9-1 R ECEIVABLES AND P AYABLES CHAPTER 9 9-2 R ECEIVABLES AND P AYABLES CHAPTER 9 CAUTION ! Most...

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RECEIVABLES AND PAYABLES

CHAPTER 9CHAPTER 9

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RECEIVABLES AND PAYABLES

CHAPTER 9CHAPTER 9

CAUTION !

Most students find this chapter to be the most challenging in the first

semester of introductory accounting.

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Accounts ReceivableAccounts Receivable

Amounts owed to the company.

Arise from credit sales to customers.

Not all customers will pay in full.

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Subsidiary Ledger and Subsidiary Ledger and Control AccountsControl Accounts

Until now, we have assumed that each accounts receivable account will be

shown in the generalgeneral ledgerledger.

However, because of certain efficiencies, customers’ accounts are actually kept

in a subsidiarysubsidiary ledgerledger in practice.

This practice necessitates the use of a general ledger controlcontrol accountaccount .

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A subsidiary ledger subsidiary ledger is a group of related accounts which show the details of the

balance of a general ledger control general ledger control account.account.

A general ledger controlgeneral ledger control accountaccount shows the total balance of all the subsidiary

accounts related to it.


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Accounts Receivable Control Account

General Ledger

Subsidiary Ledger

Customer A

Customer DCustomer C

Customer B2,500

1,500 500

1,000

Bal. 5,500


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Until now, we have also assumed that all accounts receivable will be collected.

However, because of various circumstances, some customers will not be able to keep their promises to

pay.

Uncollectible AccountsUncollectible Accounts

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As a result, businesses must record the fact that some customers will not

ever pay their account.

Therefore, at the end of each year, an adjusting entry is made to record an

estimateestimate of the uncollectible accounts (i.e., “bad debts”) related to

the period.


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Why use an estimate? Why not wait until a specific customer fails to pay

and use an exact amount?

ANSWER: The Matching Principle.Matching Principle.

1994 1995 1996

Sales XXX

Expenses -XX

Net Income X


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When the adjusting entry is made, we do not know whowho the customers are

who will not pay.

We only know that some of the customers will likely not be able to pay.

That is why we have to use an estimateestimate for the entry.


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Direct Write-Off Method

Allowance Method

Methods to Account for Uncollectible Accounts


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Direct Write-Off Method

Allowance Method

Methods to Account for Uncollectible Accounts

GAAP

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Allowance MethodAllowance Method

Record an estimate of uncollectible accounts expense

in the period the revenue is generated.

Adheres to the matching principle.

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GENERAL JOURNAL Page 34

Date DescriptionPost. Ref. Debit Credit


Adjusting entry to record the estimate of uncollectible accounts expense:

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Uncollectible Accounts Expense XXX

Allowance for Uncollectible Accounts XXX


Adjusting entry to record the estimate of uncollectible accounts expense:

Classified as a selling expense on the income

statement.

Classified as a contra-asset account on the balance

sheet.

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Accounts receivableLess: Allowance for uncollectible accountsNet realizable value of accounts receivable

The net realizable value is the amount of the accounts receivable

that the business expects to collect (i.e., the true asset).


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Allowance MethodAllowance MethodHow is the estimate for the adjusting

entry determined?

You will meet a woman who will pay

off all your accounts...

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Two approaches for estimating Uncollectible Accounts

Percentage-of-Sales

Percentage-of-Receivables


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Percentage-of-SalesPercentage-of-Sales

Percentage is estimated based on actual uncollectible accounts

from prior years’ credit sales.

Focus is on determining the amount to record on the income statement as uncollectible accounts expense.

SA

LES

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Percentage-of-SalesPercentage-of-Sales

Net Sales % Estimated Uncollectible

Amount of Journal Entry

Net Sales % Estimated Uncollectible

Amount of Journal EntryS

ALE

S

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a. $ 750.b. $4,750.c. $5,500. d. No entry is needed.

Percentage-of-Sales Percentage-of-Sales QuestionQuestion

During 1998, Tools Etc. had total sales of $550,000, of which $75,000 were cash sales.

In the past, Tools Etc.’s bad debt percentage has been 1% of credit sales. On

12/31, Tools Etc. will credit the Allowance for Uncollectible Accounts

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a. $ 750.b. $4,750.c. $5,500. d. No entry is needed.

Percentage-of-Sales Percentage-of-Sales QuestionQuestion

During 1998, Tools Etc. had total sales of $550,000, of which $75,000 were cash sales.

In the past, Tools Etc.’s bad debt percentage has been 1% of credit sales. On

12/31, Tools Etc. will credit the Allowance for Uncollectible Accounts

$550,000 Total Sales- 75,000 Cash Sales 475,000 Credit Sales× .01 $ 4,750

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During 1998, Books, Inc. had total sales of $1,000,000 of which $250,000 were cash sales.

In the past, Books Inc.’s bad debt percentage has been ½ of 1% of credit sales.

Prepare the adjusting journal entry required for Books, Inc. to record uncollectible accounts

expense for 1998.

Percentage-of-Sales Percentage-of-Sales ExampleExample

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Percentage-of-Sales Percentage-of-Sales ExampleExample



Dec. 31 Uncollectible Accounts Expense 3,750

Allowance for Uncollectible Accounts 3,750

To record uncollectible accounts

expense

$1,000,000 - $250,000 = $750,000 .005 = $3,750

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Percentage-of-ReceivablesPercentage-of-Receivables

Focus is on determining the desired balance in the Allowance for

Uncollectible Accounts on the balance sheet.

Acc

ount

s R

ecei

vabl

e

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First, determine the historical bad debt percentage based on accounts receivableaccounts receivable.

Then, compute the estimated uncollectible amount of accounts receivable by either:

(1) Total accounts receivable balance times a single percentage or

(2) An aging of accounts receivable times several percentages


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The amount calculated with this method represents the desired balancedesired balance for the

allowance for uncollectible accounts (i.e., the account balance which must result from

making the adjusting entry.)

Since the allowance for uncollectible accounts is a permanent account and normally has an

existing balance, that balance must be considered in determining the amount of the

adjusting entry.


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Therefore, to determine the amount for the adjusting entryadjusting entry, first compute the amount of the desired balance in the allowance

account.

Then, compare it with the existing balance in the account.

Finally, make the adjusting entry necessary to “force” the required balance.


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Accounts Receivable% Estimated Uncollectible

Desired Balance in Allowance Account+ Allowance Account Debit Balance


Accounts Receivable % Estimated Uncollectible

Desired Balance in Allowance Account- Allowance Account Credit Balance


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Let’s look at an example

for Books, Inc.


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At 12/31/98, Books, Inc.’s Accounts Receivable balance was $80,000 and the balance before

adjustment in the Allowance for Uncollectible Accounts was $500 (credit).

In the past, the uncollectible accounts percentage has been 3% of accounts

receivable.

Prepare the adjusting journal entry required for Books, Inc. to record uncollectible accounts

expense for 1998.

Percentage-of-ReceivablesPercentage-of-ReceivablesExample #1Example #1

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80,000$ 3.00%

2,400 - 500

1,900$


Accounts Receivable % Estimated Uncollectible

Desired Balance in Allowance Account- Allowance Account Credit Balance


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Percentage-of-Receivables Percentage-of-Receivables Example #1Example #1






expense

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GENERAL JOURNAL





expense

Percentage-of-Receivables Percentage-of-Receivables Example #1Example #1

ACCOUNT NAME: Allowance for Uncollectible Accounts ACCOUNT No. 172

Date Description PR Debit Credit Balance

12/31 Balance 500

12/31 Adjusting entry GJ34 1,900 2,400

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Now, let’s look at an example

for Geeks, Inc.


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At 12/31/98, Geeks, Inc.’s Accounts Receivable balance was $80,000 and the

balance before adjustment in the Allowance for Uncollectible Accounts was $500 (debit).

Historically, the bad debt percentage based on accounts receivable has been 3%.

What would be the adjusting entry to record uncollectible accounts expense for 1998?


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ALLOWANCE FOR UNCOLLECTIBLE ACCTS

Bal. Before Adjustment 500


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80,000 x .03 = 2,400 (Desired bal.)



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80,000 x .03 = 2,400 (Desired bal.)

2,400 After Adjustment



??

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80,000 x .03 = 2,400 (Desired bal.)

-500 + X = 2,400 X = 2,900



??

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2,900 Adjusting Entry



80,000 x .03 = 2,400 (Desired bal.)

-500 + X = 2,400 X = 2,900



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GENERAL JOURNAL

Page 1

Date Description PR Debit Credit

12/31/98 Uncollectible Accounts Expense 2,900

Allowance for Uncollectible Accts. 2,900

To record 1998 estimate for

uncollectible accounts


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Now, let’s look at a

third example


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Tools Etc.December 31, 1998 Aging

Days Past DueA/R

BalanceEstimated Bad

Debt %Uncollectible

EstimateCurrent 45,000$ 1%1-30 Days 15,000 3%31-60 Days 5,000 5%Over 60 Days 2,000 10%

Total A/R 67,000$ Desired Credit

Balance

Allowance for Uncoll. Accts.

Amount for Journal Entry

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Days Past DueA/R


Debt %Uncollectible



Balance



(350)


The December 31 balance in the Allowance for Uncollectible

Accounts was $350 (credit).

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Days Past DueA/R


Debt %Uncollectible



Balance



(350)


What will be the balance in the Allowance for Uncollectible Accounts after Tools Etc. makes the

year-end adjusting entry?

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Days Past DueA/R


Debt %Uncollectible



Balance



(350)

$ 450 450 250 200

1,350

$ 1,000


What will be the balance in the Allowance for Uncollectible Accounts after Tools Etc. makes the

year-end adjusting entry?

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GENERAL JOURNAL

Page 1


12/31/98 Uncollectible Accounts Expense 1,000

Allowance for Uncollectible Accts. 1,000

To record 1998 estimate for

uncollectible accounts


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Write-Off of ReceivablesWrite-Off of Receivables

When it will become apparent that a specificspecific account receivable will not be

collected, it must be “written off”.

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The entry to write-off the uncollectible account receivable.

Write-Off of ReceivablesWrite-Off of Receivables




Accounts Receivable XXX

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Prepare the journal entry to record the following transaction.

On March, 28, 1998, Books, Inc. determines that Ready-To-Read’s accounts receivable

for $500 is uncollectible.

Write-Off of Receivables Write-Off of Receivables ExampleExample

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Mar. 28 Allowance for Uncollectible Accounts 500

Accounts Receivable 500

To record uncollectible account

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Now, assume that before the previous entry, the Accounts Receivable balance

was $67,000 and the Allowance for Uncollectible Accounts balance was

$1,350.

Let’s see what effect the write-off had on these accounts.


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Before Write-Off

After Write-Off

Accounts receivable 67,000$ 66,500$Less: Allow. for uncollectible accts. 1,350 850 Net realizable value 65,650$ 65,650$

Notice that the $500 write-off did not change the net realizable value (which means that it did not change total assets) nor did it affect

any income statement accounts!!!!!


.

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Uncollectible Accounts Uncollectible Accounts RecoveredRecovered

When a customer makes a payment after an account has been written off,

two journal entries are required: Reverse the write-off.




Allowance for Uncollectible Accounts XXX1

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Uncollectible Accounts Uncollectible Accounts RecoveredRecovered

When a customer makes a payment after an account has been written off,

two journal entries are required: Record the cash collection.





Cash XXX

Accounts Receivable XXX2

1

Why?

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Credit Card SalesCredit Card Sales

Companies accept credit cards for several reasons: To increase sales. To avoid providing credit

directly to customers. To avoid losses due to bad

checks. To receive payment quicker.

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When credit card sales are made, the company must pay the credit card

company a fee for the service it provides.

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On July 6, Kid’s Clothes’ credit card sales were $1,500. The credit card company charges a 2% service fee.

Prepare the journal entry.



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On July 6, Kid’s Clothes’ credit card sales were $1,500. The credit card company charges a 2% service fee.

Prepare the journal entry.



July 6 Cash 1,470

Credit Card Expense 30

Sales 1,500

$1,500 × 2% = $30 Credit Card Fee

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Obligations payable within one year. Normally are paid using current assets.

Clearly determinable liabilities

e.g. Payroll taxes withheld, etc.

Estimated liabilities

e.g. Product Warranty

Current LiabilitiesCurrent Liabilities

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Contingent LiabilitiesContingent Liabilities Existence of liability and amount depends on

(i.e., is contingent on) the outcome of some future event Examples include: lawsuits, income tax

disputes, co-signer of note payable

Must record in accounts if liability is probable and reasonably estimable However, this is normally not the case

If the contingent liability is not probable and reasonably estimable, how is it disclosed?

Notes to the financial statements

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Promissory NotesPromissory Notes

An unconditional written promise... Made & signed by the maker (borrower)... To pay the payee… A definite amount of money… Plus interest (usually)… On the maturity date…

Or on demand.

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$1200 Wheaton, Illinois January 5, 1999

Sixty days after date I promise to pay to

the order of

Yankee Brothers, Inc.

One thousand two hundred --------------------------------- Dollars

Payable at

Wheaton Mountain Bank

Value received with interest at per annumNo. Due

The Kitchen Taylor42 March 6, 1999

12%

Dennis Taylor


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$1200 Wheaton, Illinois January 5, 1999

Sixty days after date I promise to pay to

the order of

Yankee Brothers, Inc.

One thousand two hundred --------------------------------- Dollars

Payable at

Wheaton Mountain Bank

Value received with interest at per annumNo. Due

The Kitchen Taylor42 March 6, 1999

12%

Dennis Taylor

Payee

MakerInterest Rate

Principal

Due Date

Term


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I = P × R × TInterest Principal Rate Time

“Interesting” Calculation


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On March 1, 1998, Beautiful Cosmetics purchased a copier for 10,000 from Business Machines, Inc.

Beautiful Cosmetics gave Business Machines, Inc. $1,000 cash plus a 12% note due in 90 days.

(Assume Business Machines, Inc. uses a periodic inventory system.)

Prepare the journal entries for Beautiful Cosmetics and Business Machines, Inc.

Promissory NotesPromissory NotesExampleExample

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10,000



Mar. 1 Notes Receivable 9,000

Cash 1,000

Sales

To record copier sale

Business Machines, Inc.

10,000

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9,000

1,000



Mar. 1 Office Equipment 10,000

Notes Payable

Cash

To record copier purchase

Beautiful Cosmetics

1,000

9,000

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What is the maturity date of the note between Beautiful Cosmetics and Business

Machines, Inc.?

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What is the maturity date of the note between Beautiful Cosmetics and Business

Machines, Inc.?

Days in March 31 days- Note Date 1

Days Outstanding in March 30 days+ Days in April 30 days

Days Outstanding in March/April 60 days+ Days in May to Equal 90 30 days

Total Life of Note 90 days

(PLUG)

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How much total cash will Beautiful Cosmetics pay at maturity?

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Interest = $9,000 × 12% × 90/360

Note Principal 9,000$Interest 270 Total Cash Paid 9,270$

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Prepare the journal entries at maturity for Beautiful Cosmetics and Business Machines, Inc.

Note Principal 9,000$Interest 270 Total Cash Paid 9,270$

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9,270



May 30 Notes Payable 9,000

Interest Expense 270

Cash

To record note payment

Beautiful Cosmetics

9,270

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May 30 Cash 9,270

Interest Revenue 270

Notes Receivable 9,000

To record cash receipt

Business Machines, Inc.

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If a note is still outstanding at the end of the accounting period, an adjusting entry is

required to record the accrued interest on both the maker’s and payee’s books.

Maker’s Adjusting Entry

Interest Expense Dr.

Interest Payable Cr.

Maker’s Adjusting Entry

Interest Expense Dr.

Interest Payable Cr.

Accruing InterestAccruing Interest

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If a note is still outstanding at the end of the accounting period, an adjusting entry is

required to record the accrued interest on both the maker’s and payee’s books.

Payee’s Adjusting Entry

Interest Receivable Dr.

Interest Revenue Cr.

Payee’s Adjusting Entry

Interest Receivable Dr.

Interest Revenue Cr.

Accruing InterestAccruing Interest

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Dishonored NotesDishonored Notes

Maker . . .

Fails to pay amounts due at maturity.

Records Interest Expense and Interest Payable.

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Dishonored NotesDishonored Notes

Payee . . .

Transfers Note Receivable to Accounts Receivable.

Records Interest Revenue and Interest Receivable.

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Two Types of Two Types of Promissory NotesPromissory Notes

Interest-bearing A/K/A “Straight Loan” Interest is paid at maturity Borrower receives cash

equal to amount of note Noninterest-bearing

A/K/A “Discounted” note Interest is withheld by bank up front Borrower receives cash equal to

amount of the note less interest

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Interest-Bearing NoteInterest-Bearing Note(“Straight” Loan)(“Straight” Loan)

This one is relatively simple.

For example, borrower asks bank for $20,000 and receives $20,000, then makes

the following journal entry:

Cash 20,000

Notes Payable 20,000

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Non-Interest-Bearing NoteNon-Interest-Bearing Note(Discounted Note)(Discounted Note)

Uses a new account, Discount on Notes Payable

Is a contra-liability account Normal balance is debit

Initial account balance is the difference between the note’s maturity value and the cash proceeds received by borrower i.e., represents interest withheld by bank

This amount is allocated to interest expense over life of note

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On March 1, 1999 Hillbilly Sounds, Inc. discounted a $20,000, 6-month, non-interest-bearing note at American Bank at 9%. On Sept. 1, 1999 Hillbilly Sounds pays American Bank in full. How would these entries be recorded by Hillbilly Sounds?

Non-Interest-Bearing NoteNon-Interest-Bearing NoteExampleExample

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GENERAL JOURNAL

Page 1


3/1/99 Cash 19,100Discount on Notes Payable 900 Notes Payable 20,000To record discounting of note

$20,000 × .09 × ½ = $900 bank discount

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GENERAL JOURNAL

Page 1


3/1/99 Cash 19,100Discount on Notes Payable 900 Notes Payable 20,000To record discounting of note

$20,000 × .09 × ½ = $900 bank discount

CONTRA-LIABILITY ACCOUNT


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Partial Balance Sheet at March 1, 1999Partial Balance Sheet at March 1, 1999

Current Liabilities:

Notes Payable $ 20,000

Less: Discounts on Notes Payable 900 19,100

Carrying Value


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At maturity on Sept. 1, 1999, Hillbilly Sounds, Inc. pays American Bank in full.

GENERAL JOURNAL

Page 1


9/1/99 Notes Payable 20,000Interest Expense 900 Discount on Notes Payable 900 Cash 20,000To record interest and note payment

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WE ARE SAILING RIGHT ALONG!!

9-1 R ECEIVABLES AND P AYABLES CHAPTER 9 9-2 R ECEIVABLES AND P AYABLES CHAPTER 9 CAUTION ! Most...

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