Phillips PLL 6e Chap08

Chapter 8
Receivables, Bad Debt Expense, and

Interest Revenue
PowerPoint Author:
Brandy Mackintosh, CPA,CA
8-1 Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 8-1
Describe the trade-offs of

extending credit.
Pros and Cons of Extending Credit
Advantage
1. Increases the seller’s revenues.
Disadvantages
1. Increased wage costs.
2. Bad debt costs.
3. Delayed receipt of cash.
Estimate and report the effects

of uncollectible accounts.
Accounts Receivable and Bad Debts
Jan. 1
Record sales on account Bad debt known
dr Accounts Receivable
cr Sales Revenue
Balance Sheet Income Statement

Cash Sales Revenue
Accounts Receivable Cost of Goods Sold
Inventory Gross Profit
… …
Accounts Receivable and Bad Debts,
continued
Jan. 1 Jan. 31
Record sales on account Record estimate of bad debts Bad debt known
dr Accounts Receivable dr Bad Debt Expense (+E, -SE)

cr Sales Revenue cr Allowance for Doubtful Accounts (+xA, -A)
Balance
Balance Sheet
Sheet Income Statement
Cash
Cash Sales Revenue
Accounts Receivable
Accounts Receivable Cost of Goods Sold
Less: Allowance for Doubtful Accounts
Inventory Receivable, Net
Accounts Gross Profit
…
Inventory … Debt Expense
Bad
… …
Accounts Receivable and Bad Debts,
concluded
Jan. 1 Jan. 31
Record sales on account Record estimate of bad debts Bad debt known
dr Accounts Receivable dr Bad Debt Expense (+E, -SE)

cr Sales Revenue cr Allowance for Doubtful Accounts (+xA, -A)
Balance Sheet dr Allowance for Doubtful Accounts (-xA)

Balance Sheet cr Accounts Receivable(-A)
Cash
Cash
Accounts Receivable
Accounts Receivable
Less: Allowance for Doubtful Accounts
Inventory Receivable, Net
Accounts
…
Inventory
…
Allowance Method
The allowance method follows a two-step

process, described below:
1. Make an end-of-period adjustment to
record the estimated bad debts in the
period credit sales occur.
2. Remove (“write off”) specific customer
balances when they are known to be
uncollectible.
1. Adjust for Estimated Bad Debts
– Step 1
Assume that VFC estimates $900 in bad debts at
the end of the accounting period.
1 Analyze
Assets = Liabilities + Stockholders’ Equity
Allowance for Doubtful Bad Debt
Accounts (+xA) -900 Expense (+E) -900
2 Record
Bad Debt Expense 900
Allowance for Doubtful Accounts (+xA) 900
1. Adjust for Estimated Bad Debts
– Step 1, continued
2. Remove (Write-off) Specific Customer Balances
– Step 2
VFC writes off an $800 receivable from Fast Fashions
because the company could not pay its account.
1 Analyze
Accounts
Receivable -800
Allowance for Doubtful
Accounts (-xA) +800
2 Record
Allowance for Doubtful Accounts (-xA) 800
Accounts Receivable 800
2. Remove (Write-off) Specific Customer Balances
– Step 2, continued
Allowance for Doubtful Accounts (-xA) 800
dr + Accounts Receivable (A) cr -
1/1 Bal. 200,000
1/31 Bal. 200,000

800 (2) Write-off
End Bal. 199,200
dr - Allow. For Doubtful Accts. (xA) cr + dr + Bad Debt Expense (E, SE) cr -
14,100 1/1 Bal. 1/1 Bal. 0
900 (1) Estimate (1) Estimate 900
15,000 1/31 Bal. 1/31 Bal. 900
(2) Write -off 800
14,200 End Bal.
Methods for Estimating Bad Debts
There are two acceptable methods of estimating
the bad debts in a given period.
1. Percentage of Credit Sales Method.

2. Aging of Accounts Receivable.
Simpler to apply.
More accurate
Percentage of Credit Sales Method
The percentage of credit sales method

estimates bad debt expense by
multiplying the historical percentage of
bad debt losses by the current period’s
credit sales.
Percentage of Credit Sales Method,
continued
VFC has experienced bad debt losses of ¾ of 1
percent of credit sales in prior periods. Credit sales in
January total $120,000,
2 Record
Aging of Accounts Receivable
While the percentage of credit sales method focuses on
estimating Bad Debt Expense (income statement approach) for
the period, the aging of accounts receivable method focuses on
estimating the ending balance in the Allowance for Doubtful
Accounts (balance sheet approach).
The aging method gets its name because it is based on the

“age” of each amount in Accounts Receivable at the end of the
period. The older and more overdue an account receivable
becomes, the less likely it is to be collectible.
Aging of Accounts Receivable – Step 1
VFC applies the aging of accounts receivable method to its Accounts
Receivable balances on February 28, after taking into account February
sales and cash collections. The method includes three steps: (1) Prepare
an aged list of accounts receivable, (2) Estimate bad debt loss
percentages for each category, and (3) Compute the total estimated bad
debts.
Step
1
Age Accounts Receivable.
Step
2 Estimate bad debt loss percentages for each category.
Step
3 Compute the total estimated bad debts.
Aging of Accounts Receivable, continued
AJE = ($15,500 - $14,200) = $1,300

Aging of Accounts Receivable, concluded
Prepare the AJE for Bad Debt Expense at February 28.
1 Analyze
Allowance for Doubtful Bad Debt
Accounts (+xA) -1,300 Expense (+E) -1,300
2 Record
Bad Debt Expense 1,300
Allowance for Doubtful Accounts (+xA) 1,300
3 Summarize
dr - Allow. For Doubtful Accts (xA) cr + dr + Bad Debt Expense (E,SE) cr -
14,200 Unadj. Bal. Beg. Bal. 900
1,300 AJE AJE 1,300
15,500 Adj. Bal. End Bal. 2,200
Other Issues
Revising Estimates—Bad debt estimates always differ

from the amounts that are later written off. If these
differences are material, companies are required to
revise their bad debt estimates for the current period.
Account Recoveries—Collection of a previously written

off account is called a recovery and it is accounted for in
two parts. First, put the receivable back on the books by
recording the opposite of the write-off. Second, record
the collection of the account.
Other Issues, continued
Let’s assume that VFC collects the $800 from Fast Fashions that
was previously written off. This recovery would be recorded with
the following journal entries:
(1) Reverse the write-off.
(2) Record the collection.
Compute and interpret the

receivables turnover ratio.
Receivables Turnover Analysis
The receivables turnover ratio indicates how many
times, on average, this process of selling and collecting
is repeated during the period. The higher the ratio, the
faster the collection of receivables.
Rather than evaluate the number of times accounts

receivable turn over, some people find it easier to think
in terms of the number of days to collect receivables
(called days to collect).
Receivables Turnover Analysis,
continued
Receivable $500,000 = 10 times
Net Sales Revenue $ 50,000
Turnover =
Average Net Receivables
Ratio
(Beginning net receivables + Ending net receivables) ÷ 2
Days to 365 365 = 36.5 days

= 10
Collect Receivables Turnover Ratio
Comparison to Benchmarks
Credit Terms
When companies sell on account, they specify the length of credit
period (and any cash discounts for prompt payment). By comparing the
number of days to collect to the length of credit period, you can gain a
sense of whether customers are complying with the stated policy.
Speeding Up Collections
Factoring Receivables
One way to speed up collections is to sell outstanding
accounts receivable to another company (called a
factor). Your company receives cash for the receivables
it sells to the factor (minus a factoring fee).
Credit Card Sales

Another way to avoid lengthy collection periods is to allow customers to
pay for goods using PayPal or national credit cards. This not only
speeds up the seller’s cash collection, but also reduces losses from
customers writing bad checks. PayPal and Credit card companies
charge a fee for their services.
Chapter 8
Supplement 8A
Direct Write-Off Method
Learning Objective 8-S1
Record bad debts using the direct

write-off method.
Direct Write-Off Method
The direct write-off method does not estimate bad debt. Instead, it
reports Sales when they occur and bad debt expense when it is
discovered. This method is not acceptable for GAAP.
The reason the method isn’t considered GAAP is because it reports

receivables at the total amount owed by customers rather than what is
estimated to be collectible and it violates the expense recognition
principle (matching principle) by recording bad debt expense in the
period the customer’s account is determined to be bad rather than the
period when the credit sales are actually made.
Direct Write-Off Method Example
A customer account is determined to be uncollectible and
$1,000 of Bad Debt Expense needs to be recorded.
2 Record
Accounts Receivable 1,000
Chapter 8
Solved Exercises
M8-10, E8-7, E8-8, E8-9, CP8-4, C8-1
M8-10 Using the Interest Formula to Compute Interest
Complete the following table by computing the missing amounts (?) for
the following independent cases.
Principal Amount on Annual Time Period Interest

Note Receivable Interest Rate in Months Earned
a. $ 100,000 10% 6 ?
b. $ 50,000 ? 9 $ 3,000
c. ? 10% 12 $ 4,000
Case a. $100,000 × 10% × (6/12) = $5,000
Case b. $3,000 ÷ [$50,000 × (9/12)] = 8%
Case c. [$4,000 ÷ 10%] × (12/12) = $40,000
E8-7 Computing Bad Debt Expense Using Aging of Accounts
Receivable Method
Brown Cow Dairy uses the aging approach to estimate Bad Debt Expense.
The balance of each account receivable is aged on the basis of three time
periods as follows: (1) 1–30 days old, $12,000; (2) 31–90 days old, $5,000;
and (3) more than 90 days old, $3,000. Experience has shown that for each
age group, the average loss rate on the amount of the receivable due to
uncollectibility is (1) 5 percent, (2) 10 percent, and (3) 20 percent,
respectively. At December 31 (end of the current year), the Allowance for
Doubtful Accounts balance was $800 (credit) before the end-of-period
adjusting entry is made.
Required:
1. Prepare a schedule to estimate an appropriate year-end balance for the
Allowance for Doubtful Accounts.
2. What amount should be recorded as Bad Debt Expense for December
31?
3. If the unadjusted balance in the Allowance for Doubtful Accounts was a
$600 debit balance, what amount of Bad Debt Expense should be
recorded on December 31?
E8-7 Computing Bad Debt Expense Using Aging of Accounts
Receivable Method, continued
Req. 1
Total 1 - 30 31-90 >90
$ 20,000 $ 12,000 $ 5,000 $ 3,000 Estimate Balance in Allowance $ 1,700
5% 10% 20% Existing Credit Balance in Allowance 800
$ 1,700 $ 600 $ 500 $ 600 Adjusting Journal Entry Amount $ 900
Req. 2 Allowance for Doubtful Accounts

800 Unadj. Bal.
900 AJE
1,700 Bal.

Unadj. Bal. 600
2,300 AJE
1,700 Bal.
E8-8 Recording and Reporting Allowance for Doubtful Accounts Using
the Percentage of Credit Sales and Aging of Accounts Receivable
Methods
Innovative Tech Inc. (ITI) has been using the percentage of credit sales method to
estimate bad debts. During November, ITI sold services on account for $100,000
and estimated that ½ of 1 percent of those sales would be uncollectible.
Required:
1. Prepare the November adjusting entry for bad debts.
2. Starting in December, ITI switched to using the aging method. At its December 31
year-end, total Accounts Receivable is $89,000, aged as follows: (1) 1–30 days old,
$75,000; (2) 31–90 days old, $10,000; and (3) more than 90 days old, $4,000. The
average rate of uncollectibility for each age group is estimated to be (1) 10 percent,
(2) 20 percent, and (3) 40 percent, respectively. Prepare a schedule to estimate an
appropriate year-end balance for the Allowance for Doubtful Accounts.
3. Before the end-of-year adjusting entry is made, the Allowance for Doubtful Accounts
has a $1,600 credit balance at December 31. Prepare the December 31 adjusting
entry.
4. Show how the various accounts related to accounts receivable should be
shown on the December 31 balance sheet.
E8-8 Recording and Reporting Allowance for Doubtful Accounts Using the
Percentage of Credit Sales and Aging of Accounts Receivable Method,
continued
Req. 1 November 30 AJE

($500 = $100,000 x 0.005)
Req. 2 Total 1 - 30 31-90 >90

$ 89,000 $ 75,000 $ 10,000 $ 4,000
10% 20% 40%
$ 11,100 $ 7,500 $ 2,000 $ 1,600

1,600 Unadj. Bal.
9,500 AJE
11,100 Bal.
E8-8 Recording and Reporting Allowance for Doubtful Accounts Using the
Percentage of Credit Sales and Aging of Accounts Receivable Methods,
concluded
Req. 4 The accounts related to the accounts receivable can be shown

one of two ways on the December 31 balance sheet:
Accounts Receivable $ 89,000

Less: Allowance for Doubtful Accounts (11,100)
Accounts Receivable, net of allowance $ 77,900
OR
Accounts Receivable, net of Allowance for
Doubtful Accounts of $11,100 $ 77,900
E8-9 Recording and Determining the Effects of Write-Offs, Recoveries,
and Bad Debt Expense Estimates on the Balance Sheet and Income
Statement.
Fraud Investigators Inc. operates a fraud detection service.
Required:
1. Prepare journal entries for each transaction below.
a. On March 31, 10 customers were billed for detection services totaling $25,000.
b. On October 31, a customer balance of $1,500 from a prior year was determined
to be uncollectible and was written off.
c. On December 15, a customer paid an old balance of $900, which had been
written off in a prior year.
d. On December 31, $500 of bad debts were estimated and recorded for the year.
2. Complete the following table, indicating the amount and effect (+ for
increase, - for decrease, and NE for no effect) of each transaction.
E8-9 Recording and Determining the Effects of Write-Offs, Recoveries, and
Bad Debt Expense Estimates on the Balance Sheet and Income Statement.
Req. 1
Req. 1
a. Accounts Receivable 25,000
Service Revenue 25,000
b. Allowance for Doubtful Accounts (-xA) 1,500

c. Accounts Receivable 900

Cash 900
d. Bad Debt Expense 500

E8-9 Recording and Determining the Effects of Write-Offs, Recoveries, and
Bad Debt Expense Estimates on the Balance Sheet and Income Statement.
Req. 2
Req. 2
Income
Net Net From
Transaction Receivables Sales Operations
a +25,000 +25,000 +25,000
b NE NE NE
c -900 NE NE
d -500 NE -500
CP8-4 Accounting for Accounts and Notes Receivable
Transactions
Execusmart Consultants has provided business consulting services for several years.
The company uses the percentage of credit sales method to estimate bad debts for
internal monthly reporting purposes. At the end of each quarter, the company adjusts its
records using the aging of accounts receivable method. The company entered into the
following partial list of transactions.
a. During January, the company provided services for $200,000 on credit.
b. On January 31, the company estimated bad debts using 1 percent of credit sales.
c. On February 4, the company collected $100,000 of accounts receivable.
d. On February 15, the company wrote off a $500 account receivable.
e. During February, the company provided services for $150,000 on credit.
f. On February 28, the company estimated bad debts using 1 percent of credit sales.
g. On March 1, the company loaned $12,000 to an employee who signed a 10% note,
due in 3 months.
h. On March 15, the company collected $500 on the account written off one month
earlier.
i. On March 31, the company accrued interest earned on the note.
j. On March 31, the company adjusted for uncollectible accounts, based on the aging
analysis shown on the next screen. Allowance for Doubtful Accounts has an
unadjusted credit balance of $6,000.
CP8-4 Accounting for Accounts and Notes Receivable
Transactions, continued (1)
Required:
1. For items a – j, analyze the amount and direction (+ or -) of effects on specific
financial statement accounts and the overall accounting equation.
2. Prepare journal entries for items (a) – (j).
3. Show how Accounts Receivable, Notes Receivable, and their related accounts would
be reported in the current assets section of a classified balance sheet at the end of
the quarter on March 31.
4. Sales Revenue and Service Revenue are two income statement accounts that relate
to Accounts Receivable. Name two other accounts related to Accounts Receivable
and Note Receivable that would be reported on the income statement and indicate
whether each would appear before, or after, Income from Operations for Execusmart
Consultants.
CP8-4 Accounting for Accounts and Notes Receivable Transactions,
continued (2)
Req. 1 and 2


Allowance for Doubtful Accounts(+xA) 2,000
continued (3)
Req. 1 and 2
Cash 100,000
CP8-4 Accounting for Accounts and Notes Receivable Transactions
Req. 1 and 2
Allowance for Doubtful Accounts(-xA) 500


continued (4)
Req. 1 and 2

continued (5)
Req. 1 and 2
Note Receivable 12,000

Cash 12,000

Cash 500
continued (6)
Req. 1 and 2
Interest Receivable 100

Interest Revenue 100
Desired $8,390 – Current -$6000 = Adjustment $2,390
Total 0-30 31-60 61-90 >90
Total Accounts Receivable $ 90,000 $ 36,500 $ 42,400 $ 5,100 $ 6,000
Estimated Uncollectible (%) 2% 10% 20% 40%
Estimated Uncollectible ($) $ 8,390 $ 730 $ 4,240 $ 1,020 $ 2,400

concluded
Req. 3
EXECUSMART CONSULTANTS
Partial Balance Sheet
At March 31
Assets
Current Assets:
Accounts Receivable $ 90,000
Less: Allowance for Doubtful Accounts 8,390
Accounts Receivable, Net of Allowance $ 81,610
Note Receivable 12,000
Interest Receivable 100
Req. 4
Execusmart Consultants would report Bad Debt Expense before Income
from Operations, and Interest Revenue after Income for Operations.
C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad
Debts Using the Aging of Accounts Receivable Method
Okay Optical, Inc. (OOI) began operations in January selling inexpensive sunglasses to large
retailers like Walgreen’s and other smaller stores. Assume the following transactions occurred
during its first six months of operations.
January 1 - Sold merchandise to Walgreen’s on account for $20,000; the cost of goods to OOI was
$12,000.
February 12 - Received payment in full from Walgreen’s.
March 1 - Sold merchandise to Bravis Pharmaco on account for $3,000; the cost of goods to OOI
was $1,400.
April 1 - Sold merchandise to Tony’s Pharmacy on account for $8,000. The cost to OOI was $4,400.
May 1 - Sold merchandise to Anjuli Stores on account for $2,000. the cost to OOI was $1,200.
June 17 - Received $6,500 on account from Tony’s Pharmacy.
Required:
1. Complete an aged listing of customer accounts at June 30.
2. Estimate the Allowance for Doubtful Accounts required at June 30 assuming the following
uncollectible rates: one month, 1 percent; two months, 5 percent; three months, 20 percent;
more than three months, 40 percent.
3. Show how OOI would report its accounts receivable on its June 30 balance sheet. What
amounts would be reported on an income statement prepared for the six-month period ended
June 30?
4. Bonus Question: In July, OOI collected the balance due from Bravis Pharmaco but discovered
that the balance due from Tony’s Pharmacy needed to be written off. Using this information,
determine how accurate OOI was in estimating the Allowance for Doubtful Accounts needed for
each of these two customers and in total.
C8-1 Comprehensive Exercise for Recording and Reporting Credit Sales and Bad Debts
Using the Aging of Accounts Receivable Method, continued (1)
Req. 1 June May April >3

Customer Total (1 Month) (2 Months) (3 Months) Months
Anjuli Stores $ 2,000 $ 2,000
Bravis Pharmaco 3,000 $ 3,000
Tony’s Pharmacy 1,500 $ 1,500
Walgreens -
Total $ 6,500 $ - $ 2,000 $ 1,500 $ 3,000
Req. 2 Total 2 months 3 months >3 months

Accounts Receivable $ 6,500 $ 2,000 $ 1,500 $ 3,000
Estimated Uncollectible (%) 5% 20% 40%
Estimated Uncollectible ($) $ 1,600 $ 100 $ 300 $ 1,200
Using the Aging of Accounts Receivable Method, continued (2)
Req. 3
OKAY OPTICAL, INC.

Partial Balance Sheet
At June 30
Accounts Receivable, Net of Allowance of $1,600 $4,900
OKAY OPTICAL, INC.

Partial Income Statement
For the Six Months Ended June 30
Sales Revenue $33,000
Cost of Goods Sold 19,000
Gross Profit 14,000
Income from Operations $12,400
Using the Aging of Accounts Receivable Method, concluded
Req. 4 OOI did not accurately estimate the precise amounts that would
be collected from each customer, yet the total estimate was
accurate. That is, OOI underestimated the amount collectible
from Bravis Pharmaco (40% of $3,000, or $1,200, was
estimated uncollectible where it later turned out to be collectible
in full). It overestimated the amount collectible from Tony’s
Pharmacy (20% of $1,500, or $300, was estimated uncollectible
where it later turned out to show that $1,500 was uncollectible).
Looking at Tony’s Pharmacy and Bravis Pharmaco combined,
the estimated bad debt for both customers was $1,500, which is
almost the same as the amount the company wrote off.
End of Chapter 8

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Chapter 8

Receivables, Bad Debt Expense, and

Describe the trade-offs of

Estimate and report the effects

Record sales on account Bad debt known

Balance Sheet Income Statement

dr Accounts Receivable dr Bad Debt Expense (+E, -SE)

dr Accounts Receivable dr Bad Debt Expense (+E, -SE)

Balance Sheet dr Allowance for Doubtful Accounts (-xA)

The allowance method follows a two-step

1/31 Bal. 200,000

1. Percentage of Credit Sales Method.

The percentage of credit sales method

The aging method gets its name because it is based on the

AJE = ($15,500 - $14,200) = $1,300

Revising Estimates—Bad debt estimates always differ

Account Recoveries—Collection of a previously written

(1) Reverse the write-off.

(2) Record the collection.

Compute and interpret the

Rather than evaluate the number of times accounts

(Beginning net receivables + Ending net receivables) ÷ 2

Days to 365 365 = 36.5 days

Credit Card Sales

Direct Write-Off Method

Record bad debts using the direct

The reason the method isn’t considered GAAP is because it reports

M8-10, E8-7, E8-8, E8-9, CP8-4, C8-1

Principal Amount on Annual Time Period Interest

Case a. $100,000 × 10% × (6/12) = $5,000

Case b. $3,000 ÷ [$50,000 × (9/12)] = 8%

Case c. [$4,000 ÷ 10%] × (12/12) = $40,000

Req. 2 Allowance for Doubtful Accounts

Req. 3 Allowance for Doubtful Accounts

Req. 1 November 30 AJE

($500 = $100,000 x 0.005)

Req. 2 Total 1 - 30 31-90 >90

Req. 3 Allowance for Doubtful Accounts

Req. 4 The accounts related to the accounts receivable can be shown

Accounts Receivable $ 89,000

b. Allowance for Doubtful Accounts (-xA) 1,500

c. Accounts Receivable 900

d. Bad Debt Expense 500

Accounts Receivable 200,000

Bad Debt Expense 2,000

Allowance for Doubtful Accounts(-xA) 500

Accounts Receivable 150,000

Bad Debt Expense 1,500

Note Receivable 12,000

Accounts Receivable 500

Interest Receivable 100

Bad Debt Expense 2,390

Req. 1 June May April >3

Req. 2 Total 2 months 3 months >3 months

OKAY OPTICAL, INC.

OKAY OPTICAL, INC.

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