RECEIVABLES

Dr. Michael Shen

© Copyright National University of Singapore. All Rights Reserved.

 LEARNING OBJECTIVES

1. Describe accounts receivable and how they occur and are

recorded
2. Apply the direct write-off method to account for accounts
receivable
3. Apply the allowance method and estimate uncollectibles
based on accounts receivable
4. Account for notes receivable and adjustments for interest
LEARNING OBJECTIVE 1
Describe accounts receivable and
how they occur and are recorded
 ACCOUNTS RECEIVABLE
▪ Arise from sales or services provided to customer on account
(on credit)
▪ Informal promise by customer to pay for goods or services
▪ Generally converted to cash (collected from customer) within
a few months (less than a year so short-term or current asset)
▪ Very liquid asset, after cash and short-term investments
(liquidity means how fast an asset can be converted into
cash)
 ACCOUNTS RECEIVABLE

On July 1, TechCom had a credit sale of $950 to CompStore

and a collection of $720 from RDA Electronics from a prior
credit sale

*The additional journal entry Dr COGS and Cr Merchandise Inventory will be

covered in lecture on inventories and cost of sales.
 ADIDAS’ RECEIVABLES

Accounts receivable 2nd largest current asset, about

27% of total current assets. It is a material item.
 ACCOUNTS RECEIVABLE: GOOD OR BAD?
▪ Good:
▪ Some customers cannot pay cash or prefer to buy on
credit: Increase revenue
▪ Bad:
▪ Some credit customers may not pay later: Need to record
expense
 ACCOUNTS RECEIVABLE

Some customers may not pay their account.

Uncollectible amounts are referred to as bad debts
expense and recognized as a cost of doing business,
so classified as an operating expense.

Accounting for bad debts:

Direct Write-Off Method
Allowance Method
 LEARNING OBJECTIVE 2
Apply the direct write-off method to
account for accounts receivable
 DIRECT WRITE-OFF METHOD
Company waits until it is clear that a customer cannot pay,
which may be after the accounting period that the receivable
was recorded:

TechCom determines on January 23 that it cannot collect

$520 owed to it by its customer J. Kent which credit sale
was recorded in the previous period.

The cost/expense of running

business: to boost sales
 MATCHING PRINCIPLE

The matching (expense recognition) principle requires

expenses to be reported in the same accounting period as
the sales they helped produce.

The direct write-off method usually does not best match

sales and expenses.
 LEARNING OBJECTIVE 3
Apply the allowance method and estimate
uncollectibles based on accounts receivable
 ALLOWANCE METHOD
◼ Record bad debts expense in the period when the related
sales are recorded (matching principle)

◼ Bad debts expense

◼ The cost/expense of running business: to boost sales

◼ Allowance for Doubtful Accounts

▪The estimated amount of outstanding accounts receivable
that can not be collected
 ALLOWANCE FOR DOUBTFUL ACCOUNTS
▪ Allowance for doubtful accounts is a contra asset account
▪ An asset is debit, so the contra asset is credit
▪ Business/economic intuition:
▪ The estimated amount of outstanding AR that can not be
collected back

Allowance for
Accounts Receivable Doubtful Accounts

+ - - +
Normal Normal
 PRESENTATION IN
STATEMENT OF FINANCIAL POSITION
TechCom had credit sales of $300,000 during its first year of
operations. At the end of the first year, $20,000 of credit
sales remained uncollected. Based on the experience of
similar businesses, TechCom estimated that $1,500 of its
accounts receivable would be uncollectible.

The company can also show the accounts receivable amount

as $18,500 (carrying amount or net amount) and show details
about the allowance in notes to financial statements.
 ADIDAS’ RECEIVABLES

Refer to Note 7 for disclosures on accounts receivable.

ADIDAS’ ACCOUNTS RECEIVABLE NOTE 7

Net or carrying amount is

€ 2,315 million

Gross amount of accounts receivable € millions =

2,315 + 169 = 2,484
 CALCULATE BAD DEBTS EXPENSE
1. Compute the estimated uncollectable amount of Accounts
Receivable (Estimated Allowance for Doubtful Accounts) at
year end
▪ Percent of Receivables
▪ Aging of Receivables

2. Bad Debts Expense is computed as:

Estimated Allowance for Doubtful Accounts

– Unadjusted Balance in Allowance Account
= Bad Debts Expense for this period
 RECORDING BAD DEBTS EXPENSE
TechCom had credit sales of $300,000 during its first year of
operations. At the end of the first year, $20,000 of credit
sales remained uncollected. Based on the experience of
similar businesses, TechCom estimated that $1,500 of its
accounts receivable would be uncollectible.
Adjusting entry
E+;NI-;RE-;OE-
CA+; A-

The cost/expense of The estimated

running business: to uncollectable amount of
boost sales Accounts Receivable
 RECORDING BAD DEBTS EXPENSE
E+;NI-;RE-;OE-
CA+; A-

The cost/expense of The estimated

running business: to uncollectable amount of
boost sales Accounts Receivable

This contra account allows readers to know both the gross

amount of the AR and allowance to date
 WRITING OFF A BAD DEBT

TechCom decides that J. Kent’s $520 account is uncollectible

CA-; A+
A-

New Bal. 19,480 New Bal. 980

 WRITING OFF A BAD DEBT

The write-off does NOT affect the realizable or carrying

amount of accounts receivable.

Carry Amount of AR = AR(gross amount) - AFDA

 RECOVERING A BAD DEBT
To help restore credit standing, a customer sometimes volunteers
to pay all or part of the amount owed on an account even after it
has been written off

On March 11, Kent pays in full his $520 account previously

written off.
 UNADJUSTED BALANCE OF AFDA
Musicland has $50,000 in accounts receivable and a $200 unadjusted
credit balance in Allowance for Doubtful Accounts on December 31, 2015

Write-offs
during the
year 2015
 WHEN ESTIMATES DIFFER FROM WRITE-OFFS
Accounts receivable written off during a period will rarely equal
the estimated uncollectible amount.

Allowance for Doubtful Accounts

Beginning Balance:
Estimated allowance from
last period
Total amount of accounts
receivable written off in
this period

Shows a debit balance when the
total amount of accounts
receivable written off is greater
than the estimated allowance
from last period
Shows a credit balance when the
total amount of accounts
receivable written off is less than
Unadjusted balance the estimated allowance from last
period
 PERCENT OF RECEIVABLES METHOD
Musicland has $50,000 in accounts receivable and a $200 unadjusted
credit balance in Allowance for Doubtful Accounts on December 31,
2015. Past experience suggests that 5% of receivables are uncollectible.

Desired balance in Allowance for

Doubtful Accounts: estimated
uncollectable amount of AR

$ 50,000 1
× 5% 3 (3)=(2)-(1)
= $ 2,500 2
 AGING OF RECEIVABLES METHOD

❑ Classify each receivable by how long it is past due

❑ Each age group is multiplied by its estimated uncollectable
percentage
❑ Estimated uncollectable for each group are totaled
AGING OF RECEIVABLES

Longer past due, higher percents

 AGING OF RECEIVABLES
Musicland has an unadjusted Allowance for Doubtful
credit balance in the allowance Accounts
account is $200. 200
2,070
We estimated the proper balance
2,270
to be $2,270.
SUMMARY OF ALLOWANCE METHOD
Credit Sales Credit Sales Credit Sales
Year 1 Year 2 Year 3

Matching Matching Matching

Bad Debts Bad Debts Bad Debts

Expense Expense Expense
Year 1 Year 2 Year 3

Allowance for doubtful accounts adjusted over the years

◼ Sales and expenses accounts are temporary accounts

closed end of every year
◼ Allowance for doubtful accounts is a permanent account
 LOGIC OF ALLOWANCE METHOD
Two advantages of the allowance method:
1. Matching revenues with expenses: it records estimated bad debts
expense in the period when the related sales are recorded
2. It reports accounts receivable on the statement of financial
position at the estimated amount of cash to be collected (AR-
AFDA)

Results in:
• More relevant asset amounts
• Better match between revenues and expenses
• Improved information for decision making
 LEARNING OBJECTIVE 4
Account for notes receivable and adjustments for interest
 NOTES RECEIVABLE
A promissory note is a written promise to pay a specified
amount of money, usually with interest, either on demand or at a
definite future date.

Assume TechCom received this note at the time of a product sale

 COMPUTING MATURITY AND INTEREST
The maturity date of a note is the day the note (principal
and interest) must be repaid

On July 10, TechCom received a $1,000, 90-day, 12%

promissory note as a result of a sale to Julia Browne.

The note is due and payable on October 8

 INTEREST COMPUTATION

Even for If the note is

maturities less expressed in
than one year, days, base a
the rate is year on 360
annualized. days.

Interest computations assume a 360-day year, known as the bankers’ rule.

 RECORDING END-OF-PERIOD
INTEREST ADJUSTMENTS

On December 16, TechCom accepts a $3,000, 60-day,

12% note from a customer in granting an extension on a
past-due account. When TechCom’s accounting period
ends on December 31, $15 of interest has accrued on the
note.

$3,000 x 12% x 15/360 = $15

Adjusting entry
 RECORDING END-OF-PERIOD
INTEREST ADJUSTMENTS
Days in December 31
Minus the date of the note 16
Day remaining in December 15
Days in January 31
Days in February 14
Period of the note in days 60

Recording collection on note at maturity.

A+
R+; NI+; RE+; OE+
A-
A-

$3,000 x 12% x 60/360 = $60

THE END