Financial Accounting: Tools For Business Decision Making: Reporting and Analyzing Receivables

Financial Accounting: Tools for
Business Decision Making

Ninth Edition
Kimmel; Weygandt; Kieso
Chapter 8
Reporting and Analyzing Receivables
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Chapter Outline
Learning Objectives
LO 1 Explain how companies recognize accounts
receivable.
LO 2 Describe how companies value accounts receivable
and record their disposition.
LO 3 Explain how companies recognize, value, and
dispose of notes receivable.
LO 4 Describe the statement presentation of receivables
and the principles of receivables management.
Copyright ©2019 John Wiley & Sons, Inc. 2
Learning Objective 1
Explain How Companies Recognize

Accounts Receivable
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 3

Types of Receivables

Receivables for Major Companies
Amounts due from individuals and companies that are
expected to be collected in cash.
Receivables as a
Company Percentage of
Company Total Assets
Ford Motor 43.2%
Company General Electric 41.5
Minnesota Mining and Manufacturing Company (3M) 12.7
DuPont Co. 11.7
Intel Corporation 3.9

Recognizing Accounts Receivable
• Service organizations record a receivable when it
performs service on account
• Merchandisers record accounts receivable at point of
sale of merchandise on account
• Seller may offer a discount to encourage early payment
• Buyer might return goods found to be unacceptable
• Sales returns reduce receivables

Recognizing Accounts Receivable
Illustration
Assume that Jordache Co. on July 1, 2022, 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 Receivable 1,000
Sales Revenue 1,000

Recognizing Returns on Account
Illustration
On July 5, Polo returns merchandise worth $100 to

Jordache Co.
Jul. 5 Sales Returns and Allowances 100
Accounts Receivable 100

Recognizing Discounts on Receivables
Illustration
On July 11, Jordache receives payment from Polo

Company for the balance due.
Jul. 11 Cash ($900 − $18) 882

Sales Discounts ($900 × .02) 18

Credit Card Receivables
Illustration
Some retailers issue their own credit cards. Assume that

you use your JCPenney Company credit card to purchase
clothing with a sales price of $300.
Jul. 15 Accounts Receivable 300

Sales Revenue 300

Interest on Credit Card Receivables
Illustration
If you still owe the $300 from the June 15 transaction at
the end of the month, JCPenney charges interest of 1.5%
per month on the balance due. JCPenney makes an
adjusting entry to record interest revenue on June 30 as
follows.
Jul. 30 Accounts Receivable 2.25
Interest Revenue 2.25
1
($300  1.5%  )
2
Describe How Companies Value

Accounts Receivable and Record
Their Disposition

Accounts Receivable
Valuation and Reporting
• Reporting accounts receivable
• Current asset
• Valuing accounts receivable
• Net realizable value
• Sales on account raise possibility of accounts not being
collected
• Resulting in uncollectible accounts receivable
• Seller records losses that result from extending credit as
Bad Debt Expense
Accounting for Uncollectible Accounts
Methods
Direct Write-Off Method
• No matching
• Receivable not stated at net realizable value
• Not acceptable for financial reporting
Allowance Method
• Better matching
• Receivable stated at net realizable value
• Required by GAAP
Accounts Receivable Reporting
Illustration
How are these accounts presented on the Balance Sheet?

Illustration Solution #1
ABC Corporation Balance Sheet (partial)
Current Assets:
Cash $ 330
Accounts receivable $500
Less: Allowance for doubtful accounts (25) 475
Inventory 812
Prepaid expense 40
Total current assets 1,657

Illustration Solution #2
Alternate Presentation
Current Assets:
Cash $ 330
Accounts receivable, net of $25 allowance 475
Inventory 812
Prepaid expense 40

Accounts Receivable Transactions
Sales on Account
Credit sale of $100
Sales 100

Collections on Account
Collection of $333 on account
Cash 333

Estimate Doubtful Accounts
Adjustment of $15 for estimated bad debts
Bad Debts Expense 15
Allowance for Doubtful Accounts 15

Write-Off Uncollectible Accounts
Write-off of uncollectible accounts of $10


Accounts Receivable
Reporting on the Balance Sheet

Current Assets:
Cash $ 330
Accounts receivable, net of $30 allowance 227
Merchandise Inventory 812
Prepaid expense 40

Direct Write-Off Method for Uncollectibles
Illustration
Assume that Warden Co. writes off M. E. Doran’s $200
balance as uncollectible on December 12. Warden’s entry
is:
Bad Debt Expense 200

Not acceptable for financial reporting.

Allowance Method for Uncollectible
Accounts
• Companies estimate uncollectible accounts receivable
• Debit Bad Debt Expense
• Credit Allowance for Doubtful Accounts, a contra-
asset account
• Companies write off uncollectible accounts receivable
at the time the specific account becomes uncollectible
• Debit Allowance for Doubtful Accounts
• Credit Accounts Receivable
Recording Estimates Uncollectible Accounts Receivable
Illustration
Hampson Furniture has credit sales of $1,200,000 in 2022,

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 Debt Expense 12,000

Allowance for Doubtful Accounts 12,000

Reporting Receivables Under the
Allowance Method
Illustration

Write-Off of Uncollectibles Using the Allowance Method
Illustration
On March 1, 2023, Hampson Furniture writes-off $500

owed by R. A. Ware. The entry to record the write-off is:
Mar. 1 Allowance for Doubtful Accounts 500


Recovery of an Uncollectible Account Using the Allowance Method
Illustration
On July 1, R. A. Ware pays the $500 amount that Hampson

Furniture had written off on March 1. Hampson makes these
entries:
July 1 Accounts Receivable 500

1 Cash 500

Methods of Estimating the Allowance
Percentage-of-Receivables Basis
• Management establishes a percentage relationship
between amount of receivables and expected losses
from uncollectible accounts
• Bad debt expense to be recorded
• Difference between required balance and existing
balance in allowance account

Estimating the Allowance Using an Aging

Illustration with a Credit Balance
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.

Illustration with a Debit Balance
Illustration: Assume the unadjusted trial balance shows Allowance

for Doubtful Accounts with a debit balance of $500. Prepare the
adjusting entry assuming $2,228 is the estimate of uncollectible
receivables.

Disposing of Accounts Receivables
Selling to a Factor
Sale of Receivables to a Factor
• A factor can be a finance company or bank
• Factors buys receivables from businesses and then
collect payments directly from customers
• Typically charges a commission to company that is
selling receivables
• Fee ranges from 1% to 3% of receivables purchased

Sale of Receivables to a Factor
Illustration
Assume that Hendredon Furniture factors $600,000 of

receivables to Federal Factors. Federal Factors assesses a
service charge of 2% of the amount of receivables sold.
The journal entry to record the sale by Hendredon
Furniture is as follows.
Cash 588,000
Service Charge Expense 12,000
Accounts Receivable 600,000
($600,000 × 2% = $12,000)
National Credit Card Sales
• Retailer pays card issuer a fee of 2 to 4% of the invoice
price for its services.
• Recorded the same as cash sales
• Advantages to retailer:
• Issuer does credit investigation of customer
• Issuer maintains customer accounts
• Issuer undertakes collection and absorbs losses
• Receives cash more quickly

National Credit Card Sales
Illustration
Anita Ferreri purchases $1,000 of sound equipment for
her restaurant from Karen Kerr Music Co., using her Visa
First Bank Card. First Bank charges a service fee of 3%.
The entry to record this transaction by Karen Kerr Music
on March 22, 2022, is as follows.
Cash 970
Service Charge Expense 30
Sales Revenue 1,000
($1,000 × 3% = $30)
Explain How Companies Recognize,

Value, and Dispose of Notes
Receivable

The Nature of Notes Receivable
Companies may grant credit in exchange for a promissory
note.
• 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
• when individuals and companies lend or borrow money,
• when amount of transaction and credit period exceed
normal limits, or
• in settlement of accounts receivable.

Notes Receivable Illustration
To the payee, the promissory note is a note receivable.
To the maker, the promissory note is a note payable.

Determining the Maturity Date
Maturity date of a promissory note may be stated in one
of three ways:
• On demand.
• On a stated date.
• At the end of a stated period of time.
Note terms are expressed in
• Months
• Days
Computing Interest
Face Value of Note × Annual Interest Rate × Time in
Terms of One Year = Interest
When counting days, omit date note is issued, but include
due date

Recording Notes Receivable
Illustration
Calhoun Company wrote a $1,000, two-month, 12%

promissory note dated May 1, to settle an open account.
Prepare the entry that Wilma Company makes for the
receipt of the note.
May 1 Notes Receivable 1,000

Accounts Receivable 1,000

Valuing Notes Receivable
• Report short-term notes receivable at their cash (net)
realizable value
• Estimation of cash realizable value and recording bad
debt expense and related allowance are similar to
accounts receivable

Disposing of Notes Receivable
• Notes may be held to their maturity date
• Maker may default and payee must make an adjustment
to the account
• Holder speeds up conversion to cash by selling the note
receivable

Honoring and Dishonoring Notes
• Honor of note receivable
• Occurs when its maker pays it in full at its maturity
date
• Dishonor of notes receivable
• A note that is not paid in full at maturity
• .Dishonored notes receivable are no longer negotiable

Honor of Notes Receivable
Illustration
Wolder Co. lends Higley Inc. $10,000 on June 1, accepting a five-

month, 9% interest note. If Wolder presents the note to Higley Inc.
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
5
($10, 000  9%   $375)
12

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.
4
($10, 000  9%   $300)
12
Sept. 1 Interest Receivable 300

Collection of a Note and Interest
Illustration
Prepare the entry Wolder’s would make to record the honoring of

the Higley note on November 1.
Nov. 1 Cash 10,375
Interest Receivable 300

Interest Revenue 75
1
($10, 000  9%   $75)
12

Dishonor of Notes Receivable
Illustration With Expected Collection
Assume that Higley Co. on November 1 indicates that it cannot pay

at the present time. If it does expect eventual collection, Wolder Co.
would make the following entry at the time the note is dishonored
(assuming no previous accrual of interest).:
Nov. 1 Accounts Receivable 10,375


Dishonor of Notes Receivable
Illustration With No Expected Collection
If instead on November 1 there is no hope of collection, the note
holder would write off the face value of the note by making the
following entry at the time the note is dishonored (assuming no
previous accrual of interest).:
Nov. 1 Allowance for Doubtful Accounts 10,000

Describe the Statement Presentation

of Receivables and the Principles of
Receivables Management

Financial Statement Presentation of
Receivables

Managing Receivables
Managing accounts receivable involves five steps:
1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
4. Evaluate the liquidity of receivables.
5. Accelerate cash receipts from receivables when
necessary.

Extending Credit
• If credit policy is too tight, a company will lose sales
• If credit policy is too loose, a company may sell to
customers who will pay either very late or not at all
• It is important to
• check references on potential new customers
• check financial health of continuing customers

Establishing a Payment Period for
Receivables
• Companies should determine a required payment period
• Must communicate that policy to their customers
• Payment period should be consistent with that of
competitors

Monitoring Collections of Receivables
• Companies should prepare an accounts receivable aging
schedule at least monthly
• Helps managers estimate timing of future cash
inflows
• Provides information about collection experience of
company and identifies problem accounts
• Significant concentrations of credit risk must be
discussed in notes to financial statements

Evaluating Liquidity of Receivables
Accounts receivable turnover

• Helps to assess liquidity of receivables
• Measures the number of times, on average, a company
collects receivables during the period
Average collection period

• Helps to assess the effectiveness of credit and collection policies
• Should not exceed credit term period

Evaluating Liquidity of Receivables
Illustration
Net Credit Sales
Accounts Receivable Turnover 
AverageNet AccountsReceivable
365
Average Collection Period 
Accounts Receivable Turnover
Ratio Nike ($ in millions) Skechers USA

2017 2016 2016
A numerator of $34,350 divided by a denominator of $3,677 plus $3,241 divided by 2 = 9.9 times
Accounts receivable $34,350

 9.9 times 9.8 times 10.6 times
turnover ($3, 677  $3, 241) / 2
365 days divided by 9.9 = 36.9 days
Average collection 365days

period
 36.9 days 37.2 days 34.4 days
9.9

Accelerating Cash Receipts
Three reasons receivables are sold
• Size
• Companies may sell receivables because they may be
the only reasonable source of cash
• Billing and collection are often time-consuming and
costly

The Flow of Managing Receivables

Financial Accounting: Tools For Business Decision Making: Reporting and Analyzing Receivables

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Financial Accounting: Tools for

Business Decision Making

Explain How Companies Recognize

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 3

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 4

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 5

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 6

Assume that Jordache Co. on July 1, 2022, sells

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 7

On July 5, Polo returns merchandise worth $100 to

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 8

On July 11, Jordache receives payment from Polo

Jul. 11 Cash ($900 − $18) 882

Accounts Receivable 900

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 9

Some retailers issue their own credit cards. Assume that

Jul. 15 Accounts Receivable 300

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 10

Describe How Companies Value

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 12

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 15

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 16

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 17

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 18

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 19

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 20

Write-off of uncollectible accounts of $10

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 21

ABC Corporation Balance Sheet (partial)

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 22

Bad Debt Expense 200

Not acceptable for financial reporting.

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 23

Hampson Furniture has credit sales of $1,200,000 in 2022,

Dec. 31 Bad Debt Expense 12,000

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 25

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 26

On March 1, 2023, Hampson Furniture writes-off $500

Mar. 1 Allowance for Doubtful Accounts 500

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 27

On July 1, R. A. Ware pays the $500 amount that Hampson

Allowance for Doubtful Accounts 500

Accounts Receivable 500

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 28

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 29

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 30

The unadjusted trial balance shows Allowance for Doubtful

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 31

Illustration: Assume the unadjusted trial balance shows Allowance

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 32

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 33

Assume that Hendredon Furniture factors $600,000 of

LO 2 Copyright ©2016 John Wiley & Sons, Inc. 35

Explain How Companies Recognize,

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 37

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 38

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 39

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 41

Calhoun Company wrote a $1,000, two-month, 12%

May 1 Notes Receivable 1,000

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 42

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 43

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 44