Accounting For Receivables: Debbie Musil Kwantlen Polytechnic University

Chapter 8
Accounting for Receivables
Prepared by:
Debbie Musil
Kwantlen Polytechnic University
Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition
© 2010 John Wiley & Sons Canada, Ltd.
Accounting for Receivables
• Accounts receivable
• Recognition and valuation
• Notes receivable
• Recognition and disposition
• Statement presentation and management
of receivables
• Presentation
• Analysis
• Accelerating cash receipts from receivables
Types of Receivables
• Amounts due from individuals and other
companies
• Accounts receivable:
• Amounts owed by customers on account
• Expected to be collected within 30 days
• Notes receivable:
• Supported by formal instruments of credit
• For periods of 30 days or longer
• Interest bearing
Recognizing Accounts
Receivable
• A receivable is recorded when:
• Services are provided
• Merchandise is sold on account
Jan 1 Accounts Receivable - Zellers 1,000
Sales 1,000
To record sale of merchandise on account.
4 Sales Returns and Allowances 100

Accounts Receivable - Zellers 100
To record merchandise returned
10 Cash [($1,000 - $100) x 98%] 882

Sales Discounts [($1,000 - $100) x 2%] 18
Accounts Receivable - Zellers 900
To record collection of accounts receivable
Subsidiary Accounts
Receivable Ledger
• Subsidiary accounts receivable ledger is
used to track individual customer accounts
• Each entry is effectively posted twice:
• To the subsidiary ledger
• To the general ledger in summary form
Interest Revenue
• If a customer does not pay in full within a
specified period, financing charges (interest) is
added to the balance due
• Recognized as interest revenue
Aug. 31 Accounts Receivable - Kids Online 30

Interest Revenue 30
To record interest on amount due
Nonbank Credit Card Sales
• Nonbank credit card sales are treated as sales
on account
• Unlike bank credit card sales - treated as cash sales
Oct. 24 Accounts Receivable - Credit Card Company 480
Credit Card Expense ($500 x 4%) 20
Sales 500
To record nonbank credit card sale
• Receipt of cash from nonbank credit cards is

recorded as follows
Nov. 7 Cash 480
Accounts Receivable - Credit Card Company 480
To record redemption of credit card billing
Valuing Accounts Receivable
• Some receivables will become uncollectible
• Not reported as assets if no future benefit
• Net realizable value: the collectible amount
• Receivables are written down to their
collectible amount
• By recording bad debt expense
• In the same period as related revenues are
recorded
The Allowance Method
Three features of allowance method:
1. Amount of uncollectible receivables is
estimated and recorded at end of period
2. Actual uncollectibles are written off against the
allowance when it is determined the specific
account is uncollectible
3. If an account previously written off is recovered
the write off is reversed and the collection
recorded
1. Recording Estimated
Uncollectibles
Dec. 31 Bad Debts Expense 24,000
Allowance for Doubtful Accounts 24,000
To record estimate of uncollectible accounts
• Estimated amount of uncollectible

accounts is:
• Debited to an expense account – bad debts
expense
• Credited to a contra asset account –
allowance for doubtful accounts
Allowance for Doubtful Accounts
• Deducted from Accounts Receivable in the
current assets section of balance sheet
• Net realizable value =
Accounts Receivable − Allowance for
Doubtful Accounts
• Two methods used to estimate allowance:
• Percentage of receivables approach
• Percentage of sales approach
Estimating the Allowance:
Percentage Receivables Approach
• Calculates the percentage of receivables
that are estimated to be uncollectible
• Based on past experience and credit policy
• Can be applied to total receivables
balance or amounts grouped by age
• Requires an aging schedule to be prepared
• Better estimate of net realizable value
• Also called the balance sheet method
Estimating the Allowance:
Percentage of Sales Approach
• Calculates bad debt expense as a
percentage of net credit sales
• Based on past experience and company’s
credit policy
• Example: 2% of credit sales of $1,200,000 =
$24,000
• Bad debts expense is related to sales in
the same period
• Also called the income statement method
Comparison of Approaches
Percentage of Sales Percentage of Receivables

Matching Net Realizable Value
Bad Debts Allowance

Sales Accounts
Expense for Doubtful
Receivable
Accounts
Income Statement Balance Sheet

Approach Approach
2. Recording Write-Off of an
Uncollectible Account
• Amount written-off is debited to the allowance
account
• Bad debt expense is not increased
• Expense previously recognized when allowance
initially recorded
Mar. 1 Allowance for Doubtful Accounts 4,500

Accounts Receivable - Kids Online 4,500
Write-off of uncollectible account
3. Recovery of an Uncollectible
Account
• If cash is collected from a customer after the
account has been written off:
1. Reverse write-off entry to restore customer’s account
2. Record collection of the account receivable in the
usual way
July 1 Accounts Receivable - Kids Online 4,500

Allowance for Doubtful Accounts 4,500
To reverse write-off of Kids Online account
July 1 Cash 4,500

Accounts Receivable - Kids Online 4,500
To record collection from Kids Online
Notes Receivable
• Credit may be granted in exchange for a
promissory note:
• A formal credit instrument
• 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
Recognizing Notes Receivable
• If note is received to settle an outstanding
account receivable:
May 31 Notes Receivable - Higly 10,000
Accounts Receivable - Higly 10,000
To record acceptance of Higly note
• If received for cash, credit is to Cash

• Notes are valued at net realizable value
• Similar process to determine bad debt
expense and allowance as for accounts
receivable
Recording Interest
• Formula for calculating interest:
Principal Annual Interest Time in Terms of
Value of Note × Rate × One Year = Interest
• An annual rate of interest

• Separate interest receivable account is used
(value of note is not altered)
June 30 Interest Receivable 50
Interest Revenue ($10,000 x 6% x 1/12) 50
To accrue interest on Higly note
Disposing of Notes Receivable
• A note is honoured when paid in full on its
maturity date
• Amount due is principal + interest
Sept. 30 Cash 10,200

Notes Receivable - Higly 10,000
Interest Revenue ($10,000 x 6% x 3/12) 150
Interest Receivable 50
To record collection of Higly note
Disposing of Notes
Receivable 2
• A note is dishonoured if not paid in full at
maturity
• Note is no longer negotiable
• Payee still has a valid claim against maker
• Balance is transferred to Accounts Receivable
in hopes of collection
Sept. 30 Accounts Receivable - Higly 10,200
Notes Receivable - Higly 10,000
Interest Revenue 150
Interest Receivable 50
To record dishonouring of Highly note, collection expected
Statement Presentation
• Each major type of receivable is identified
on the balance sheet or in the notes
• Generally reported separately in the
current or noncurrent sections of the
balance sheet
• Disclose the net amount of receivables
• Under IFRS must disclose the gross amount
and the allowance for doubtful accounts
Analysis of Receivables
• Management monitors relationship
between sales, receivables and cash
• Receivables should increase with sales
• Unusual increase could signal trouble
• Receivables ratios:
• Used to help determine if management of
receivables is helping or hurting liquidity
Analysis of Receivables 2
Receivables turnover ratio:
= Net Credit Sales ÷ Average Receivables
• Measures the number of times that
receivables are collected in a period
• Higher the number, the more liquid are
receivables
Analysis of Receivables 3
Collection period:
= 365 ÷ Receivables Turnover Ratio
• Calculates the average number of days that
accounts receivable are outstanding
Operating Cycle:
= Days Sales in Inventory + Collection Period
• Calculates the number of days to complete
the operating cycle
• Purchase of inventory through collection of cash
Accelerating Cash From
Receivables
• To shorten the cash-to-cash operating cycle
• Loans secured by receivables:
• Borrow from bank using receivables as
collateral
• Sale of receivables:
• Factoring: sell receivables to a finance
company or bank (called a factor)
• Securitization: sell receivables to a trust held by
many investors
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Copyright © 2010 John Wiley & Sons Canada, Ltd. All rights
reserved. Reproduction or translation of this work beyond that
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Chapter 8

Accounting for Receivables

4 Sales Returns and Allowances 100

10 Cash [($1,000 - $100) x 98%] 882

Aug. 31 Accounts Receivable - Kids Online 30

• Receipt of cash from nonbank credit cards is

• Estimated amount of uncollectible

Percentage of Sales Percentage of Receivables

Bad Debts Allowance

Income Statement Balance Sheet

Mar. 1 Allowance for Doubtful Accounts 4,500

July 1 Accounts Receivable - Kids Online 4,500

July 1 Cash 4,500

• If received for cash, credit is to Cash

• An annual rate of interest

Sept. 30 Cash 10,200

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