CHAPTER FOUR

ACCOUNTS RECEIVABLES
The term receivable refers to amounts due from individuals and companies. Receivables are
claims that are expected to be collected in cash. The management of receivables is a very
important activity for any company that sells goods or services on credit. Receivables are
important because they represent one of a company’s most liquid assets. For many companies,
receivables are also one of the largest assets.
To reflect important differences among receivables, they are frequently classified as
(1) Accounts Receivable, (2) Notes Receivable, and (3) Other Receivables.
Accounts receivable are amounts customers owe on account. They result from the sale of goods
and services. Companies generally expect to collect accounts receivable within 30 to 60 days.
They are usually the most significant type of claim held by a company.
Notes receivable represent claims for which formal instruments of credit are issued as evidence
of the debt. The credit instrument normally requires the debtor to pay interest and extends for
time periods of 60–90 days or longer. Notes and accounts receivable that result from sales
transactions are often called trade receivables.
Other receivables include nontrade receivables such as interest receivable, loans to company
officers, advances to employees, and income taxes refundable. These do not generally result
from the operations of the business.
Methods of Recording Accounts Receivable in A Cash Discount Situation:
Companies may use the following two methods of recording accounts receivable transactions
when a cash discount situation is involved.
1. Gross method: companies usually records sales and related sales discounts transactions by
entering receivable and sale at the gross amount. Under this method, companies recognize
sales discounts only when they receive payment within the discount period. The income
statement shows sales discounts as a deduction from sales to arrive at net sales.
2. Net method: if using the gross method, accompany reports sales discounts as a deduction
from sales in the income statement. Proper expense recognition dictates that the company
also reasonable estimates the expected discounts to be taken and charges that amount against
sales. If using the net method, a company considers sales discount forfeited.

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 Methods of Recording Bad Debts:
There are two ways a company can account for bad debt expense:
1. Direct write-off method allows a business to record Bad Debt Expense only when a specific
account has been deemed uncollectible. The account is removed from the account receivable
balance and Bad Debt Expense is increased.
Example 1: on March 2, Sun Co. has deemed that $ 1,400 in Account Receivable, due from Joc
Smith, is uncollectible and should be recorded as a bad debt.
Solution
Date Account Titles and Explanations Ref Dr Cr
March 2 Bad Debts Expense $ 1,400
Accounts Receivable— Joc Smith $ 1,400
(To record write-off of Joc Smith account)

Example 2: Assume, for example, that Warden Co. writes off as uncollectible M. E. Doran’s
$200 balance on December 12. Warden’s entry is:
Solution
Date Account Titles and Explanations Ref Dr Cr
Dec. 12 Bad Debts Expense 200
Accounts Receivable—M. E. Doran 200
(To record write-off of M. E. Doran account)

2. The allowance method: creates bad debt expense before the company knows specifically
which customers will not pay. Based on prior history, the company knows the approximate
percentage or sales or outstanding receivables that will not be collected. Using those
percentages, the company can estimate the amount of bad debt that will occur. That allows
as to record the bad debt but since accounts receivable is simply the total of many small
balances, each belonging to a customer. We cannot credit account receivable when this entry
is recorded.

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CONTRA ACCOUNTS:
A contra account is an account found in an account ledger that is used to reduce the value of a
related account. A contra account`s natural balance is opposite of the associated account. If a
debit is recorded in related account, the contra account record also records a credit.
Three common examples of contra accounts:
1. Accumulate Depreciation. To reduce the value of asset.
2. Allowance for Doubtful Account, reduce the value of accounts receivable.
3. Drawing Accounts, to reduce the value of capital.

Example 3: assume that Jordache Co. on July 1, 2012, sells merchandise on account to Polo
Company for $1,000, terms 2/10, n/30. On July 5, Polo returns merchandise worth $100 to
Jordache Co. On July 11, Jordache receives payment from Polo Company for the balance due.
The journal entries to record these transactions on the books of Jordache Co. are as follows.
Solution

Date Account Titles and Explanations Ref Dr Cr

July 1 Accounts Receivable—Polo Company 1,000
Sales Revenue 1,000
(To record sales on account)
July 5 Sales Returns and Allowances 100
Accounts Receivable—Polo Company 100
(To record merchandise returned)
July 11 Cash ($900 - $18) 882
Sales Discounts ($900 3 .02) 18
Accounts Receivable—Polo Company 900
(To record collection of accounts receivable)

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Example 4: Restin Co. uses the gross method to record sales made on credit. On June 1, 2016, it
made sales of $ 50,000 with terms 3/15, n/45. On June 12, 2016, Restin received full payment for
the June 1 sale. Prepare the required journal entries for Restin Co.

Solution:
Restin Co.
Journal entries
Date Account Titles and Explanations Ref Dr Cr
2016, June 1 Accounts Receivable 50,000
Sales 50,000
(To record sales on credit)
2016, June 12 Cash 48,5000
Sales Discount 1,500
Account Receivable 50,000
(To record the collection)

Example 5: Western Inc. operates in an industry that has a high rate of bad debts. Before any
year-end adjustment, the balance in Account Receivable account was $ 700,000 and the
Allowance for Doubtful Accounts had a debit balance of $ 25,000. The year-end balance
reported in the balance sheet for the Allowance for Doubtful Debt Accounts will be based on the
aging schedule shown below:
Days Account Outstanding Amount Probability of Collection
Less than 16 days 400,000 95%
Between 16 and 30 days 100,000 90%
Between 31 and 45 days 80,000 85%
Between 46 and 60 days 50,000 75%
Between 61 and 90 days 40,000 40%
Over 90 days 30,000 5%
Required:
i. What is the appropriate balance for the Allowance for Doubtful Account at year-end?
ii. What is the amount effect of the year-end bad debt adjustment on the income?

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 iii. Show how accounts receivable would be presented on the balance sheet.

Solution
Req. (i) WOSTERN INC.
Accounts Receivable Aging Schedule
Days Account Amount Probability Probability Estimated
Outstanding of Collection of Collectible Uncollectible
Less than 16 days 400,000 95% 5% 20,000
Between 16 and 30 days 100,000 90% 10% 10,000
Between 31 and 45 days 80,000 85% 15% 12,000
Between 46 and 60 days 50,000 75% 25% 12,500
Between 61 and 90 days 40,000 40% 60% 24,000
Over 90 days 30,000 5% 95% 28,500
700,000 Balance for Allowance for 107,000
Doubtful Account

(ii) Year end bad debt expense = 107,000 + 25,000 = $ 132,000

(iii) The balance sheet presentation:
Accounts Receivable 700,000
Less: Allowance for Doubtful Account 132,000
Account Receivable (net) 568,000