Accounting Principles

Second Canadian Edition

Weygandt · Kieso · Kimmel · Trenholm

Prepared by:
Carole Bowman, Sheridan College
 CHAPTER

ACCOUNTING FOR
RECEIVABLES
 RECEIVABLES
RECEIVABLES

• The term receivables refers to amounts due from

individuals and other companies; they are claims
expected to be collected in cash.
• Three major classes of receivables are:
1. Accounts Receivable
2. Notes Receivable
3. Other Receivables
 ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

The three primary accounting problems

associated with accounts receivable are:
1. Recognizing accounts receivable.
2. Valuing accounts receivable.
3. Disposing of accounts receivable.
 RECOGNIZING
RECOGNIZING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 1 Accounts Receivable - Adorable Junior 1,000
Sales 1,000
To record sales on account.

When a business sells merchandise to a

customer on credit, Accounts Receivable is
debited and Sales is credited.
 RECOGNIZING
RECOGNIZING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 5 Sales Returns and Allowances 100
Accounts Receivable - Adorable 100
To record merchandise returned.

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
RECOGNIZING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 31 Cash ($1,000 - $100) 900
Accounts Receivable - Adorable 900
To record collection of account.

When a business collects cash from a customer

for merchandise previously sold on credit, Cash
is debited and Accounts Receivable is credited.
 RECOGNIZING
RECOGNIZING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 31 Accounts Receivable - Adorable 13.50
Interest Revenue 13.50
To record interest on amount due.

When financing charges are added to a balance

owing, Accounts Receivable is debited and
Interest Revenue is credited.
 VALUING
VALUING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE
• To ensure that receivables are not
overstated on the balance sheet, they are
stated at their net realizable value.
• Net realizable value is the net amount
expected to be received in cash and
excludes amounts that the company
estimates it will not be able to collect.
 VALUING
VALUING
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE
• Two methods of accounting for
uncollectible accounts are:

1. Allowance method

2. Direct write-off method

 DIRECT
DIRECT WRITE-OFF
WRITE-OFF METHOD
METHOD
• Under the direct write-off method, no entries
are made for bad debts until an account is
determined to be uncollectible at which time
the loss is charged to Bad Debts Expense.
• No attempt is made to match bad debts to
sales revenues or to show the net realizable
value of accounts receivable on the balance
sheet.
 DIRECT
DIRECT WRITE-OFF
WRITE-OFF METHOD
METHOD

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Jan. 12 Bad Debts Expense 200

Accounts Receivable — E. Schaefer 200

For write-off of E. Schaefer account.

Periera Company writes off E. Schaefer’s $200

balance as uncollectible on January 12. When
this method is used, Bad Debts Expense will
show only actual losses from uncollectibles.
 THE
THE ALLOWANCE
ALLOWANCE METHOD
METHOD

• The allowance method is required when

bad debts are deemed to be material in
amount.
• Uncollectible accounts are estimated and
the expense for the uncollectible accounts is
matched against sales in the same
accounting period in which the sales
occurred.
 THE
THE ALLOWANCE
ALLOWANCE METHOD
METHOD

GENERAL JOURNAL
Date Account Title and Explanation Debit Credit
Dec. 31 Bad Debts Expense 24,000
Allowance for Doubtful Accounts 24,000
To record estimate of uncollectible accounts.

Estimated uncollectible amounts are debited to

Bad Debts Expense and credited to Allowance
for Doubtful Accounts (a contra asset account)
at the end of each period.
 ADORABLE JUNIOR GARMET
Balance Sheet (partial)

Current assets
Cash $ 14,800
Accounts receivable $200,000
Less: Allowance for doubtful accounts 24,000 188,000

Net Realizable Value

 THE
THE ALLOWANCE
ALLOWANCE METHOD
METHOD

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
500
Mar. 1 Allowance for Doubtful Accounts
Accounts Receivable — Nadeau 500

Write-off of Nadeau account.

Actual uncollectible accounts are debited to

Allowance for Doubtful Accounts and credited to
Accounts Receivable at the time the specific
account is written off.
 THE
THE ALLOWANCE
ALLOWANCE METHOD
METHOD

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
500
July 1 Accounts Receivable — Nadeau
Allowance for Doubtful Accounts 500

To reverse write-off of Nadeau

account.

When there is recovery of an account that has

been written off:
1. reverse the entry made to write off the account
and ...
 THE
THE ALLOWANCE
ALLOWANCE METHOD
METHOD

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
500
July 1 Cash
Accounts Receivable —Nadeau 500

To record collection from Nadeau.

2. Record the collection in the usual manner.

 BASES
BASES USED
USED FOR
FOR THE
THE
ALLOWANCE
ALLOWANCE METHOD
METHOD

• Companies use either of two methods in

the estimation of uncollectible accounts:
1. Percentage of sales
2. Percentage of receivables
• Both bases are GAAP; the choice is a
management decision.
 ILLUSTRATION
ILLUSTRATION 9-4
9-4
COMPARISON
COMPARISON OF
OF BASES
BASES OF
OF
ESTIMATING
ESTIMATING UNCOLLECTIBLES
UNCOLLECTIBLES

Percentage of Sales Percentage of Receivables

Net Realizable Value
Allowance
Accounts for
Receivable Doubtful
Accounts

Emphasis on Income Emphasis on

Statement Relationships
Balance Sheet
Relationships
 PERCENTAGE
PERCENTAGE OF
OF SALES
SALES BASIS
BASIS

• In the percentage of sales basis, management

establishes a percentage relationship between
the amount of credit sales and expected losses
from uncollectible accounts.
• Expected bad debt losses are
determined by applying the
percentage to the sales base
of the current period.
• This basis better matches expenses
with revenues.
 PERCENTAGE
PERCENTAGE OF
OF
RECEIVABLES
RECEIVABLES BASIS
BASIS

• Under the percentage of receivables

basis, management establishes a
percentage relationship between the
amount of accounts receivable and the
required balance in the allowance
account.
• This percentage can be applied to
the total accounts receivable balance,
or to individual accounts
receivable balances stratified by age.
 PERCENTAGE
PERCENTAGE OF
OF
RECEIVABLES
RECEIVABLES BASIS
BASIS

• The required balance in the allowance account

is determined by applying the percentage to
the accounts receivable balance at the end of
the current period.
• The amount of the adjusting entry to record
expected bad debt losses for the current
period is the difference between the required
balance and the existing balance in the
allowance account.
• This basis produces the better estimate of net
realizable value of receivables.
 DISPOSING
DISPOSING OF
OF
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

To accelerate the receipt of cash from

receivables, owners frequently:
1. sell to a factor, such as a finance company
or a bank, and
2. make credit card sales.
 DISPOSING
DISPOSING OF
OF
ACCOUNTS
ACCOUNTS RECEIVABLE
RECEIVABLE

• A factor buys receivables from businesses

for a fee and collects the payments
directly from customers.
• Credit cards are frequently used by retailers
who wish to avoid the paperwork of issuing
credit.
• Retailers can receive cash more quickly
from the credit card issuer.
 CREDIT
CREDIT CARD
CARD SALES
SALES

• Three parties are involved when credit cards are

used in making retail sales:
1. the credit card issuer,
2. the retailer, and
3. the customer.
• The retailer pays the credit card issuer a
percentage fee of the invoice price for its services.
• From an accounting standpoint, sales from bank
cards (e.g., Visa and MasterCard) are treated
differently than sales from non-bank cards (e.g.,
American Express).
 BANK
BANK CARD
CARD SALES
SALES

• Sales resulting from the use of VISA and

MasterCard are considered cash sales by the
retailer.
• These cards are issued by banks.
• Upon receipt of credit card sales slips from a
retailer, the bank immediately
adds the amount to the
seller’s bank balance.
 BANK
BANK CARD
CARD SALES
SALES

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
965
July 31 Cash
Credit Card Expense ($1,000 x 3.5%) 35

Sales 1,000

To record VISA credit card sales.

Anita Ferreri purchases a number

of compact discs for her restaurant
from Karen Kerr Music Co. for
$1,000 using her Royal Bank VISA
card. The service fee that the Royal
charges is 3.5 percent.
 NON-BANK
NON-BANK CARD
CARD SALES
SALES

• Sales using American Express and other

non-bank cards are reported as credit sales,
not cash sales.
• Conversion into cash does not occur until
American Express remits the net amount
to the seller.
 NON-BANK
NON-BANK CARD
CARD SALES
SALES

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
475
July 31 Accounts Receivable
Credit Card Expense ($500 x 5%) 25

Sales 500

To record American Express

credit card sales.

Kerr Music Co. accepts an

AMERICAN EXPRESS card
for a $500 sale. The service fee
that AMERICAN EXPRESS
charges is 5 percent.
 NOTES
NOTES RECEIVABLE
RECEIVABLE

• A promissory note is a written promise to

pay a specified amount of money on demand
or at a definite time.
• The party making the promise is the maker.
• The party to whom
payment is made is
called the payee.
 ILLUSTRATION
ILLUSTRATION 9-8
9-8
FORMULA
FORMULA FOR
FOR
C
CALCULAT
ALCULATING
ING INTEREST
INTEREST

The basic formula for calculating interest on an

interest-bearing note is:

Annual Time
Face Value X X = Interest
Interest in Terms of
of Note
Rate One Year
RECOGNIZING
RECOGNIZING NOTES
NOTES RECEIVABLE
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
1,000
May 1 Notes Receivable
Accounts Receivable — Brent Company 1,000
To record acceptance of Brent
Company note.

Wilma Company receives a $1,000, 6%

promissory note, due in two months (July 31)
from Brent Company to settle an open account.
 VALUING
VALUING NOTES
NOTES RECEIVABLE
RECEIVABLE

• Like accounts receivable, short-term notes

receivable are reported at their net
realizable value.
• The notes receivable
allowance account is
Allowance for
Doubtful Notes.
 HONOUR
HONOUR OF
OF NOTES
NOTES RECEIVABLE
RECEIVABLE
GENERAL JOURNAL
Date Account Title and Explanation Debit Credit
Sept. 30 Cash 10,150
Notes Receivable - Higly 10,000
Interest Revenue 150
To record collection of Higly note.

• A note is honoured when it is paid in full at its maturity date.

• Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a
4.5% interest-bearing note, due in 4 months, on September 30.
• Wolder collects the maturity value of the note from Higley on
September 30.
 DISHONOUR
DISHONOUR OF
OF NOTES
NOTES RECEIVABLE
RECEIVABLE
GENERAL JOURNAL
Date Account Title and Explanation Debit Credit
Sept. 30 Accounts Receivable - Higly 10,150
Notes Receivable - Higly 10,000
Interest Revenue 150
To record the dishonour of Higly note.

• A dishonoured note is a note that is not paid in full at

maturity.
• A dishonoured 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.
 BALANCE SHEET PRESENTATION
OF RECEIVABLES
• Each of the major types of receivables
should be identified in the balance sheet or
in the notes to the financial statements.
• In the balance sheet, short-term
receivables are reported within the current
assets section below cash and temporary
investments.
• Both the gross amount of receivables and
the allowance for doubtful accounts should
be reported.
 USING THE INFORMATION IN THE
FINANCIAL STATEMENTS

• Financial ratios are calculated to evaluate the

short-term liquidity of a company.
• These ratios include the
1. current ratio,
2. acid test (quick) ratio,
3. receivables turnover ratio, and the
4. collection period ratio.
 CURRENT RATIO

• The current ratio (working capital ratio) is a

widely used measure for evaluating a company’s
liquidity and short-term debt-paying ability.

CURRENT ASSETS
CURRENT RATIO = ——
—————————

CURRENT
LIABILITIES
 ACID TEST RATIO

• The acid test ratio (quick ratio) is a

measure of a company’s short-term
liquidity.

CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET)

ACID TEST RATIO = ————————————————————————————

CURRENT LIABILITIES
 ACCOUNTS RECEIVABLE
TURNOVER RATIO
• The ratio used to assess the liquidity of the
receivables is the receivables turnover ratio.

Net Credit
Sales
 Average Net
Receivables =
Receivables
Turnover
 COLLECTION PERIOD

• The collection period in days is a variant of the

receivables turnover ratio and makes liquidity
even more evident.
• The general rule is that the collection period
should not exceed the credit term period.

Days in Year Receivables Collection

 =
(365) Turnover Period in Days
 COPYRIGHT

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