John Wiley

John Wiley & Sons, Inc.

Financial Accounting, 5e

Prepared byKurt M. Hull, MBA CPA

California State University, Los Angeles

Weygandt, Kieso, & Kimmel

CHAPTER 9ACCOUNTING FOR RECEIVABLES


STUDY OBJECTIVESAfter studying this chapter, you should understand:

Types of receivables

Disposition

of A/R

Valuation

of N/R

Recognition of A/R

Maturity & Interest of N/R

Disposition of N/R

Valuation

of A/R

Recognition

of N/R

F/S Presentation & Analysis

STUDY OBJECTIVE 1

TYPES OF RECEIVABLESSTUDY OBJECTIVE 1

TYPES OF RECEIVABLES

Receivables are amounts due from individuals and other companies.There are three major classes of receivables:

A/R N/R OtherOwed by customers

on account, from credit sales, due in

30-60 days.

Claims supported by a formal credit instrument. Due in 60-90 days, with

interest.

Loans to company officers, employee

advances, refundable income taxes.

PRIMARY ACCOUNTING ISSUESPRIMARY ACCOUNTING ISSUES

Recognition

Valuation

Disposition

STUDY OBJECTIVE 2

RECOGNIZING A/RSTUDY OBJECTIVE 2

RECOGNIZING A/R

Date Description Debit Credit

July 1 A/R—Polo Company 1000

Sales 1000

(sales on account)

July 5 Sales returns & allowances 100

A/R—Polo Company 100

(merchandise returned)

July 11 Cash 882

Sales Discounts 18

A/R—Polo Company 900

(collection of A/R)

A classic general journal sequence for credit sales.

• Receivables are current assets on the balance sheet• They are stated at net realizable value, the amount

expected to be received in cash. • Uncollectible A/R are accounted for using two methods

STUDY OBJECTIVE 3

VALUATION OF A/RSTUDY OBJECTIVE 3

VALUATION OF A/R

Direct Write-OffMethod

AllowanceMethod

• No entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to bad debts expense.

• Bad debt expense shows only actual losses.• Not acceptable for financial reporting purposes

unless losses are insignificant.

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD

Bad debts expense

Operating expenseon the

income statement

Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense

will show only actual losses from uncollectibles.

Date Account Titles Debit Credit

General Journal

Dec. 12 Bad Debts Expense 200 Accounts Receivable – M.E. Doran 200

DIRECT WRITE-OFF METHODDIRECT WRITE-OFF METHOD

• The allowance method is required when bad debts are material.

• Uncollectible accounts are estimated

• The expense is matched against sales in the same accounting period.

ALLOWANCE METHODALLOWANCE METHOD

Uncollectible accounts expense = bad debts expense

Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful

Accounts at the end of each period.


General Journal

Dec. 31 Bad Debts Expense 12,000 Allowance for Doubtful Accounts 12,000

ALLOWANCE METHODRECORDING ESTIMATED UNCOLLECTIBLES

ALLOWANCE METHODRECORDING ESTIMATED UNCOLLECTIBLES

Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable

at the time the specific account is written off.


General Journal

Mar. 1 Allowance for Doubtful Accounts 500

Accounts Receivable - R. A. Ware 500

ALLOWANCE METHODRECORDING A WRITE-OFF

ALLOWANCE METHODRECORDING A WRITE-OFF

To recover an account that has been written off:

1 reverse the write-off entry.


General Journal

July 1 Accounts Receivable – R. A. Ware 500 Allowance for Doubtful Accounts 500

ALLOWANCE METHODRECORDING A RECOVERY

ALLOWANCE METHODRECORDING A RECOVERY


General Journal

July 1 Cash 500 Accounts Receivable 500

2 record the collection in the usual manner.

Percentage of Sales Percentage of Receivables

Emphasis on Income Statement Relationships

Emphasis on Balance Sheet Relationships

ALLOWANCE METHODBASIS FOR ESTIMATING UNCOLLECTIBLES

ALLOWANCE METHODBASIS FOR ESTIMATING UNCOLLECTIBLES

Two methods of estimating uncollectible accounts comply with GAAP.

Uses aging schedule

• Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience.

• Matches expenses with revenues.

• No consideration given to existing balance in the allowance.

ALLOWANCE METHODPERECENTAGE OF SALES BASIS

ALLOWANCE METHODPERECENTAGE OF SALES BASIS


General Journal

Dec. 1 Bad Debts Expense 8,000

Allowance for Doubtful Accounts 8,000

If net credit sales for the year are $800,000, the estimated

bad debts expense is $8,000 (1% X $800,000).

• Bad debt expense based on % of the ending balance in A/R. • The adjusting entry is the difference between the required

balance and the existing balance in the allowance account.• Estimates NRV of receivables.

ALLOWANCE METHODPERECENTAGE OF RECEIVABLES BASIS

ALLOWANCE METHODPERECENTAGE OF RECEIVABLES BASIS


General Journal

Dec. 1 Bad Debts Expense 1,700

Allowance for Doubtful Accounts 1,700

If the trial balance shows Allowance for Doubtful Accounts with a credit balance of $528, an adjusting entry for $,1,700 ($2,228 - $528) is necessary.

Which of the following approaches for bad debtsis referred to as a balance sheet method?A. Percentage of receivables methodB. Direct write-off methodC. Percentage of sales methodD. Both a and b

REVIEW QUESTIONREVIEW QUESTION

Answer: (A) Percentage of receivables method.

STUDY OBJECTIVE 4

DISPOSING OF A/RSTUDY OBJECTIVE 4

DISPOSING OF A/R

Two ways to dispose of A/R

Factoring Credit cardsales

Henderson Furniture factors $600,000 of receivables to Federal Factors, Inc. Federal Factors assesses a 2% service charge.


General Journal

Cash 588,000

Service Charge Expense (2% x $600,000) 12,000

Accounts Receivable 600,000

DISPOSING OF A/RFACTORING (SALE) OF RECEIVABLES

DISPOSING OF A/RFACTORING (SALE) OF RECEIVABLES

A factor is a finance company that buys A/R from companies, then collects payments directly from the customers.

Three parties are involved with credit card sales:

The retailer pays the credit card issuer

a fee of 2-6% of the invoice price.

Sales from Visa, MasterCard, and Discover are treated

differently than American Express & Diners Club

Credit card issuer Retailer Customer

CREDIT CARD SALESCREDIT CARD SALES

• Considered cash sales by the retailer.

• Upon receipt of credit card sales slips from a retailer, the bank adds the amount to the seller’s bank balance.

VISA, MASTERCARD, & DISCOVERVISA, MASTERCARD, & DISCOVER


General Journal

Cash 970Service Charge Expense 30 Sales 1,000

Barbara Hardy purchases CD’s for her restaurant from Ty Parker Music Co. for $1,000 using her VISA First Bank Card.

First Bank charges a 3% fee.

• Considered credit sales by the retailer.• Conversion into cash does not occur until the

companies remits the net amount to the seller.

AMERICAN EXPRESS & DINERS CLUBAMERICAN EXPRESS & DINERS CLUB


General Journal

Accounts Receivable – American Express 285Service Charge Expense 15

Sales 300

Four Seasons for her restaurant from Karen Kerr Music Co. for $1,000 using her VISA First Bank Card. The service fee that First Bank charges is 3%.

• A promissory note is 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 receive payment is the payee.

PROMISSORY NOTESPROMISSORY NOTES

• When the life of the note is expressed in terms of days, you need to count the days.

• In counting, the date of issue is omitted but the due date is included.

• Example: The maturity date of a 60-day note dated July 17 is:

STUDY OBJECTIVE 5

MATURITY & INTEREST – NOTES RECEIVABLE

STUDY OBJECTIVE 5

MATURITY & INTEREST – NOTES RECEIVABLE

Term of note 60 days

July (31-17) -14 days

August -31days

Maturity date: September 15

The formula for computing interest on an interest-bearing note is:

The interest rate specified on the note is an annual rate of interest.

Face Valueof Note

Annual Interest

Rate

Timein Terms of

One YearInterestX X =

COMPUTING INTEREST COMPUTING INTEREST

$ 730 X 18% X 120/360 = $ 43.80 $1,000 X 15% X 6/12 = $ 75.00 $2,000 X 12% X 1/1 = $240.00

COMPUTATION OF INTEREST COMPUTATION OF INTEREST

The interest rate specifiedis the annual rate.

Compute the missing amount below:

REVIEW QUESTION REVIEW QUESTION

$450120 days9%?

Total InterestTimeAnnual Interest RateFace Value

I = P x R x T(face value = principal)

$450 = P x .09 x 120/360

P = $15,000

Wilma Company receives a $1,000, 2-month, 12% promissory note from Brent Company to settle an open account.


General Journal

May 1 Notes Receivable 1,000 Accounts Receivable – Brent Company 1,000

STUDY OBJECTIVE 6

RECOGNIZING NOTES RECEIVABLESTUDY OBJECTIVE 6

RECOGNIZING NOTES RECEIVABLE

Notes receivable are recorded at FACE VALUE

• N/R are recorded at face value.• Allowance for Doubtful Accounts used to

record estimated uncollectible accounts.• N/R reported on the balance sheet at net

realizable value.

STUDY OBJECTIVE 7

VALUATION OF NOTES RECEIVABLESTUDY OBJECTIVE 7

VALUATION OF NOTES RECEIVABLE

Gross N/R – Allowance = Net Realizable Value

Betty Co. lends Higley Inc. $10,000 on June 1, accepting a 5-month, 9% interest-bearing note.

Betty collects the maturity value of the note from Higley on Nov 1.

STUDY OBJECTIVE 8

DISPOSING OF NOTES RECEIVABLEHONORED NOTE

STUDY OBJECTIVE 8

DISPOSING OF NOTES RECEIVABLEHONORED NOTE

A note is honored when it is paid in full at its maturity date.For an interest-bearing note,

the maturity amount is the face value plus interest.


Nov 1 Cash 10,375

Notes Receivable 10,000

Interest Revenue 375

(collection of Higley, Inc. note)

If Betty Co. prepares prepares financial statements on September 30, interest for 4 months, would be accrued.

ACCRUING INTEREST --HONORED NOTE RECEIVABLE



Sept 30 Interest Receivable ($10,000 x 9% x 4/12) 300


(accrue 4 month’s interest on Higley, Inc. note)

Interest receivable is a current asset

When interest has been accrued, it is necessary

to credit Interest Receivable at maturity.




Nov 1 Cash 10,375


Interest Receivable 300

Interest Revenue 75

(collection of note at maturity)

A dishonored note is a note that is not paid in full at maturity. Since the payee still has a claim against the maker of the note, the balance in

Notes Receivable is usually transferred to Accounts Receivable.

DISHONOR OFNOTE RECEIVABLE



Nov 1 A/R—Higley, Inc. 10,375



(record dishonor of Higley note)

NOTE: This scenario assumes the note

will eventually be collected.


Nov 1 Allowance for doubtful accounts 10,000


(record dishonor of Higley note)



If there is no hope of collection,

The face value eliminated, and the allowance is debited.

Also, no interest would be accrued.

• In the balance sheet, short-term receivables are reported in the current assets section below short-term investments.

• Report both the gross amount of receivables and the allowance for doubtful accounts.

STUDY OBJECTIVE 9

FINANCIAL STATEMENT PRESENTATION & ANALYSIS

STUDY OBJECTIVE 9

FINANCIAL STATEMENT PRESENTATION & ANALYSIS

Accounts receivable $1,200,000

Less: allowance for doubtful accounts (48,000)

Accounts receivable, net $1,152,000

• Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable.

• The accounts receivables turnover ratio is used to assess the liquidity of the receivables.

• The data below is from Cisco Systems:

Net CreditSales

Average Net Receivables

AccountsReceivableTurnover

/ =

A/R TURNOVER RATIOA/R TURNOVER RATIO

$18,878 / ( $1,105 + $1,351)/2 = 15.4 times

• The average collection period in days is a variant of the turnover ratio that makes liquidity even more evident.

• This is done by dividing the turnover ratio into 365 days. • The general rule is that the collection period should not exceed

the credit term period.• Cisco System’s turnover ratio is computed as:

/ =

AVERAGE COLLECTION PERIODAVERAGE COLLECTION PERIOD

Days in yearA/R Turn

Ratio

AverageCollection

Period

365 / 15.4 23.7 days

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