct write-off method, bad debt expense is reported:
a. When an account receivable is estimated to be uncollectible.
5-9
LO5-7
9. At the beginning of the year, Dawnetta Fashions has total accounts receivable of $300,000.
By the end of the year, Dawnetta reports total credit sales of $1,500,000 and total accounts
receivable of $200,000. What is the receivables turnover ratio for Dawnetta Fashions?
LO5-8
10. On September 1, Bates Supplies borrows $30,000 from Vines Incorporated by signing an 8%
note due in 12 months. Calculate the amount of interest revenue Vines will record on
December 31, four months after the note is issued.
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
customers receiving services on account. The following events occur.
June 16 Mary, an expectant mother, calls to set up an appointment.
June 21 Mary visits Mercy and receives a physical exam for the discounted price.
June 27 Mary pays for her physical exam.
Required:
1. On what date should Mercy record patient revenue?
2. Record service revenue for Mercy.
3. Mercy receives Mary’s payment in full on June 27 (within the discount period). Record the
cash collection for Mercy.
4. Calculate the balance of accounts receivable and net revenue after the cash payment is
received.
Solution:
1. June 21 – the date the service is provided.
2.
June 21
Debit
Credit
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . .
150
3.
June 27
Debit
Credit
4.
Accounts Receivable
Credit sale from #2
150
5-11
Problem #2
At the beginning of the year, Compassion Clinic’s allowance for uncollectible accounts has a
balance of $60,000 credit.
Required:
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
estimated percentage uncollectibles at the end of the year.
3. Use a T-account to determine the year-end adjustment to the allowance account.
4. Record the year-end adjusting entry for bad debts expense.
5. Prepare a partial balance sheet showing accounts receivable and the allowance for
uncollectible accounts.
Solution:
1.
Debit
Credit
2.
Age Group
Amount
Receivable
Estimated
Percent
Uncollectible
Estimated
Amount
Uncollectible
Not yet due
$400,000
5%
$20,000
1-45 days past due
More than 45 days past due
$525,000
$45,000
3.
Allowance for Uncollectible Accounts
60,000
Beginning balance
50,000
Write-offs
4.
December 31
Debit
Credit
Chapter 05 – Receivables and Sales
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* Notice from #3 that the balance of the allowance account before adjustment is $10,000
credit. Based on the estimated allowance of $45,000 credit from #2, we need a credit
adjustment of $35,000.
5.
Compassion Clinic
Partial Balance Sheet
December 31
Assets
Current assets:
Chapter 05 – Receivables and Sales
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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,
2018, 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, 2019.
Solution:
1.
November 1, 2018
Debit
Credit
Notes Receivable. . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2.
December 31, 2018
Debit
Credit
Interest Receivable. . . . . . . . . . . . . . . . . . . . . . . . .
100
Interest Revenue (2 months’ interest). . . . . .
3.
May 1, 2019
Debit
Credit
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,300
Notes Receivable. . . . . . . . . . . . . . . . . . . . . . .
5,000
Interest Receivable. . . . . . . . . . . . . . . . . . . . .
Interest Revenue (4 months’ interest). . . . . .
Chapter 05 – Receivables and Sales
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Key Points by Learning Objective
LO5-1 Recognize accounts receivable.
LO5-2 Calculate net revenues using discounts, returns, and allowances.
LO5-3 Record an allowance for future uncollectible accounts.
We recognize accounts receivable as assets in the balance sheet and record them at
their net realizable values, that is, the amount of cash we expect to collect.
Under the allowance method, companies are required to estimate future uncollectible accounts
LO5-4 Use the aging method to estimate future uncollectible accounts.
LO5-5 Apply the procedure to write off accounts receivable as uncollectible.
Writing off a customer’s account as uncollectible reduces the balance of accounts receivable but
also reduces the contra asset—allowance for uncollectible accounts. The net effect is that there is
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.
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.
Chapter 05 – Receivables and Sales
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Common Mistakes
Common Mistake
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
amount of net income. However, contra revenues represent reductions of revenues, whereas
expenses represent the separate costs of generating revenues.
Common Mistake
misclassify this account as a liability, which also has a normal credit balance. Instead, a contra
asset represents a reduction in a related asset.
Common Mistake
Common Mistake
Some students erroneously think firms should reduce total assets and record bad debt expense at
the time the bad debt actually occurs. However, companies anticipate future bad debts and
establish an allowance for those estimates.
Because Allowance for Uncollectible Accounts has a normal credit balance, students sometimes
Chapter 05 – Receivables and Sales
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Decision Points
Question
Accounting Information
Analysis
Does a company have
a recurring problem
with customer
satisfaction?
Total sales and sales returns
and allowances
If sales returns and allowances are
routinely high relative to total sales,
this might indicate that customers are
not satisfied with the company’s
products or services.
Question
Accounting Information
Analysis
too lenient?
uncollectible accounts
accounts receivable could be an
indication that the company extends
too much credit to high-risk
customers.
Are the company’s
credit sales policies
Accounts receivable and
the allowance for
A high ratio of the allowance for
uncollectible accounts to total
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
its receivables?
generally indicates that the company’s
credit sales and collection policies are
effective.
Is the company
effectively managing
Receivables turnover ratio and
average collection period
A high receivables turnover ratio (or
low average collection period)
Chapter 05 – Receivables and Sales
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Career Corner
Career Corner
Companies that make large amounts of credit sales often employ credit analysts. These analysts
are responsible for deciding whether to extend credit to potential customers. To make this
decision, credit analysts focus on the customer’s credit history (such as delinquency in paying
bills) and information about current financial position, generally found using amounts in the
Chapter 05 – Receivables and Sales
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Ethical Dilemma
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
2018, it appears that net income for 2018 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
“bank” some of the profits for future years. Mary Beth suggests that the company’s bad debt
expense as a percentage of accounts receivable for 2018 be increased from 10% to 15%. She
believes 10% is the more accurate estimate but knows that both the corporation’s internal and
external auditors allow some flexibility in estimates. What is the effect of increasing the estimate
of bad debts from 10% to 15% of accounts receivable? How does this “bank” income for future
years? Why does Mary Beth’s proposal present an ethical dilemma?
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
estimate of future bad debts, then the company will be able to report less bad debt
expense in the following year, increasing net income in the following year. The effect of
this change in estimate is to shift profits from this year to next year.
• How do you define “accurate” reporting?
Option 1: Record the estimate of bad debts for 10% of accounts receivable
• An assumption of financial reporting is that accountants present financial information
that is reliable and accurate. Knowing that 10% is the correct percentage for bad debt
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
adjustment is not going to change investors’ decisions.
Chapter 05 – Receivables and Sales
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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