Accounting Principles, 9th Edition

Weygandt.Kieso.Kimmel

Chapter 9

Accounting for Receivables

Aims of Lecture
 Identify the different types of receivables.  Explain how companies recognize accounts receivables.  Distinguish between the methods and bases companies used to value accounts receivable.  Describe the entries to record the disposition of accounts receivable.  Compute the maturity date of and interest on notes receivable.

Aims of Lecture
 Explain how companies recognize notes receivables.  Describe how companies values notes receivables.  Describe the entries to record the disposition of notes receivable.  Explain the statement presentation and analysis of receivables.

Types of Receivables
Receivables refers to the amounts due from individuals and other companies.  They are claims expected to be collected in cash.  They are frequently classified as:  Accounts Receivable
amounts owed by customers on account

 Notes Receivable
claims for which formal instruments of credit are issued

 Other Receivables –
non-trade receivables Examples: interest receivable and advances to employees

Accounts Receivables
Three accounting issues with accounts receivable are:

 Recognizing accounts receivable.

 Valuing accounts receivable.
 Disposing of accounts receivable.

Recognizing Accounts Receivables
GENERAL JOURNAL
Date July 1 Account Titles and Explanation Accounts Receivable – Polo Co. Sales (To record sales on account) Dr. 1,000 Cr. 1,000

When a business sells merchandise to a customer on credit,
Accounts Receivable is debited and Sales is credited. Assume credit terms are 2/10, n/30.

Recognizing Accounts Receivables
GENERAL JOURNAL
Date July 5 Account Titles and Explanation Sales Returns and Allowances Accounts Receivable – Polo Company (To record merchandise returned) Dr. 100 Cr. 100

When a business receives returned merchandise previously sold to
a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited.

Recognizing Accounts Receivables
GENERAL JOURNAL
Date July 11 Account Titles and Explanation Cash ($900 - $18) sales Discount Accounts Receivable – Polo Co. (To record collection of accounts receivables) Dr. 882 18 Cr.

900

When a business collects cash from a customer for merchandise previously sold on credit during the discount period, Cash and Sales Discounts are debited and Accounts Receivable is credited.

Recognizing Accounts Receivables
 

Retailers rarely grant cash discount to customers. When people use a retailer’s credit card, instead of giving a discount, the retailer charges interest on the balance due within a specified period (usually 25-30 days).

GENERAL JOURNAL
Account Titles and Explanation Accounts Receivable Sales (To record sales of merchandise) Dr. 300 Cr. 300

Recognizing Accounts Receivables
GENERAL JOURNAL
Account Titles and Explanation Accounts Receivable Interest Revenue (To record interest on amount due) Dr. 4.50 Cr. 4.50

Assuming that the customer owe $300 at the end of the month and the retailer charges 1.5% per month on the due balance.

Valuing Accounts Receivables
  

Companies record accounts receivables on the balance sheet as an asset. Determining the amount to report is sometimes difficult due to uncollectible receivables. Cash (net) realizable value:

net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect. debited to Bad Debts Expense considered as a normal and necessary risk of doing business. Direct write-off method Allowance method

Credit losses
 

Two methods of accounting for uncollectible accounts are:
 

Direct Write-Off Method for Uncollectible Accounts

Direct write-off method
 

When a company determines that a particular account will be uncollectible, it charges the loss to Bad Debt expense. Bad Debt expense will show only the actual losses from uncollectible. The company will report accounts receivables at its gross amount. Bad debt losses are not anticipated and no allowance account is used. Doesn't attempt to math bad debt expenses to sales revenue in the income statement. Doesn't show accounts receivables at the amount company actually expects to receive. Not acceptable for financial reporting purposes.

Direct Write-Off Method
GENERAL JOURNAL
Date Dec 12 Account Titles and Explanation Bad Debts Expense Accounts Receivable – M.E Doran (To record write-off of M.E Doran account) Dr. 200 Cr. 200

Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectible.

Allowance Method for Uncollectible Accounts
  

 

Allowance method involves estimating uncollectible accounts at the en of each period. Provides better matching on the income statement. Ensures that companies state receivable on the balance at their cash realizable value. Reduces receivables in the balance sheet. Required when bad debts are deemed to be material in amount. Three essential features:

Uncollectible accounts are estimated. Expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred.

Allowance Method for Uncollectible Accounts
Estimated

uncollectible are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra-asset account) at the end of each period.
Recording Estimated Uncollectibles

GENERAL JOURNAL
Date Dec 31 Account Titles and Explanation Bad Debts Expense Allowance for Doubtful Accounts (To record estimate of uncollectible account) Dr. 12,000 Cr. 12,000

Allowance Method for Uncollectible Accounts
Actual

uncollectible are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.
Recording the write-off of an Uncollectible Account

GENERAL JOURNAL
Date Mar. 1 Account Titles and Explanation Allowance for Doubtful Accounts Accounts Receivable – R.A. Ware (To record write-off of R.A. Ware account) Dr. 500 Cr. 500

Allowance Method for Uncollectible Accounts
Recovery of an Uncollectible Account
 When there is recovery of an account that has been written off:

reverse the entry made to write off the account.
GENERAL JOURNAL
Date July 1 Account Titles and Explanation Accounts Receivable – R. A. Ware Allowance for Doubtful Accounts (To reverse write-off of R.A. Ware account) Dr. 500 Cr. 500

Allowance Method for Uncollectible Accounts
Record the collection in the usual manner.
GENERAL JOURNAL
Date July 1 Account Titles and Explanation Cash Accounts Receivable R.A.Ware (To record collection of accounts receivables) Dr. 500 Cr. 900

Allowance Method for Uncollectible Accounts

Bases Used for Allowance Method Two bases are used to determine the amount of expected uncollectibles.  Percentage of sales  Percentage of receivables Both bases are generally accepted; the choice is a management decision.

Comparison of bases for Estimating Uncollectibles
Percentage of Receivables
Cash Realizable Value
Bad Debts Expense

Percentage of Sales
Matching
Sales

Accounts Receivable

Allowance for Doubtful Accounts

Emphasis on Income Statement Relationships

Emphasis on Balance Sheet Relationships

Percentage-of-Sales

Management estimates what percentage of credit sales will be uncollectible. Expected bad debt losses are determined by applying the percentage to the sales base of the current period. Emphasizes the matching of expenses with revenues.

Percentage-of-Sales
 If net credit sales for the year are $800,000, the estimated bad debts expense is $8,000 (1% X $800,000).

GENERAL JOURNAL
Date Dec 31 Account Titles and Explanation Bad Debts Expense Allowance for Doubtful Accounts (To record estimated bad debts for the year) Dr. 8,000 Cr. 8,000

Percentage-ofReceivables

  

Management estimates what percentage of receivables will result in losses from uncollectible accounts. Under this basis, company prepares an aging schedule. This is Often called aging the accounts receivables. Amount of the adjusting entry is the difference between the required balance and the existing balance in the allowance account. Produces the better estimate of cash realizable value of receivables.

Percentage-ofReceivables
 If the trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, and the required ending balance in the account is $2,228, an adjusting entry for $1,700 ($2,228 - $528) is necessary.
GENERAL JOURNAL
Date Dec 31 Account Titles and Explanation Bad Debts Expense Allowance for Doubtful Accounts (To adjust allowance account to total estimated uncollectibles) Dr. 1,700 Cr. 1,700

Disposing of Accounts Receivable
 Companies frequently sell their receivables to another
company for cash. Shorten the cash-to-cash operating cycle. Two major reasons: The may be the only reasonable source of cash. Billing and collection are often time consuming and costly . Companies can dispose accounts receivable in one of two ways:  sell to a factor such as a finance company or a bank  factor buys receivables from businesses for a fee and collects the payment directly from customers.

make credit card sales

Sale of Receivables
Hendrendon Furniture factors $600,000 of receivables to Federal Factors, Inc. Federal Factors assesses a service charge of 2% of the amount of receivables sold.
GENERAL JOURNAL
Account Titles and Explanation Cash Service Charge Expense (2% x $600,000) Accounts Receivable (To record the sale of accounts receivables) Dr. 588,000 12,000 Cr.

600,000

Credit Card Sales
 

 

A retailer’s acceptance of a national credit card is another form of selling receivables. Used by retailers who wish to avoid the paperwork of issuing credit Cash is received quickly from the credit card issuer. National credit cards  Visa, MasterCard, Discover, and American Express. Three parties are involved:  Credit card issuer  Retailer  Customer

Credit Card Sales
 Advantage of credit cards to the retailer:
  

Issuer does credit investigation of the customer. Issuer maintains customer accounts. Issuers undertake collection process and absorbs any losses. Retailer receives cash more quickly.

Retailer pays the credit card issuer a fee of 2-6% of the invoice price for its services.

Credit Card Sales

National credit cards are issued by banks. Retailers generally considers sales from the use of national credit card sales as cash sales. Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.

Credit Card Sales
Anita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her VISA First Bank Card. The service fee that First Bank charges is 3%.
GENERAL JOURNAL
Account Titles and Explanation Cash Service Charge Expense (2% x $600,000) Sales (To record Visa credit card sales) Dr. 970 30 Cr.

1,000

Notes Receivable
   

Companies may grant credit in exchange for a Promissory note. Its a written promise to pay a specified amount of money on demand or at a definite time. It gives the payee a stronger claim to assets. Promissory notes may be used:
 

When individuals and companies lend or borrow money. When the amount of the transaction and the credit period exceeds normal limit. In settlement of accounts receivable. Maker- The party making the promise. Payee-The party to whom payment is made.

Two parties are involved:
 

Notes Receivable

The basic issues in accounting for notes receivable are the same as those for accounts receivable.
  

Recognizing Notes receivable. Valuing Notes receivable. Disposing of notes receivable.

Determining the Maturity Date

The life of a note is expressed in terms of months. The due date is found by counting the months from the date of issue. Example: The maturity date of a 3-month note dated May 1 is August 1.

Determining the Maturity Date

If the life of the note is expressed in terms of days, one needs to count the days. the date of issue is omitted but the due date is included. Example: The maturity date of a 60-day note dated July 17 is:
Term of note July (31– 17) August Maturity date: September 60 14 31 45 15

Computing Interest
The basic formula for computing interest on an interestbearing note is:
Face Value of Note Annual Interest Rate Time in Terms of One Year

X

X

=

Interest

The interest rate specified on the note is an annual rate of interest.

Computing Interest

Terms of Note

Face
$ 730, 18%, 120 days $1,000, 15%, 6 months $2,000, 12%, 1 year

Interest Computation X Rate X Time =
18% X 15% X 12% X

Interest

$ 730 X $1,000 X $2,000 X

120/360 = $ 43.80 6/12 = $ 75.00 1/1 = $240.00

The interest rate specified, is the annual interest rate.

Recognizing Notes Receivable
Chalhoun Company receives a $1,000, 2-month, 12% promissory note from Brent Company to settle an open account.
GENERAL JOURNAL
Date May 1 Account Titles and Explanation Notes Receivable Accounts Receivables-Chalhoun Company (To record acceptance of Chalhoun Company note.) Dr. 1,000 Cr. 1,000

Valuing & Disposing of Notes Receivable

Like accounts receivable, short-term notes receivable are reported at their cash (net) realizable value. The notes receivable allowance account is Allowance for Doubtful Accounts. Sometimes the holder of the notes speed up the conversion to cash by selling the notes receivable.

Honor of Notes Receivable
 A note is honored when it is paid in full at its maturity date.  For an interest-bearing note, the amount due at maturity is the face value of the note plus interest for the length of time specified on the note.  Betty Co. lends Wayne Higley Inc. $10,000 on June 1, accepting a 5month, 9% interest-bearing note.  Betty Co. collects the maturity value of the note from Wayne Higley Inc. on November 1.

GENERAL JOURNAL
Date Nov 1 Account Titles and Explanation Cash Notes Receivable Interest Revenue (To record collection of Higley Inc. Note) Dr. 10,375 Cr. 10,000 375

Honor of Notes Receivable
If Betty Co. prepares financial statements as of September 30, interest for 4 months, or $300, would be accrued.

GENERAL JOURNAL
Date Sept 30 Account Titles and Explanation Interest Receivable (10,000*9%*4/12) Interest Revenue (To accrue 4-months interest) Dr. 300 Cr. 300

Honor of Notes Receivable
When interest has been accrued, it is necessary to credit Interest Receivable at maturity.
GENERAL JOURNAL
Date Nov 1 Account Titles and Explanation Cash Notes Receivable Interest Receivable Interest Revenue(10,000*9%*1/12) (To record collection of Note at maturity) Dr. 10,375 Cr. 10,000 300 75

Dishonor of Notes Receivable
A dishonored note is a note that is not paid in full at maturity.
A dishonored note receivable is no longer negotiable.  Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.
GENERAL JOURNAL
Date Nov 1 Account Titles and Explanation Accounts Receivable-Wayne Higley Inc. Notes Receivable Interest Revenue (To record the dishonor of Higley Inc. Note) Dr. 10,375 Cr. 10,000 375

Statement Presentation and Analysis
Presentation

In the balance sheet, short-term receivables are reported in the current assets section below short-term investments. Report both the gross amount of receivables and the allowance for doubtful accounts. In a multiple-step income statement,

Companies report bad debt expense and service charge expense as selling expense. Interest revenue appears under “other revenues and gains”.

Statement Presentation and Analysis
Analysis
 

Ratios are computed to evaluate the liquidity of a company’s accounts receivable. Accounts receivables turnover ratio used to assess the liquidity of the receivables. If Cisco had net credit sales of $29, 462 million for the year and beginning net accounts receivable balance of $3,303 million and ending net accounts receivable balance of $ 3,989 million, then: Net Credit Sales Average Net Receivables Accounts Receivable Turnover

/

=

$29,462

/

3,303 + $ 3,989 )/2 =

8.1times

Statement Presentation and Analysis
 

A variant of the turnover ratio that makes liquidity even more evident is its conversion into an average collection period. This is done by dividing the turnover ratio into 365 days. The general rule is that the collection period should not exceed the credit term period. Cisco’s turnover ratio is computed as:

Days in Year/AR Turnover = Average Collection Period in Days 365 days / 8.1 times = 45.1 days