Week 7 - Presentation Slides

Financial Accounting Fifth Edition
Receivables and
Sales
CHAPTER
5 Spiceland • Thomas • Herrmann
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 5-1
Part A
RECOGNIZING ACCOUNTS RECEIVABLE
Learning Objective 1
LO5–1 Recognize accounts receivable
Credit Sales
• Transfer products and services to a customer
today and expect to collect cash in the future
• Also known as sales on account or services on
account Acc receivable
• Common for many business transactions
Accounts Receivable
• Cash owed to the company by its customers
from sales or services on account
• Recorded at the time of the sale or service
• Also called trade receivables
Recording of Credit Sales
• Link’s Dental charges $500 for teeth
whitening. Dee Kay decides to have her teeth
whitened on March 1 but doesn’t pay cash at
the time of service. She promises to pay the
$500 whitening fee to Link by March 31.
March 1 Debit Credit

Accounts Receivable ……………………. 500
Service Revenue …………….......... 500
(Provide services on account)
Other Types of Receivables
• Nontrade receivables: receivables that
originate from sources other than customers
 Tax refund claims, interest receivable, and loans by
the company to other entities, including
stockholders and employees
• Notes receivable: formal credit arrangements
evidenced by written debt instruments (or
“notes”)
Concept Check 5–1
Which of the following are sometimes called
trade receivables?
a. Accounts receivable
b. Interest receivable
c. Notes receivable
d. Tax refund claims
Accounts receivable are sometimes called trade
receivables. Nontrade receivables include tax
refund claims, interest receivable, and loans by the
company to other entities.
LO5–2 Calculate net revenues using discounts,

returns, and allowances.
Trade Discounts
• Reduction in list price of a product or service
 Used to provide incentives to larger customers or
certain consumer groups (senior citizens, military)
 Recognized by recording revenue for lower amount
• Link’s Dental typically charges $500 for teeth
whitening. Dr. Link offers a 20% discount on
teeth whitening.
Accounts Receivable ……………………. 400
Service Revenue …………….......... 400
(Make credit sale of $500 with a 20% trade discount)
Sales Returns and Allowances
• Customers are sometimes dissatisfied with a product
or service
Sales Return Sales Allowances

• Customer returns goods • Customer does NOT
previously purchased return a product
(a) Seller issues a cash (a) Seller issues a cash
refund if original sale refund if original sale
was for cash was for cash
(b) Seller reduces balance (b) Seller reduces balance
of accounts receivable of accounts receivable
if original sale was on if original sale was on
account account
Sales Allowances
• After getting her teeth whited on March 1, Dee
notifies Dr. Link on March 5 that another dentist is
offering the same procedure for $350
• Dr. Link reduces Dee’s account balance by $50
March 5 Revenue acc!!! But dr mean increases Debit Credit
Sales Allowances .………………………… 50
Accounts Receivable ……………... 50
(Provide sales allowance for previous credit sale)
• Sales Returns or Sales Allowances

 Contra revenue accounts
 Reported with total revenues in the income
statement, but with negative balances
Common Mistake
Students sometimes misclassify contra revenue
accounts—sales returns and sales allowances—
as expenses. Like expenses, contra revenues
have normal debit balances and reduce the
reported amount of net income. However,
contra revenues represent reductions of
revenues, whereas expenses represent the
separate costs of generating revenues.
Sales Discount
• Offer a customer a reduction if payment is made
within a specified period of time
• Link’s Dental offers Dee terms of 2/10, n/30 on
$350 owed; Dee pays on March 10 (w/in 10 days)
Trade Cash ……………………………………………. 343
discount is Sales Discounts …………………………… 7
not a acc
Just minus Accounts Receivable ……………... 350
the amount (Collect cash on account with a 2% sales discount = $350 × 2%)
• Sales Discounts = Contra revenue account
 Reported with total revenues in the income
statement, but with a negative balance
Illustration 5–1
Income Statement Reporting Revenues
Net of Sales Allowances and Sales
Discounts
LINK’S DENTAL
Income Statement (partial)
Includes $100
Service revenue $400 reduction for
trade discount
Less: Sales allowances (50)
Less: Sales discounts (7)
Net service revenue $343
Illustration 5–2
Balance of Accounts Receivable after Credit
Sale and Subsequent Collection on Account
Accounts Receivable
Credit sale of $500 with Mar. 1 400
$100 trade discount Mar. 5 50 Sales allowance of $50
Mar. 10 350 Cash collection of $343

with $7 sales discount
Ending balance Bal. 0
Concept Check 5–2
The effect of a sales allowance will result in which of
the following:
a. An increase to net income
b. A decrease to net income
c. An increase to accounts receivable
d. An increase to sales revenue
The effect of a sales allowance is to decrease net

income. A sales allowance decreases sales revenue in
the income statement. A sales allowance also decreases
assets by decreasing the balance of accounts receivable.
Contra revenue – reduce revenue
Concept Check 5–3
Which of the following computations would be used
to compute Net Revenue?
a. Total Revenue + Accounts Receivable – Sales
Discounts – Sales Allowances
b. Net Revenue + Sales Allowances – Sales Discounts
c. Total Revenue – Sales Discounts – Sales
Allowances
d. Net Income – Change in Accounts Receivable
Net Revenue is equal to Total Revenue less Sales
Discounts and Sales Allowances.
Illustration 5–3
Income Statement Reporting Revenues Net
of Sales Discounts, Returns, and Allowances
GENERAL HEALTH
For the year ended 2018
Sales and service revenue $ 400,000

Less: Sales discounts ($6,000 actual + $1,000 estimate) (7,000)
Less: Sales returns ($10,000 actual + $2,000 estimate) (12,000)
Less: Sales allowances ($14,000 actual + $3,000 estimate) (17,000)
Net revenue $364,000
Part B
VALUING ACCOUNTS RECEIVABLE
LO5–3 Record an allowance for future uncollectible

accounts.
Key Point
We recognize accounts receivable as assets in
the balance sheet and report them at their net
realizable value, that is, the amount of cash we
expect to collect.
Allowance Method (GAAP)
• Some accounts receivable will not be collected
• Companies are required to:
 Estimate future uncollectible accounts
 Record estimates in the current year
• Estimated uncollectible accounts
 Reduce assets (accounts receivable)
 Increase expenses (bad debt expense)
Key Point
Under the allowance method, companies are
required to estimate future uncollectible
accounts and record those estimates in the
current year. Estimated uncollectible accounts
reduce assets and increase expenses.
Estimating Uncollectible Accounts
• Percentage-of-receivables method
 Bases the estimate of bad debts on a balance
sheet amount—accounts receivable
 Also called the “balance sheet method”
• At the end of 2021, Kimzey is owed $20 million
from customers and estimates that 30% will
not be collected.
December 31, 2021 ($ in millions) Debit Credit
Bad Debt Expense ……………………………………. 6
Allowance for Uncollectible Accounts... 6
(Estimate future bad debts)
($20 million × 30% = $6 million)
• Bad Debt Expense
 Expense reported in the income statement
• Allowance For Uncollectible Accounts
 Contra asset reported in the balance sheet
 Reduces the balance of accounts receivable
Illustration 5–3
Partial Income Statement Showing
Estimated Bad Debt Expense
KIMZEY MEDICAL CLINIC

($ in millions)
Credit sales $50
Bad debt expense (6)
$44
Illustration 5–4
Accounting for Uncollectible Accounts and
the Accounts Receivable Portion of the
Balance Sheet
2021 2022
($ in millions) (next year)
(current year)
$50 $20 $14 Collectible
Credit sales Not collected Estimate
during 2021 by end of year $6 Uncollectible

Asset Balance Sheet (partial) Contra
December 31, 2021 Asset
Current assets:
Accounts receivable $20
Less: Allowance (6)
Net accounts receivable $14
Key Point
• Adjusting for estimates of future uncollectible

accounts matches expenses (bad debts) in the
same period as the revenues (credit sales)
they help to generate.
• Recording an allowance for uncollectible
accounts correctly reports accounts receivable
at their net realizable value.
Bad debt  like default (customer’s fault)

 Company bear that amount of money
Common Mistake
Because Allowance for Uncollectible Accounts
has a normal credit balance, students
sometimes misclassify this account as a liability,
which also has a normal credit balance. Instead,
this contra asset represents a reduction in a
related asset account.
Concept Check 5–4
Which of the following is true regarding Allowance for
Uncollectible Accounts?
a. It is a liability account.
b. It is added to the total of Sales Discounts, Sales
Returns, and Sales Allowances.
c. It is subtracted from the balance of Accounts
Receivable in the balance sheet.
d. It appears in the income statement as an expense.
The allowance account is a contra asset and is used to
record estimated future uncollectible accounts. The balance
is subtracted from Accounts Receivable in the balance sheet
to arrive at Accounts Receivable’s carrying value.
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
5-31
LO5–4 Use the aging method to estimate future

uncollectible accounts.
Illustration 5–5
Kimzey’s Accounts Receivable Aging
Schedule
Days Past Due
More than
Patients Not Yet Due 1–60 61–120 120 Total
Shirley Akin $ 12,000 $ 12,000
Bruce Easley $ 4,000 4,000
Ben Greene $ 5,000 5,000
Anita Hand $ 7,000 7,000
Ima Hertz 9,000 9,000
Noah Luck 8,000 8,000
Phil Sikley 6,000 6,000
Justin Payne 10,000 10,000
Others 9,973,000 5,987,000 2,993,000 986,000 19,939,000
Total Accounts
Receivable $10,000,000 $ 6,000,000 $ 3,000,000 $1,000,000 $20,000,000
Estimated Percent
Uncollectible 10% 30% 50% 70% % increases
with age
Estimated Amount
Uncollectible $ 1,000,000 $1,800,000 $1,500,000 $ 700,000 $ 5,000,000
Total estimated
uncollectible
Aging Method
• Considers the age of receivables
 Older accounts are more likely uncollectible
• More accurate than using a single percentage
• From Kimzey’s aging schedule (Illustration 5–6
on the previous slide) the estimate of
uncollectible accounts equals $5 million.
December 31 ($ in millions) Debit Credit
Concept Check 5–5
Which of the following is true about the aging
method?
a. No estimate for uncollectible accounts is made.
b. Older accounts are more likely to be collected.
c. It is not acceptable for GAAP.
d. Older accounts are less likely to be collected.
The aging method recognizes that the longer

accounts are past due, the less likely they are to be
collected. The aging method should provide a more
accurate estimate of total uncollectible accounts
compared to using a single percentage.
Illustration 5–6
Excerpt from Tenet Healthcare
Corporation’s Annual Report
TENET HEALTHCARE CORPORATION
Notes to the Financial Statements (excerpt)
We provide for an allowance against accounts receivable that could become uncollectible by establishing an allowance
to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance
based on the aging of our accounts receivable by hospital, our historical collection experience by hospital and for each
type of payer over a look-back period, and other relevant factors. There are various factors that can impact collection
trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of
uninsured and underinsured patients, the volume of patients through the emergency department, the increased
burden of co-payments and deductibles to be made by patients with insurance, and business practices related to
collection efforts. These factors continuously change and can have an impact on collection trends and our estimation
process.
The following tables present the approximate aging by payer of our continuing operations’ net accounts receivable.
Indemnity, Self-Pay,
Age Medicare Medicaid Managed Care and Other Total
0–60 days $262 $ 67 $943 $ 158 $1,430
61–120 days 29 34 229 104 396
121–180 days 13 18 100 60 191
Over 180 days 19 34 157 225 435
Total $323 $153 $1,429 $547 $2,452
Key Point
Using the aging method to estimate
uncollectible accounts is more accurate than
applying a single percentage to all accounts
receivable. The aging method recognizes that
the longer accounts are past due, the less likely
they are to be collected.
LO5–5 Apply the procedure to write off accounts

receivable as uncollectible.
Writing Off Accounts Receivable
• When it becomes clear a customer will not pay,
the company writes off the customer’s account
balance as uncollectible Just like you take money from bank
You use the money to buy food
• The write-off: Nth changes in the bank
 Reduces the balance of Accounts Receivable

 Reduces the balance of the Allowance for Uncollectible
Accounts
• The write-off has no effect on total assets (balance
sheet) or total expenses (income statement)
• Negative effects of bad debts were recorded in an
adjusting entry at the end of the previous year.
Writing Off Accounts Receivable
• Kimzey receives notice that Bruce Easley has filed for
bankruptcy and will not pay $4,000
• Kimzey writes off Bruce’s account receivable
February 23, 2022 Debit Credit
Allowance for Uncollectible Accounts …… 4,000
Accounts Receivable ………………………… 4,000
(Write off a customer’s account )
• The write-off involves:

 Decreasing a contra asset (Allowance for Uncollectible
Accounts)
 Decreasing an asset (Accounts Receivable)
• The net effect on total assets is zero
Common Mistake
Students often mistakenly record bad debt
expense when they write off an uncollectible
account. The bad debt expense was recorded in
a prior year at the time of estimating
Bad debt affect acc receivable
Collection of Accounts Previously
Written Off
• Bruce later pays 25% ($1,000) of amount owed
September 8, 2022 Debit Credit
Accounts Receivable ………………………………… 1,000
Allowance for Uncollectible Accounts… 1,000
(Reestablish portion of account previously written off)
September 8, 2022 Debit Credit

Cash …………………………………………………………. 1,000
Accounts Receivable …………………………... 1,000 (Collect
cash on account)
• Collection has no effect on total assets or net income

Concept Check 5–6
When writing off an uncollectible account:
a. Bad debt expense is debited.
b. Net income is decreased.
c. Total assets are unchanged.
d. The allowance account is credited.
The write-off of an account receivable has no effect
on total amounts reported in the balance sheet or
in the income statement. There is no decrease in
total assets and no decrease in net income.
Key Point
Writing off a customer’s account as uncollectible
reduces the balance of accounts receivable but
also reduces the contra asset—allowance for
uncollectible accounts. The net effect is that
there is no change in the net receivable (accounts
receivable less the allowance) or in total assets.
We recorded the decrease to assets as a result of
the bad debt when we established the allowance
for uncollectible accounts in a prior year.
Allowance Method in the Following Year
• Recall that using the aging method, Kimzey
estimated bad debts at the end of 2021 to be $6
million (future write-offs of $6 million)
• Actual bad debts were only $4 million (write-offs
in 2022). In other words, the year-end 2021
amount was overestimated by $2 million
• Using the aging method, Kimzey estimated bad
debts at the end of 2022 to be $7 million
• How does Kimzey record its $7 million estimate of
future bad debts at the end of 2022?
Illustration 5–7
Balance of Kimzey’s Allowance for
Uncollectible Accounts
Allowance for Uncollectible Accounts
($ in millions)
6 Beg. balance for 2022
Write-offs in 2022 4
2 Bal. before adjustment
? Year-end adjustment
7 Ending balance for 2022

Illustration 5–8
Bad Debt Expense in the Income
Statement
Income Statement
($ in millions)
Revenue from credit sales $80
Expenses:
Bad debt expense $ 5
Other operating expenses 50 55
Net income $25
ILLUSTRATION 5–9
Accounts Receivable Portion of the
Balance Sheet
Balance Sheet (partial)
December 31, 2022
Assets
Current assets ($ in millions):
Accounts receivable $30
Less: Allowance for uncollectible accounts (7)
Net accounts receivable $23
Underestimating Bad Debts--Example
1. What if actual bad debts in 2022 were $6 million,
compared to an estimate of $5 million?
2. What adjustment is required at year-end?
Allowance for Uncollectible Accounts
($ in millions)
5 Beg. balance for 2022
Write-offs in 2022 6
Bal. before adj. 1
? Year-end adjustment
7 Ending balance for 2022

Illustration 5-10
Excerpt from Tenet Healthcare
Corporation’s Annual Report
TENET HEALTHCARE CORPORATION
Notes to the Financial Statements (excerpt)
The preparation of financial statements, in conformity with accounting principles generally
accepted in the United States of America (“GAAP”), requires us to make estimates and
assumptions that affect the amounts reported in our Consolidated Financial Statements
and these accompanying notes. We regularly evaluate the accounting policies and
estimates we use. In general, we base the estimates on historical experience and on
assumptions that we believe to be reasonable given the particular circumstances in which
we operate. Although we believe all adjustments considered necessary for a fair
presentation have been included, actual results may vary from those estimates.
Concept Check 5–7
When an entry is made to write off an
uncollectible account,
a. Bad debt expense is debited.
b. Net income is decreased.
c. Total accounts receivable is unchanged.
d. The allowance account is credited.
Overall, the write-off of an account receivable has no
effect on total amounts reported in the balance sheet or
in the income statement. There is no decrease in total
assets and no decrease in net income with the write-off.
LO5–6 Contrast the allowance method and direct

write-off method when accounting for
Direct Write-Off Method (Not GAAP)
• Write off bad debts only at the time they

actually become uncollectible
 Unlike the allowance method, which requires
estimation of uncollectible accounts before they
even occur
• Used:
 When uncollectible accounts are not anticipated
or are immaterial
 Primarily used for tax reporting
Illustration 5–11
Comparing the Allowance Method and
the Direct Write-off Method for
Recording Uncollectible Accounts
2021 Allowance Method Direct Write-off Method
Year-end Adjustment Bad Debt Expense 2,000 No adjustment
(Estimate = $2,000)
Allowance for Uncollectible Accounts 2,000
2022
Actual Write-offs Bad Debt Expense 2,000
(Actual = $2,000) Allowance for Uncollectible Accounts 2,000 Accounts Receivable 2,000
Accounts Receivable 2,000
• Allowance account is credited for the estimate and

debited for the actual write-off (balance cancels)
• Over both years, net effect is to debit Bad Debt
Expense and credit Accounts Receivable
 Difference between the methods is timing
Common Mistake
Some students erroneously think firms should
reduce total assets and record bad debt expense
at the time the bad debt actually occurs.
However, companies anticipate future bad
debts and establish an allowance for those
estimates.
Key Point
The direct write-off method reduces accounts
receivable and records bad debt expense at the
time the account receivable proves
uncollectible. If the credit sale occurs in a prior
reporting period, bad debt expense is not
properly matched with revenues (credit sales).
Also, accounts receivable will be overstated in
the prior period. The direct write-off method
typically is not acceptable for financial reporting.
Concept Check 5–8
On December 31 before adjusting entries, a
company’s balance of Allowance for Uncollectible
Accounts is a credit of $2,000. What does a “credit”
balance prior to adjusting entries indicate?
a. The company did not estimate bad debts last year.
b. Last year’s estimate of bad debts was too low.
c. The company’s estimate equals actual bad debts.
d. Last year’s estimate of bad debts was too high.
The Allowance for Uncollectible Accounts is a contra account
with a credit balance. The balance is reduced (debited) for
actual bad debts. If the account balance at the end of the year
is a credit, then estimated bad debts for this year are greater
than this year’s actual bad debts.
Concept Check 5–9
On December 31 before adjusting entries, a company reports the
following balances:
Accounts Receivable $100,000
Allowance for Uncoll. Accts.$2,000 (credit)
The company estimates bad debts to be 20% of accounts
receivable. The adjusting entry would include:
a. A debit to Bad Debt Expense = $18,000
b. A credit to Allowance for Uncoll. Accts. = $24,000
c. A credit to Allowance for Uncoll. Accts. = $22,000
d. A debit to Bad Debt Expense = $20,000
Bad debts are estimated to be $20,000 (= $100,000 × 20%). The
current $2,000 credit balance of the Allowance needs a credit
adjustment of $18,000 to be equal to $20,000 credit. The
adjustment of $18,000 is recorded as a debit to Bad Debt Expense
and a credit to Allowance for Uncollectible Accounts.
Part C
NOTES RECEIVABLE
LO5–7 Account for notes receivable and interest

revenue.
Illustration 5–12
Note Receivable
• Similar to accounts receivable but include a written debt
agreement, or note
 Normal debit balance
• Classified as either current or noncurrent asset
depending on time until due date
Face value $ 10,000 Date February 1, 2021
Due date Six months after date I promise to pay to the

order of Kimzey Medical Clinic
Payee Ten thousand and no/100 dollars
for value received with interest at the rate of 12% .
Interest rate Justin Payne
Maker
Recording Notes Receivable
• Kimzey provided $10,000 of services to Justin Payne,
who is not able to pay immediately
• Justin Payne signs a promissory note, offering to pay
$10,000 plus 12% interest in six months (August 1).
February 1, 2021 Debit Credit

Notes Receivable ………………………………… 10,000
Service Revenue ……………………………. 10,000
(Accept a six-month, 12% note receivable for services provided)
• No interest is recorded on February 1
Key Point
Notes receivable are similar to accounts
receivable except that notes receivable are
formal credit arrangements made with a written
debt instrument, or note.
Interest Calculation and Collection of
Notes Receivable
• After six months, Kimzey collects the full amount
owed by Justin, including interest
Face Annual Fraction
Interest = value × interest rate × of the year
$600 = $10,000 × 12% × 6/12
August 1, 2021 Debit Credit

Cash …………………………………………………. 10,600
Notes Receivable ………………………… 10,000
Interest Revenue ………………………… 600
(Collect note receivable and interest)
(Interest revenue = $10,000 × 12% × 6/12)
Illustration 5–13
Calculating Interest Revenue over Time
for Kimzey Medical Clinic
• What if the six-month note was accepted on
November 1, 2021 (due on May 1, 2022)?
2021 2022
Nov. 1 May 1
(Note issued) (Note due)
Nov. Dec. Jan. Feb. Mar. Apr.
$100 $100 $100 $100 $100 $100
2 months of 4 months of
interest revenue interest revenue
In 2021 = $200 in 2022 = $400
Accrue Interest and Collect Interest
• On December 31, 2021, Kimzey accrues interest for
note receivable accepted on November 1, 2021.
December 31, 2021 Debit Credit
Interest Receivable ……………………………… 200
Interest Revenue …………………………… 200
(Accrual of interest revenue = $10,000 × 12% × 2/12)
• On May 1, 2022, the maturity date, Kimzey collects

the note of $10,000 and the interest of $600.
May 1, 2022 Debit Credit
Cash ……………………………………………………. 10,600
Notes Receivable …………………………… 10,000
Interest Receivable (from 2021) …….. 200
Interest Revenue (from 2022) ………… 400
(Collect note receivable and interest)
(Interest revenue = $10,000 × 12% × 4/12)
5-66
Concept Check 5–10
A company accepts a note receivable of $5,000 on
September 1, 2021, that matures in 10 months and
has stated interest of 6%. What amount of interest
revenue will the company record in 2021 and 2022?
a. 2021 = $100; 2022 = $150
b. 2021 = $125; 2022 = $125
c. 2021 = $150; 2022 = $100
d. 2021 = $0; 2022 = $250
Interest Face Annual Fraction
= × interest rate ×
Revenue value of the year
2021: Interest Revenue = $5,000 × 6% × 4/12 = $100
2022: Interest Revenue = $5,000 × 6% × 6/12 = $150
Analysis - Learning Objective 8
LO5–8 Calculate key ratios investors use to monitor

a company’s effectiveness in managing
receivables.
Receivables Turnover Ratio
• Number of times during a year the average
accounts receivable balance is collected
Average Collection Period

• Number of days the average accounts
receivable balance is outstanding
Illustration 5–14
Comparison of Receivables Ratios between
Tenet Healthcare Corporation and LifePoint
Hospitals
Receivables Turnover Ratio Average Collection Period
Tenet Healthcare $21,070 ÷ $3,759.5 = 5.6 times 365 ÷ 5.6 = 65.2 days
LifePoint Hospitals $7,274 ÷ $1,672.5 = 4.3 times 365 ÷ 4.3 = 84.9 days
• Tenet:
 Higher receivables turnover
 Shorter collection period
 More efficiently collects cash from patients
Key Point
The receivables turnover ratio and average
collection period can provide an indication of
management’s ability to collect cash from
customers in a timely manner.
5-71
Which of the following would be true for a company that
has an accounts receivable turnover of 10?
a. The company turns over their accounts receivable more
than once a month.
b. The company would have an average collection period
of 36.5 days.
c. The company would be considered as doing an efficient
job of collecting receivables if the terms were net 30.
d. The company would have an average collection period
of 20 days.
The average collection period is computed as 365
divided by the accounts receivable turnover of 10
(= 36.5 days).
5-72
Appendix - Learning Objective 9
LO5–9 Estimate uncollectible accounts using the

percentage-of-credit-sales method.
5-73
Percentage-of-Credit-Sales Method
• Estimates uncollectible accounts based on the

percentage of credit sales
 Also called the income statement method
• Adjusts the allowance for uncollectible
accounts for the current year’s credit sales
that we don’t expect to collect
Illustration 5–15
Adjusting for Estimates of
Uncollectible Accounts
Percentage-of-Receivables Percentage-of-Credit Sales
Method Method
Estimate of Uncollectible Accounts Estimate of Uncollectible Accounts
• 20% of Accounts Receivable at the • 10.0% of credit sales in 2022 year will
end of 2022 will not be collected. not be collected.
• 20% of $30 million = $6 million. • 10.0% of $80 million = $8 million.
• Adjust Allowance account from $2 • Ignore $2 million existing balance of
million existing balance to estimate Allowance account and add $8 million.
of $6 million
Adjustment ($ in millions) Adjustment ($ in millions)
Bad Debt Expense 4 Bad Debt Expense 8
Allowance for Uncoll. Accts. 4 Allowance for Uncoll. Accts. 8
Illustration 5–16
Financial Statement Effects of
Percentage-of-Receivables Percentage-of-Credit-Sales
Method Method
($ in millions) ($ in millions)
Income Statement Effect Income Statement Effect
Revenues $80 Revenues $80
Bad debt expense Bad debt expense (8)
Net income (4) Net income $72
Balance Sheet Effect $76 Balance Sheet Effect
Accounts receivable Accounts receivable $30
Less: Allowance $30 Less: Allowance (10)*
Net accounts receivable (6)* Net accounts receivable $20
*$6 = $2 + $4 (adjustment) $24
*$10 = $2 + $8 (adjustment)
On December 31 before adjusting entries, a company
reports the following balances:
Accounts Receivable $100,000
Allowance for Uncoll. Accts. $2,000 (credit)
Credit Sales $500,000
The company estimates bad debts to be 4% of credit sales.
The adjusting entry would include:
a. A debit to Bad Debt Expense = $18,000
b. A credit to Allowance for Uncoll. Accts. = $24,000
c. A credit to Allowance for Uncoll. Accts. = $22,000
d. AThe
debit to Bad Debt
adjustment Expense
equals = $20,000
$500,000 × 4% = $20,000. The
adjusting entry includes a debit to Bad Debt Expense
and a credit to Allowance for Uncollectible Accounts.
5-77
Summary
1. LO5–1 Recognize accounts receivable.
2. LO5–2 Calculate net revenues using discounts,
returns, and allowances.
3. LO5–3 Record an allowance for future uncollectible
accounts.
4. LO5–4 Use the aging method to estimate future
5. LO5–5 Apply the procedure to write off accounts
receivable as uncollectible.
Summary
1. LO5–6 Contrast the allowance method and direct
write-off method when accounting for uncollectible
accounts.
2. LO5–7 Account for notes receivable and interest
revenue.
3. LO5–8 Calculate key ratios investors use to monitor
a company’s effectiveness in managing receivables.
4. LO5–9 Estimate uncollectible accounts using the
percentage-of-credit-sales method.
End of Chapter 5

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Financial Accounting Fifth Edition

5 Spiceland • Thomas • Herrmann

LO5–1 Recognize accounts receivable

• Common for many business transactions

March 1 Debit Credit

LO5–2 Calculate net revenues using discounts,

Sales Return Sales Allowances

• Sales Returns or Sales Allowances

Mar. 10 350 Cash collection of $343

The effect of a sales allowance is to decrease net

Sales and service revenue $ 400,000

LO5–3 Record an allowance for future uncollectible

KIMZEY MEDICAL CLINIC

KIMZEY MEDICAL CLINIC

• Adjusting for estimates of future uncollectible

Bad debt  like default (customer’s fault)

LO5–4 Use the aging method to estimate future

The aging method recognizes that the longer

LO5–5 Apply the procedure to write off accounts

 Reduces the balance of Accounts Receivable

• The write-off involves:

September 8, 2022 Debit Credit

• Collection has no effect on total assets or net income

December 31, 2022 ($ in millions) Debit Credit

December 31, 2022 ($ in millions) Debit Credit

LO5–6 Contrast the allowance method and direct

• Write off bad debts only at the time they

• Allowance account is credited for the estimate and

LO5–7 Account for notes receivable and interest

Due date Six months after date I promise to pay to the

February 1, 2021 Debit Credit

• No interest is recorded on February 1

August 1, 2021 Debit Credit

• On May 1, 2022, the maturity date, Kimzey collects

LO5–8 Calculate key ratios investors use to monitor

Average Collection Period

LO5–9 Estimate uncollectible accounts using the

• Estimates uncollectible accounts based on the

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