chapter
8
Receivables
______________________________________________
OPENING COMMENTS
Chapter 8 presents the accounting issues related to accounts receivable and notes receivable. The chapter
opens with the common classifications of receivables. While presenting those classifications, you will
need to make a clear distinction between accounts receivable and notes receivable.
Accounting issues related to uncollectible receivables are covered next. Both the allowance and direct
write-off methods are presented. If class time is scarce at this point, coverage of the direct write-off
method (theoretically unacceptable because it violates the matching concept) may be omitted without
disrupting the flow of the text. Simply omit coverage of Objectives 3 and 5.
The last part of the chapter presents a Financial Analysis and Interpretation section that discusses
financial ratios related to receivables: the accounts receivable turnover and the number of days’ sales in
receivables.
After studying the chapter, your students should be able to:
2. Describe the accounting for uncollectible receivables.
4. Describe the allowance method of accounting for uncollectible receivables.
6. Describe the accounting for notes receivable.
7. Describe the reporting of receivables on the balance sheet.
8. Describe and illustrate the use of accounts receivable turnover and number of days’ sales in
receivables to evaluate a company’s efficiency in collecting its receivables.
KEY TERMS
accounts receivable
accounts receivable turnover
aging the receivables
Allowance for Doubtful Accounts
allowance method
bad debt expense
direct write-off method
dishonored note receivable
maturity value
net realizable value
notes receivable
number of days’ sales in receivables
receivables
STUDENT FAQS
• Why should we have to learn the direct write-off method of recording bad debts when we cannot use
it with the accrual basis of accounting?
• How accurate are companies with their estimates (guesses)?
• Isn’t estimating bad debts a way of manipulating net income?
• How does a company keep control on these estimates?
• How does one go about determining if uncollectible receivables are within a reasonable range?
• How can Allowance for Doubtful Accounts have a debit balance? Does that mean the company did
something wrong? Can Allowance for Doubtful Accounts have a debit balance at the end of the year
after adjustments have been made?
Chapter 8 Receivables 147
OBJECTIVE 1
Describe the common classes of receivables.
SYNOPSIS
Receivables include all money claims against other entities and may be a significant part of the current
assets. There are two different classes of receivables discussed. An account receivable is created when a
customer receives merchandise but does not pay when they receive the goods. The amount that they owe
Key Terms and Definitions
• Account Receivable – A claim against the customer created by selling merchandise or services
on credit.
• Notes Receivable – A customer’s written promise to pay an amount and possibly interest at an
agreed-upon rate.
• Receivables – All money claims against other entities, including people, business firms, and other
organizations.
SUGGESTED APPROACH
The purpose of this objective is to familiarize students with terms related to receivables. Hints for your
review of those terms follow.
LECTURE AID—Classification of Receivables
The common classifications of receivables are the following:
2. Notes Receivable — credit granted through a formal credit instrument known as a promissory note.
Notes are often used for credit periods of more than 60 days and involve payment of interest.
3. Other Receivables — such as interest receivable or receivables resulting from loans to officers or
employees.
Trade receivables are receivables resulting from the sale of merchandise or services on credit. Both
accounts receivable and notes receivable can be classified as trade receivables.
148 Chapter 8 Receivables
Students generally have the most difficulty distinguishing between accounts receivable and notes
receivable. Remind them that an account receivable results from a credit sale on an open account, such as
Three things generally distinguish a note receivable from an account receivable:
2. Notes typically require a formal written agreement stating due date and interest rate.
3. Notes typically involve interest being paid.
OBJECTIVE 2
Describe the accounting for uncollectible receivables.
SYNOPSIS
One issue not yet discussed is that some customers will not pay their accounts. These accounts become
uncollectible. Some retailers shift this responsibility to other companies. If a business accepts only cash or
Key Terms and Definitions
• Allowance Method – The method of accounting for uncollectible accounts that provides an
expense for uncollectible receivables in advance of their write-off.
• Bad Debt Expense – The operating expense incurred because of the failure to collect receivables.
• Direct Write-Off Method – The method of accounting for uncollectible accounts that recognizes
the expense only when accounts are judged to be worthless.
SUGGESTED APPROACH
Objective 2 reminds students that a business incurs an expense when customers fail to pay. Three
common account titles used to record this expense are (1) uncollectible accounts expense, (2) bad debts
Chapter 8 Receivables 149
There are two methods of recording uncollectible accounts: direct write-off method and allowance
method. When introducing the two methods of recording uncollectible accounts, you will want to stress
OBJECTIVE 3
Describe the direct write-off method of accounting for uncollectible receivables.
SYNOPSIS
If using the direct write-off method, a company waits until a customer’s account is determined to be
worthless and then writes off that customer’s account. Bad Debt Expense is debited, and Accounts
Receivable is credited. If for some reason the account is later collected and payment is received, the
previous entry is reversed by debiting Cash and crediting the receivable. This method is used by
businesses that have a small percentage of their assets in receivables.
Relevant Example Exercises and Exhibits
• Example Exercise 8-1 Direct Write-Off Method
SUGGESTED APPROACH
Under the direct write-off method, the expense of an uncollectible account is recognized when the
company decides that further collection efforts on a delinquent account are useless. This method,
LECTURE AID—Direct Write-Off of Uncollectible Receivables
Under the direct write-off method, the following occur:
1. Uncollectible Accounts Expense is recorded when an account is written-off.
2. If an account that has been written-off is collected, the account is reinstated before recording
the payment received.
150 Chapter 8 Receivables
2. The amount of uncollectible accounts is immaterial.
TM 8-3 presents five transactions to be recorded under the direct write-off method. Ask your students to
work in small groups to journalize these transactions. TM 8-4 shows the solution to this exercise.
OBJECTIVE 4
Describe the allowance method of accounting for uncollectible receivables.
SYNOPSIS
If using the allowance method, a business estimates the uncollectible accounts receivable at the end of the
accounting period. The entry to Bad Debt Expense is an adjusting entry recorded at the end of the period.
Since this entry is an estimate of the total amount uncollectible, specific accounts cannot be credited. It is
recorded by debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts, a contra asset
account. When a specific account is identified as worthless, it is removed from both Allowance for
The basis for the adjusting entry at the end of the period is the estimate of the amount uncollectible. The
two methods that are commonly used are the percent of sales method and the analysis of receivables
method. Since the accounts receivable is created by credit sales, the uncollectible amount can be
estimated as a percentage of sales. After calculating the amount that you want in Allowance for Doubtful
Accounts, you need to check the current balance of the account. After writing off the past period’s
worthless accounts, the account may have either a debit or credit balance at the end of the period. If the
account has a credit balance, it must be subtracted to determine the amount of the adjustment. If the
Key Terms and Definitions
• Aging the Receivables – The process of analyzing the accounts receivable and classifying them
according to various age groupings, with the due date being the base point for determining age.
Relevant Example Exercises and Exhibits
• Example Exercise 8-2 Allowance Method
• Example Exercise 8-3 Percent of Sales Method
SUGGESTED APPROACH
It is helpful to open your discussion of the allowance method by proving the need to estimate
uncollectible accounts. The following lecture notes will assist you in relating the allowance method to the
matching concept.
The allowance method of accounting for uncollectible receivables asks the accountant to estimate the
accounts that will not be collected and to record this expense before customers actually fail to pay. This
method adheres to the matching concept by recognizing the expense of uncollectible accounts in the same
was written off. This is also a good time to discuss the meaning of a debit or credit balance in the
allowance account prior to the adjusting entry. 2) The second area involves how the adjusting entry
amount is determined. There are two options: the percentage of sales method and the analysis of accounts
receivable method. If you break the text content into these two distinct areas, it can minimize the fact that
there is a lot of material in this one objective.
152 Chapter 8 Receivables
LECTURE AID—Uncollectible Accounts and the Matching Concept
The following explanation may help you present the need to estimate and record uncollectible accounts.
The matching concept dictates that all expenses incurred in making a sale or providing a service are to be
In most cases, however, you don’t find out that an account receivable is uncollectible until several months
after the sale is made. Therefore, at the end of each accounting period, you must estimate your losses
resulting from sales to customers who will not pay and record this expense.
The journal entry to record uncollectible accounts:
Bad Debt Expense……………… XXX
Allowance for Doubtful Accounts……. XXX
DEMONSTRATION PROBLEM—Entries for Uncollectible Accounts
Kids-At-Play is a toy store that began operations this year. At the end of its first year of operations, Kids–
At–Play had accounts receivable totaling $50,000. The store’s manager estimates that $1,500 of those
receivables will not be collected.
Journal entry to record uncollectible accounts at the end of the year:
Bad Debt Expense……………… 1,500
Allowance for Doubtful Accounts……. 1,500
Chapter 8 Receivables 153
Many students will want to debit Bad Debt Expense when writing-off an account. Explain that Shirley
Smith’s $500 account was included in the $1,500 uncollectible accounts expense recorded at the end of
last year. Therefore, debiting the expense account now would record the expense twice.
After writing-off the uncollectible account, the T accounts and balance sheet would appear as follows:
Accounts Receivable Allowance for Doubtful Accounts
Bal. 50,000 Entry to Bal. 1,500
500 Write-Off 500
Account
Bal. 49,500 Bal. 1,000
Point out that the net realizable value of accounts receivable did not change. Kids–At-Play still expects to
collect $48,500 of its receivables. All that has changed is that the company now knows that Shirley
Smith, who owes $500, is one credit customer who will probably not pay. There still is approximately
$1,000 in bad debts left to be discovered.
Ask your students to record the following journal entry in their notes: Kids–At-Play received notice that
another customer, George Jackson, will not be able to pay his $100 account receivable.
Allowance for Doubtful Accounts…………….. 100
Accounts Receivable—G. Jackson……. 100
DEMONSTRATION PROBLEM—Estimating Uncollectible Accounts Based
on Sales
When accountants estimate uncollectible accounts based on sales, they determine the amount of expense
to be recorded.
Assume that a business sold $750,000 worth of merchandise on credit. The business estimates that 2
percent of all credit sales are uncollectible.
Expense to be recorded = $750,000 2% = $15,000
DEMONSTRATION PROBLEM—Estimating Uncollectible Accounts Based
on Receivables
Break this explanation into three parts. First, use the series of exercises from the book to demonstrate 1)
calculating the due date of overdue accounts, 2) completing a spreadsheet to determine the amount of
estimated uncollectible accounts for the upcoming accounting period, and 3) recording the journal entry
to establish the Allowance for Doubtful Accounts adjusting entry.
Additional explanation of the adjusting entry execution is provided below.
based on the estimate of bad debts
The adjusting entry to record uncollectible accounts is:
Bad Debt Expense………………. 1,800
Allowance for Doubtful Accounts…….. 1,800
Assume that the accountant determines that $2,000 of the current accounts receivable will probably not be
Your students may question why the Allowance for Doubtful Accounts would have a debit balance. The
following T account explaining the entries that affect the Allowance will show that a debit balance occurs
when the amount of bad debts is underestimated and there are more actual write-offs than expected. In the
above example, bad debts from the previous period were underestimated by $200. Since the allowance
came up short, the entry to record bad debts in the current period is $2,200—the current expense of
156 Chapter 8 Receivables
Allowance for Doubtful Accounts
Actual Write-Off Adjusting Entry to
of Bad Debt Record Estimate of
Bad Debt
GROUP LEARNING ACTIVITY—Entries for Uncollectible Accounts
TM 8-1 presents entries for your students to prepare in small groups. This exercise asks them to estimate
uncollectible accounts based on receivables, make the adjusting entry for uncollectible accounts, and
write-off bad accounts. The solution to this exercise is shown on TM 8-2.
OBJECTIVE 5
Compare the direct write-off and allowance methods of accounting for uncollectible
accounts.
SYNOPSIS
Using the direct write-off method, there is no adjusting entry at the end of the period. At the end of each
period, the allowance method records an adjusting entry. These two approaches are compared in Exhibit
4, and differences are shown in Exhibit 5.
Relevant Example Exercises and Exhibits