Valuation of Receivables

(Credit Losses on
Receivables)
Valuation of Receivables
Unfortunately not all customers will pay.
Do not want to overstate the asset on the
balance sheet.
The company estimates the amount that
will not be paid and sets up what is like a
holding account, called Allowance for
Credit Losses.
Presentation of AR
Accounts Receivable $100,000
Less: Allowance for Credit Losses (3,750)
$96,250
Two Methods to Estimate
1. Percentage of sales method
2. Percentage of receivables method
Similarities Between Methods
Under both methods:
1. Determine the expected credit losses on
outstanding receivables.
2. Determine the credit loss expense the
company needs to recognize on the income
statement in the current period.
3. Record a debit to an expense account called
credit loss expense and a balancing credit
to the allowance for credit losses account.
 Allowance For Credit Losses
Allowance for Credit Losses
(1) Beginning balance

(2) Credit losses written (3) Collection of previously written-

off off credit losses
(4) Amount charged to income
statement as credit loss
expense
(5) Ending balance
% of Sales Method
Calculate the percent of sales that will not
be collected. This is the credit loss
expense for the period.
This method matches sales and credit
losses in the same period.
Has an income statement focus.
 Percent of Sales T-Account
Allowance for Credit Losses
(1) Beginning balance

(2) Credit losses written off (3) Collection of previously written-

off credit losses
(4) Amount charged to IS as
credit loss expense
(Calculated)
(5) Ending balance (Residual)
% of Receivables Method
Uses ending AR to estimate amount that
will not be collected.
Calculates the ending balance of the
allowance account on the BS.
Has a balance sheet focus.
 Percent of AR T-Account
Allowance for Credit Losses
(1) Beginning balance

(2) Credit losses written off (3) Collection of previously written-

off credit losses
(4) Amount charged to IS as
credit loss expense (Residual)
(5) Ending balance (Calculated)
1) Beginning Balance
The beginning balance must always be a credit
balance.

This is usually one of the numbers given in the

problem.
2) Accounts Actually Written Off
The JE to write off a specific receivable is:
Dr Allowance for Credit Losses X
Cr AR Company ABC X

No expense is recognized at this time because the

expense was recognized when the Allowance
account was set up.
This amount is usually given in the problem.
3) Collecting Previously
Written-off Credit Loss
The company must:
1. Reverse the previous entry that wrote it off, and
2. Record the cash and then write off the receivable
because it was collected.
These steps combine to the following entry
Dr Cash X
Cr Allowance for credit losses X
This amount is usually given in the problem.
4) Amount Charged as
Credit Loss Expense
Each period the company will recognize credit
loss expense on the income statement.
Under the % of Sales method, this amount is
calculated as a % of the credit sales during the
period.
Under the % of Receivables method, this amount
is the balancing amount in the allowance
account.
4) Credit Loss Journal Entry
Under both, the entry to record the credit loss is:
Dr Credit loss expense X
Cr Allowance for credit losses X
The Allowance account must be credited because
we do not know which customer will not pay.
5) Ending Balance
of Allowance Account
Account will have a credit ending balance.
Under the % of Receivables method, this amount
is calculated as a % of the ending receivables
balance at the end of the period.
Under the % of Sales method, this amount will
be the balancing amount in the Allowance
account.
Percent of Sales Method Steps
1. Calculate credit loss as a % of total
credit sales.
2. Record the credit loss with a credit to
the allowance account.
3. Calculate the ending balance in the
allowance account.
4. Check the reasonableness of the
Allowance account balance.
 Percent of Sales T-Account
Allowance for Credit Losses
(1) Beginning balance

(2) Credit losses written off (3) Collection of previously written-

off credit losses
(4) Amount charged as credit
loss expense for the period
as calculated from the
amount of credit sales
(5) Ending balance (Residual)
Percent of Receivables Method Steps
1. Calculate the ending balance in the
Allowance account using a % of ending
A/R.
2. Determine the credit loss amount for
the period – it is equal to the balancing
amount in the allowance account.
3. Record the credit loss as calculated.
 Percent of AR T-Account
Allowance for Credit Losses
(2) Credit losses written off
(1) Beginning balance
(3) Collection of previously written-
off credit losses
(4) Amount charged as credit
loss expense for the period
(Residual figure)
(5) Ending balance calculated
using ending accounts
Summary of Valuation of AR
Two methods to estimate allowance for
credit losses.
1. Percent of sales
2. Percent of receivables

Both use the allowance for credit losses

account with the same entries - the
difference is in how the items are calculated
Using an Aging Table
An accounts receivable aging report can
be used to determine the required ending
balance in the allowance account.
Example: Anita’s Supply Co. uses the percentage of receivables
method to value its accounts receivable and uses its accounts
receivable aging report to estimate the current expected credit
losses from the outstanding receivables. At December 31, 20X9,
Anita’s prepared the following aging schedule in order to
calculate the balance it needed to have in its allowance for credit
losses account:
Outstanding % Expected
Age of Accounts Balances Credit Losses
Under 60 days $925,000 2%
61-90 days 115,000 5%
91-120 days 56,000 10%
Over 120 days 44,000 30%
As of December 31, 20X9, before recording the year-end
adjustment for the allowance account, Anita’s had a debit
balance of $5,000 in its allowance account.
The accounts receivable manager calculated that the balance in
the allowance account needed to be a credit balance of $43,050
by multiplying each aging category’s receivable balance by its
expected credit losses percentage and summing the results, as
follows:
($925,000 × 0.02) + ($115,000 × 0.05) + ($56,000 × 0.10)
+ ($44,000 × 0.30) = $43,050
Since the balance before adjustment in the allowance account
was a debit balance of $5,000, to adjust the debit balance of
$5,000 to a credit balance of $43,050, a credit transaction in the
amount of $48,050 ($43,050 + $5,000) needs to be recorded in
the allowance account as of December 31, 20X9. The other side
of the transaction will be a debit of $48,050 to credit loss
expense.
Note: If the balance before adjustment in the allowance account
had been a credit balance of $5,000 instead of a debit balance
of $5,000, the necessary credit to the allowance account to
adjust its balance to a credit balance of $43,050 would have
been $38,050 ($43,050 − $5,000), and the debit to credit loss
expense would have also been $38,050.
 Factoring Receivables –
Using Receivables as an
Immediate Source of Cash
Speeding Cash Flows
Instead of waiting for a receivable to be
collected, a company can sell a receivable
to get the cash from the receivable sooner.
Ways of Factoring Receivables
Can be done “with” or “without” recourse.
With Recourse
If the customer does not pay the receivable
when it comes due, the company that sold
the receivable needs to pay it.
Without Recourse
If the customer does not pay the receivable
when it comes due, the seller of the
receivable does NOT need to pay.
Disclosing Factored Receivables
If the receivables are sold with recourse a
recourse liability is recorded on the books
of the seller.