CHAPTER2

Accounting for
Receivables

1. Definition
Learning
Outcomes 2. Recognition
3. Valuation

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 Types of Receivables
• Amounts due from individuals and other companies that are
expected to be collected in cash. Source: Credit sales, lending money
• Money Claims against businesses & Individuals.

Amounts owed by Claims for which “Nontrade” (interest,

customers that result formal instruments of loans to officers,
from the sale of credit are issued advances to
goods and services. as proof of debt. employees, and
income taxes
refundable).

Accounts Notes Other

Receivable Receivable Receivables

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 Accounts Receivables

Two accounting issues:

1. Recognizing accounts receivable.
2. Valuing accounts receivable.

Recognizing Accounts Receivable

 Service organization - records a receivable when it
provides service on account.
 Merchandiser /Manufacturer- records accounts
receivable at the point of sale of merchandise/finished
goods on account.

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 Accounts Receivables

Illustration: Assume that Jordache Co. on July 1, 2012, sells

merchandise on account to Polo Company for $1,000 terms
2/10, n/30. Prepare the journal entry to record this transaction
on the books of Jordache Co.

Jul. 1 Accounts/Notes receivable 1,000

Sales revenue 1,000

sales Cash
Cash
Credit Receivables Uncollectibles

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DWM AWM
 Accounts Receivables
Valuing Accounts Receivables
 Current asset.
 Valuation (net realizable value).
Uncollectible Accounts Receivable
 Sales on account raise the possibility of accounts not being
collected.
 Uncollectible Accounts/ Bad Debts/ Doubtful Accounts
Expense: Operating expenses incurred because of failure to
collect receivables.
 Seller records losses that result from extending credit as Bad
Debts Expense.
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 Accounts Receivables
Methods of Accounting for Uncollectible Accounts
Direct Write-Off Method
Theoretically undesirable:
 No matching.
 Receivable not stated at
cash realizable value.
 Not acceptable for
financial reporting.
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Allowance Method
Losses are estimated:
 Better matching.
 Receivable stated at cash
realizable value.
 Required by GAAP.
 Accounts Receivables

I. Direct Write-off Method for Uncollectible Accounts

• Recognizes uncollectible accounts as an expense or loss when an

account specifically deemed/known/certain/determined/proved to be
actually uncollectible.

1. Write-off entry
Assume that ABC Co. writes off M. E. Doran’s $200 balance as
uncollectible on December 12. Warden’s entry is:

Bad debts expense 200

Accounts receivable 200

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 Accounts Receivables
2. Recovery [Collection post write-off-part or whole]
Assume that ABC Co. received the amount written off earlier.
Case 1: Same year
a. Reinstatement
A/R………………………200
Bad Debts Expense……….200
b. Collection
Cash…………………….200
A/R………………………….200
Case 2: Subsequent year
a. Reinstatement
A/R………………………………………...200
Recovery of accounts written off……………..200
b. Collection
Cash…………………….200
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A/R………………………….200
 Accounts Receivables

II. Allowance Method for Uncollectible Accounts

1. Companies estimate uncollectible accounts
receivable.

2. Recognizes uncollectible accounts as an expense

when it is apparent/evident/probable

3. Debit Bad Debts Expense and credit Allowance for

Doubtful Accounts (a contra-asset account).

4. Companies debit Allowance for Doubtful Accounts

and credit Accounts Receivable at the time the
specific account is written off as uncollectible.
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 Accounts Receivables

1. Provision/Allowance/Reserve for Uncollectible Accounts

Illustration: Hampson Furniture has credit sales of $1,200,000 in

2012, of which $200,000 remains uncollected at December 31. The
credit manager estimates that $12,000 of these sales will prove
uncollectible.

Dec. 31 Bad debts expense 12,000

Allowance for doubtful accounts 12,000

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 Accounts Receivables

Illustration: Presentation of allowance for doubtful accounts

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 Accounts Receivables

2. Recording Write-Off of an Uncollectible Account

Illustration: The vice-president of finance of Hampson Furniture on
March 1, 2013, authorizes a write-off of the $500 balance owed by
R. A. Ware. The entry to record the write-off is:

Mar. 1 Allowance for doubtful accounts 500

Accounts receivable 500

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 Accounts Receivables

3. Recovery of an Uncollectible Account [Collection

after write-off]
Illustration: On July 1, R. A. Ware pays the $500 amount that
Hampson had written off on March 1. Hampson makes these entries:

July 1 Accounts receivable 500

Allowance for doubtful accounts 500

1 Cash 500
Accounts receivable 500

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 Accounts Receivables

Estimating the Allowance

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 Accounts Receivables

Estimating the Allowance

Management estimates
what percentage of credit
sales will be uncollectible.
This percentage is based
on past experience and
anticipated credit policy
[tight/strict vs flexible].

BDE = Allowance = Credit Sales X Uncollectibles %

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 Accounts Receivables

Percentage-of-Sales
Illustration: Assume that Gonzalez Company elects to use
the percentage-of-sales basis. It concludes that 1% of net credit
sales will become uncollectible. If net credit sales for 2012 are
$800,000, the adjusting entry is:

Dec. 31 Bad debts expense 8,000 *

Allowance for doubtful accounts 8,000

* $800,000 x 1%

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 Accounts Receivables

Percentage-of-Sales
 Emphasizes matching of expenses with revenues.

 Adjusting entry to record bad debts disregards the existing

balance in Allowance for Doubtful Accounts.

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 Accounts Receivables

Estimating the Allowance

Management establishes a
percentage relationship
between the amount of
receivables and expected
losses from uncollectible
accounts.

BDE = Allowance + Previous Bal. of A/D/A

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 Accounts Receivables

Allowance for Allowance for

Doubtful Accounts Doubtful Accounts
D C
D+A=BDE A-C = BDE

E=A E=A

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 Accounts Receivables
Example 1
Aging the accounts receivable - customer balances are
classified by the length of time they have been unpaid.

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 Accounts Receivables

Estimating the Allowance

Illustration: Assume the unadjusted trial balance shows Allowance
for Doubtful Accounts with a credit balance of $528. Prepare the
adjusting entry assuming $2,228 is the estimate of uncollectible
receivables from the aging schedule.

Dec. 31 Bad debts expense 1,700

Allowance for doubtful accounts 1,700

Bad debts accounts

after posting

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 Percentage-of-Receivables Approach
Example 2 Accounts Receivable
Aging Schedule

What entry
would Wilson
make assuming
that the
allowance
account had a
zero balance?

Bad Debt Expense 37,650

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Allowance for Doubtful Accounts 37,650
 Percentage-of-Receivables Approach
Accounts Receivable
Aging Schedule

What entry
would Wilson
make assuming
the allowance
account had a
credit balance
of €800 before
adjustment?

Bad Debt Expense (€37,650 – €800) 36,850

Allowance for Doubtful Accounts 36,850

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 Allowance Method

Exercise: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry to record bad debt

expense assuming Sandel Company estimates bad debts
at (a) 1% of net sales and (b) 5% of accounts receivable.

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 Allowance Method

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry assuming Sandel estimates

bad debts at (b) 1% of net sales.

Bad Debt Expense 7,500

Allowance for Doubtful Accounts 7,500
(€800,000 – €50,000) x 1% = €7,500

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 Allowance Method

Illustration: Sandel Company reports the following financial

information before adjustments.

Instructions: Prepare the journal entry assuming Sandel estimates

bad debts at (b) 5% of accounts receivable.

Bad Debt Expense 6,000

Allowance for Doubtful Accounts 6,000
(€160,000 x 5%) – €2,000) = €6,000

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 Notes Receivables

Companies may grant credit in exchange for a promissory

note. A promissory note is a written promise to pay a
specified amount of money on demand or at a definite time.

Promissory notes may be used

1. when individuals and companies lend or borrow money,

2. when amount of transaction and credit period exceed

normal limits, or

3. in settlement of accounts receivable.

Hence,
Notes receivable…………..xxx
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Sales/ A. Rec./ Cash……………xxx
 Notes Receivables

To the Payee, the promissory note is a note receivable.

To the Maker, the promissory note is a note payable.

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 Notes Receivables
Determining the Maturity Date
Alternative expressions:
 On Demand=Unknown
 Years: the same date & month in the year of maturity as in
the date of the note
date of note: May 1,2012
due date: 1 year after date = May 1, 2013
 Months: the same date in the month of maturity as in the
date of the note.
date of note: May 1,2012
due date: 2 months after date = July 1, 2012
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 Notes Receivables
 Days: count the exact number of days from the date of note
date of note: May 1,2012
due date: 90 days after date = July 30, 2012
Term of the note 90
Days that pass in May:
Number of days in May 31
Date of note 1 30
Number of days left 60
Days that pass in June 30
Number of days left (less than # days in next month) 30
Due date is July 30
Computing Interest

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 Notes Receivables

Computing Interest
When counting days, omit the date the note is issued,
but include the due date.

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 Notes Receivables

Recognizing Notes Receivable

Illustration: Calhoun Company wrote a $1,000, two-month,
12% promissory note dated May 1, to settle an open account.
Prepare entry would Wilma Company makes for the receipt of
the note.

May 1 Notes receivable 1,000

Accounts receivable 1,000

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 Notes Receivables

Valuing Notes Receivable

 Report short-term notes receivable at their cash (net)
realizable value.

 Estimation of cash realizable value and bad debts

expense are done similarly to accounts receivable.

 Allowance for Doubtful Accounts is used.

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 Notes Receivables

Disposing of Notes Receivable

1. Notes may be held to their maturity date.

2. Maker may default and payee must make an

adjustment to the account.

3. Holder speeds up conversion to cash by selling the

note receivable.

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 Notes Receivables

Disposing of Notes Receivable

Honor of Notes Receivable

 Maker pays it in full at its maturity date.

Dishonor of Notes Receivable

 Not paid in full at maturity.

 No longer negotiable.

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 Notes Receivables [ Promissory Notes]

Calculate the due date, interest, and maturity value for

these promissory notes.
 Note #1: Br5,000, 90-day, 8% promissory note
dated September 28
 Note #2: Br25,000, 180-day, 11% promissory
note dated April 2

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 Notes Receivables [ Promissory Notes]
 Solution
Note #1: Br5,000, 90-day, 8% promissory note dated September 28
Due Date:
Term of the note 90
Days that pass in September:
Number of days in Sept. 30
Date of note 28 2
Number of days left 88
Days that pass in October 31
Number of days left 57
Days that pass in November 30
Number of days left 27
Due date is December 27
Interest = PRT= Br5,000  8%  90/360 = Br100
Maturity Value = P+I= Br5,000 + Br100 = Br5,100
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 Notes Receivables [ Promissory Notes]
Note #2: $25,000, 180-day, 11% promissory note dated April 2
Due Date:
Term of the note 180
Days that pass in April:
Number of days in April. 30
Date on note 2 28
Number of days left 152
Days that pass in May 31
Number of days left 121
Days that pass in June 30
Number of days left 91
Days that pass in July 31
Number of days left 60
Days that pass in August 31
Number of days left 29
Due date is September 29
Interest: Br25,000  11%  180/360 = Br1,375
Maturity Value: Br25,000 + Br1,375 = Br26,375
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 Notes Receivables

Honor of Notes Receivable

Illustration: Wolder Co. lends Higley Co. $10,000 on June 1,
accepting a five-month, 9% interest note. If Wolder presents the
note to Higley Co. on November 1, the maturity date, Wolder’s
entry to record the collection is:

Nov. 1 Cash 10,375

Notes receivable 10,000
Interest revenue 375

($10,000 x 9% x 5/12 = $ 375)

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 Notes Receivables

Accrual of Interest Receivable

Illustration: Suppose instead that Wolder Co. prepares financial
statements as of September 30. The adjusting entry by Wolder is
for four months ending Sept. 30.

Sept. 1 Interest receivable 300

Interest revenue 300
($10,000 x 9% x 4/12 = $ 300)
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 Notes Receivables

Accrual of Interest Receivable

Illustration: Prepare the entry Wolder’s would make to record
the honoring of the Higley note on November 1.

Nov. 1 Cash 10,375

Notes receivable 10,000
Interest receivable 300
Interest revenue 75

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 Notes Receivables

Dishonor of Notes Receivable

Illustration: Assume that Higley Co. on November 1 indicates
that it cannot pay at the present time. If Wolder Co. does expect
eventual collection, it would make the following entry at the time
the note is dishonored (assuming no previous accrual of interest).

Nov. 1 Accounts receivable 10,375

Notes receivable 10,000

Interest revenue 375

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 Notes Receivables
 N/R is a negotiable instrument & can be transferred to other
parties and can be sold for cash.

 Discounting:- Selling a note to a bank in order to generate cash

before maturity date of the note.

 Discounting without recourse: no further liability on the transferor

if the maker defaults. No obligation on payee.

 Discounting with recourse: the transferor (seller) is liable if the

maker defaults. Obligation on payee. Creates a contingent liability.

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 Notes Receivables

Proceeds received
Payee Discounting the note Bank

Collection of note
Promissory note

Maker

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 Notes Receivables

Journal Entries:
Case 1: Proceeds > Face amount
Cash………………………...xxx
N/R…………………..........xxx
Interest income.……….xxx

Case 2: Proceeds < Face amount

Cash………………………..xxx
Interest expense………xxx
N/R………………………….xxx

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 Discounting Notes Receivable

ABC's TV and Electronics had a $5,000, 90-day, 8% note dated

September 14 received from a customer in settlement of a past due
account. This note was discounted at 12% on September 24.
Required:
1. Journal entry for the receipt of the note.
N/Receivable 5,000
A/Receivable 5,000
2. Calculate the cash proceeds from discounting the note.
3. Journal entry to record discounting of the note.
4. Journal entry when the Note is honored.
5. Journal entry when the Note is dishonored.
6. Discounting using a discount rate of 7%.

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 Discounting Notes Receivable
Solution:
1. Calculate the cash proceeds from discounting the note.
Step 1: Determine the interest on the note.
Interest = 5,000  8%  90/360 = 100
Step 2: Determine the maturity value of the note.
Maturity Value = 5,000 + 100 = 5,100
Step 3: Determine the discount the bank will charge.
Because 10 days have passed since the note was
signed, there are 80 days in the discount period.
Discount = Maturity Value  Discount Rate  Time
Discount = 5,100  12%  80/360 = 136
Step 4: Calculate the cash proceeds.
Cash Proceeds = Maturity Value – Discount
Cash Proceeds = 5,100 –136 = 4,964
Step 5: Interest Expense (Revenue)=5,000-4,964=36
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 Discounting Notes Receivable
3. Prepare the journal entry to record this event on Sept. 24
Cash 4,964
Interest Expense 36
Notes Receivable 5,000
 The interest expense is the difference between the
interest income earned on the note and the interest
expense (discount) paid to the bank.
 Discount rate Interest expense/ Interest income
 Discount period Interest expense/ Interest income

 Interest earned on the $5,000 note (90 days at 8%) $100

Less: Discount paid to the bank 136
Interest expense $36
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 Discounting Notes Receivable
4. Note is Honored
 No Entry
5. Note is Dishonored
 Payment to the bank
A/Receivable 5,100
Cash 5,100
 Collection from customer
Cash 5,100
A/Receivable 5,100

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 Discounting Notes Receivable
Solution:
6. Calculate the cash proceeds from discounting the note.
Step 1: Determine the interest on the note.
Interest = $5,000  8%  90/360 = $100
Step 2: Determine the maturity value of the note.
Maturity Value = $5,000 + $100 = $5,100
Step 3: Determine the discount the bank will charge.
Because 10 days have passed since the note was
signed, there are 80 days in the discount period.
Discount = Maturity Value  Discount Rate  Time
Discount = $5,100  7%  80/360 = $79
Step 4: Calculate the cash proceeds.
Cash Proceeds = Maturity Value – Discount
Cash Proceeds = $5,100 – $79 = $5,021
Step 5: Interest Expense (Revenue)=5,000-5,021=21
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 Discounting Notes Receivable

6. Journal entry for discounting the note at 7%

Cash 5,021
Interest Income 21
Notes Receivable 5,000

------------Assignment II-------------

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