Chapter 7

Receivables

201107 - Receivables
 Learning objectives
• Define and explain common types of receivables and review
internal controls for receivables
• Describe how bad debts arise
• Use the allowance method to account for bad debts
• Use the direct write-off method to account for bad debts
• Journalise credit card and debit card sales
• Account for bills receivable
• Report receivables on the balance sheet and evaluate a
business using the acid-test ratio, days’ sales in receivables
and the accounts receivable turnover ratio

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 7.1. Receivables: An introduction
• A receivable arises when a business (or person) sells goods
or services to a second business (or person) on credit
• The receivable is the seller’s claim against the buyer for the
amount of the transaction
• The creditor sells goods or a service and obtains a
receivable
• The debtor makes the purchase and takes on an
obligation/payable (a liability)
• The two main types of receivables are accounts receivable
and bills receivable

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 7.1. Receivables: An introduction
• Accounts receivable, sometimes called trade receivables or
trade debtors, are amounts to be collected from customers
from sales made on credit
• Bills (and notes) receivable are more formal than accounts
receivable.
The debtor in a bill or note receivable arrangement promises
in writing that the creditor will be paid a definite sum at a
specific future date
• A promissory note is a special type of bill receivable

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 7.2. Accounting for bad debts
(uncollectable accounts)
• Some customers do not pay, and that creates an expense
called a bad debt expense, doubtful debt expense or
uncollectable account expense
• There are two methods of accounting for uncollectable
receivables, namely the allowance method and the direct
write-off method

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 7.3. The allowance method
• It is based on the matching principle, which requires that the
bad debts expense is recorded in the same period as the
sales revenue
• The offset to the expense is a contra account called
Allowance for doubtful debts (or the Allowance for bad debts)
• The Allowance account shows the amount of the receivables
that the business expects not to collect and reduces
Accounts receivable

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 7.3. The allowance method
• The more accurate the estimate of bad debts, the more
reliable the information in the financial statements
• Businesses use their past experience as well as considering
the economy, the industry they operate in and other variables
• There are two basic ways to estimate bad debts, namely
percentage of sales method and ageing of accounts
receivable method

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 7.3. The allowance method
The percentage of sales method: calculates bad debts
expense as a percentage of net credit sales
• This method is also called the income statement approach
because it focuses on the amount of expense to be reported
on the income statement
• Bad debts expense is recorded as an adjusting entry at the
end of the period
Date Account title Dr Cr
Mar 31 Bad debts expense (E+) 300
GST clearing (L–) 30
Allowance for doubtful debts (CA+) 330
Recorded bad debts expense for the period.

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 7.3. The allowance method
The ageing of accounts method: is also called the balance sheet
approach because it focuses on the actual age of the accounts
receivable and determines a target allowance balance from that age

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 7.3. The allowance method

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 7.3. The allowance method
Identifying and writing-off bad debts
When a specific customer account is identified as uncollectible, it is
written off to the allowance account

Date Account title Dr Cr

Jul 15 Allowance for doubtful debts (CA–) 200
Accounts receivable—Andrews (A–) 80
Accounts receivable—Jones (A–) 120
Wrote off doubtful debts.

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 7.3. The allowance method
Recovery of accounts previously written-off
Sometimes a customer will pay the amount owed after the
customer’s account is written off.
To account for this recovery, the business must reverse the
effect of the earlier write-off to the Allowance account and
record the cash collection.

Date Account title Dr Cr

Sep 4 Accounts receivable—Andrews (A+) 80
Allowance for doubtful debts (CA+) 80
Cash (A+) 80
Accounts receivable—Andrews (A–) 80

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 7.4. The direct write-off method
Writing-off bad debts
•Under the direct write-off method of accounting for bad debts,
the business waits until it decides that a customer’s account
receivable is uncollectable
•The accountant then debits Bad debts expense and credits the
customer’s Account receivable to write off the account

Date Account title Dr Cr

Jul 15 Bad debts expense (E+) 200
Accounts receivable—Andrews (A–) 80
Accounts receivable—Jones (A–) 120
Wrote off a bad debt.

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 7.4. The direct write-off method
Recovery of accounts previously written-off
To account for this recovery, the business must reverse the
effect of the earlier write-off to the Bad debts expense account
and record the cash collection

Date Account title Dr Cr

Sep 4 Accounts receivable—Andrews (A+) 80
Bad debts expense (E–) 80
Cash (A+) 80
Accounts receivable—Andrews (A–) 80

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 7.5. Credit and debit card sales
Credit card sales:
• are an alternative form of receiving payment from a customer
• There are two main types of credit cards, namely credit cards that
are issued by a financial institution (bank or credit union) and
credit cards that are issued by a credit card company
• Credit cards offer customers the convenience of buying without
having to pay the cash immediately
Debit card sales: are fundamentally different from credit cards
• Businesses hire a third-party processor to process credit and
debit card transactions
• Transactions are usually entered into an electronic terminal (card
scanner) that the business either purchases or rents from the
processor
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 7.6. Bills receivable
• Bills of exchange are commonly used where foreign trade is
concerned, with businesses selling goods or services in
exchange for bills receivable
• A promissory note is defined as ‘an unconditional promise in
writing, signed by the maker, engaging to pay, on demand or at a
fixed or determinable future time, a sum certain in money, to or
to the order of a specified person, or to bearer’
• A bill of exchange is defined as as ‘an unconditional order in
writing, addressed by one person to another, signed by the
person giving it, requiring the person to whom it is addressed to
pay on demand, or at a fixed or determinable future time, a sum
certain in money to or to the order of a specified person or
bearer’

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 7.6. Bills receivable

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 7.6. Bills receivable
Identifying a bill’s maturity date
• Maturity date can be a specific date
• Maturity date can be stated in terms of number of months
• Maturity date can be stated in terms of number of days
The formula for calculating interest is

Amount
Interest
Principal Time of
rate
interest

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 7.6. Bills receivable
Recording bills receivable
Date Account title Dr Cr
Oct 20 Bill receivable - Dorman Builders (A+) 15 000
Sales revenue (R+) 15 000
To record sale (ignore the cost of goods)
Jan 18 Cash (A+) 15 370
Bill receivable—Dorman Builders (A–) 15 000
Interest revenue 370
($15 000 × 0.10 × 90/365) (R+)
To record collection at maturity.

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 7.6. Bills receivable
Recording bills receivable
A business may, by agreement, draw a bill receivable on a
trade customer who fails to pay an account receivable within
the customary 30–60 days

Date Account title Dr Cr

Oct 1 Bill receivable — Interlogic (A+) 2 400
Accounts receivable — Interlogic (A–) 2 400
To draw a bill on account on a customer.

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 7.6. Bills receivable
Accruing interest revenue
Date Account title Dr Cr
Dec 31 Interest receivable 54
($2 400 × 0.09 × 3/12) (A+)
Interest revenue (R+) 54
To accrue interest revenue earned in
2015 but not yet received.
Sep 30 Cash [$2 400 + ($2 400 × 0.09)] (A+) 2 616
Bill receivable — Interlogic (A–) 2 400
Interest receivable (A–) 54
Interest revenue (R+) 162
To collect bill receivable on which interest
has been previously accrued.
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 7.6. Bills receivable
Discounting a bill receivable

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 7.6. Bills receivable

Discounting a bill receivable

Dr Cash 15, 168

Cr Bill receivable 15,000
Cr Interest revenue 168
To discount a bill receivable

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 7.6. Bills receivable
Dishonoured bills receivable
• If the debtor of a bill doesn’t pay a bill receivable at maturity, the
debtor is said to dishonour, or default on, the bill
• As the term of the bill has expired, the original agreement is no
longer in force, and no one will buy the bill
• However, the payee still has a claim against the debtor and
usually transfers the claim from the Bills receivable account to
Accounts receivable
• The payee records interest revenue earned on the bill and debits
Accounts receivable for the full maturity value of the bill

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 7.6. Bills receivable
Dishonoured bills receivable
Ex: Suppose Thompson Jewellers had a six-month, 10% bill receivable
for $1,200 from D. Hatachi and, on the 3 February maturity date,
Hatachi defaulted. Thompson Jewellers would record the default as
follows:
Feb 3 Accounts Receivable 1,260
(1,200 + 1,200 x 0.1 x 6/12)
Bill receivable 1,200
Interest revenue 60
To record dishonour of bill receivable.

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 7.7. Using accounting information for
decision making
• In making decisions, owners and managers use some ratios
based on the relative liquidity of assets
• A measure of the firm’s ability to pay current liabilities is the acid-
test (or quick) ratio
• The acid-test ratio tells whether the entity could pay all its current
liabilities if they came due immediately
• Acid-test ratio = (Cash + Short-term + Net current investments
receivables) / Total current liabilities
• The higher the acid-test ratio, the better the business is able to
pay its current liabilities

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 7.7. Using accounting information for
decision making
• After a business makes a credit sale, the next critical event in the
business cycle is collection of the receivable
• Days’ sales in receivables, also called the collection period,
indicates how many days it takes to collect the average level of
receivables
• The number of days in average accounts receivable should be
close to the number of days customers are allowed to pay
• The shorter the collection period, the more quickly the
organisation can use cash for operations

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 7.7. Using accounting information for
decision making
• The accounts receivable turnover ratio measures the number of
times the business sells and collects the average receivables
balance in a year
• The higher the ratio, the faster the cash collections
• Accounts receivable turnover ratio = Net credit sales / Average
net accounts receivable

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 Summary: Chapter 8
• A receivable arises when a business (or person) sells goods or
services to a second business (or person) on credit
• The two main types of receivables are accounts receivable and
bills receivable
• There are two methods of accounting for uncollectable
receivables, namely the allowance method and the direct write-
off method
• The allowance method is based on the matching principle, which
requires that the bad debts expense is recorded in the same
period as the sales revenue
• Under the direct write-off method of accounting for bad debts, the
business waits until it decides that a customer’s account
receivable is uncollectable
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 Summary: Chapter 7
• Bills of exchange are commonly used where foreign trade is
concerned, with businesses selling goods or services in
exchange for bills receivable
• In making decisions, owners and managers use some ratios
based on the relative liquidity of assets
• Common ratios are acid-test (or quick) ratio, collection period,
and accounts receivable turnover ratio

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 Tasks in class
Textbook: Chapter 9
• Quick Check
• Starters
• Exercises

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 Tasks at home
1/ Homework:
Textbook: Chapter 9
• Problems
• Apply
2/ Self-study:
Key References [2]: Chapter 10

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The end of Chapter 7
Receivables

201107 - Receivables