Accounting for 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

A receivable is recorded when:

Services are provided

Merchandise is sold on account

July 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

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

See page 410 in your text

Other transactions are posted in a similar

manner:

Account collections

Interest charged on overdue accounts

July 10 Cash [($1,000 - $100) x 2%] 882

Sales Discounts [($1,000 - $100) x 2%] 18

Accounts Receivable - Zellers 900

To record collection of accounts receivable

Aug. 31 Accounts Receivable - Kids Online 30

Interest Revenue 30

To record interest on amount due

Nonbank credit card (i.e. Sears Card)

sales are treated as sales on account

Unlike bank credit card sales - treated as cash

sales

Receipt of cash from nonbank credit cards is

recorded as follows

Oct. 24 Accounts Receivable - Credit Card Company 480

Credit Card Expense ($500 x 4%) 20

Sales 500

To record nonbank credit card sale

Nov. 7 Cash 480

Accounts Receivable - Credit Card Company 480

To record redemption of credit card billing

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: matching of revenues and expenses

Three features of allowance method:

1. Amount of uncollectible receivables is

estimated and recorded at end of period

2. Specific amounts determined uncollectible

are written off against the allowance

3. Specific amounts that are recovered are

reversed out of allowance and the collection

recorded

Allowance for Doubtful Accounts

Deducted from Accounts Receivable in the

current assets section of balance sheet

Net Realizable value = Accounts Receivable less

Allowance for Doubtful Accounts

See page 415 for Balance Sheet

Dec. 31 Bad Debts Expense 24,000

Allowance for Doubtful Accounts 24,000

To record estimate of bad debts expense

Percentage of Sales: • 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

• Better matches revenues and expenses

• Also called the income

statement method

Percentage of Receivables

• 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

• Most companies prefer this method

Percentage of Sales

Matching

Sales Bad Debts

Expense

Percentage of Receivables

Net Realizable Value

Allowance for

Doubtful

Accounts

Accounts

Receivable

Income Statement

Approach Balance Sheet

Approach

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

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

A written promise to pay a specified amount

of money on demand or at a definite time

If note is received to settle an outstanding

account receivable:

If received for cash, debit is to Cash

Notes are valued at net realizable value

Similar process to determine bad debt expense and

allowance as for accounts receivable

May 31 Notes Receivable - Higly 10,000

Accounts Receivable - Higly 10,000

To record acceptance of Higly note

Formula for calculating interest:

An annual rate of interest - to determine

monthly interest, divide by twelve

Separate interest receivable account is

used (value of note is not altered)

Principal

of Note X X =

Annual

Interest

Rate

Time in

Terms of

One Year Interest

June 30 Interest Receivable 50

Interest Revenue ($10,000 x 6% x 1/12) 50

To accrue interest on Higly note

A note is honoured when paid in full on its

maturity date

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

• A note is dishonoured if not paid in full at maturity

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

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

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