Chapter 8: Accounting for Receivables

Accounts Receivable

Amounts customers owe on account that result from the sale of goods and services.

Notes Receivable

Written promise for amounts to be received. Normally requires the collection of interest.

Other Receivables

Nontrade receivables such as interest, loans to officers, advances to employees, and income taxes.

Recognizing Accounts Receivable

Service organization records a receivable when it performs service on account; Merchandiser records accounts receivable at the point of sale of merchandise on account.

Valuing Accounts Receivable

Current asset; Valuation (cash realizable value).

Uncollectible Accounts Receivable

Sales on account raise the possibility of accounts not being collected; Companies record credit losses as debits to Bad debt expense (or uncollectible accounts expense).

Direct Write-off Method

Theoretically undesirable: No matching, Receivable not stated at cash realizable value, Not acceptable for financial reporting.

Allowance Method

Losses are estimated: Better matching, Receivable stated at cash realizable value, Required by GAAP.

Bad Debt Expense

Debited when recording uncollectible accounts.

Allowance for Doubtful Accounts

A contra-asset account used to estimate uncollectible accounts receivable.

Recording Estimated Uncollectibles

Companies debit bad debt expense and credit allowance for doubtful accounts; Companies debit allowance for doubtful accounts and credit accounts receivable at the time the specific account is written off as uncollectible.

Cash Realizable Value

The net amount expected to be collected from accounts receivable.

Journal Entry for Accounts Receivable

Assume that Jordache Co. on July 1, 2022, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co.: July 1 accounts receivable 1,000 Sales revenue 1,000.

Warden Co. Write-off Entry

Assume that Warden Co. writes off M. E. Doran's $200 balance as uncollectible on December 12. Warden's entry is: Dec. 12 bad debt expense 200 Accounts receivable 200.

Hampson Furniture Credit Sales

Hampson Furniture has credit sales of $1,200,000 in 2022, its first year of operations.

Accounting Issues for Receivables

Three accounting issues: Recognizing accounts receivable, Valuing accounts receivable, Disposing of accounts receivable.

Disposing of Accounts Receivable

The process of removing uncollectible accounts from the books.

Service Organization Receivable Recognition

Records a receivable when it performs service on account.

Merchandiser Receivable Recognition

Records accounts receivable at the point of sale of merchandise on account.

Credit Losses

Recorded as debits to Bad debt expense when accounts are deemed uncollectible.

GAAP Requirement

The allowance method is required by GAAP for financial reporting.

Bad Debt Expense

Theoretical undesirable expense recognized when accounts receivable are estimated to be uncollectible.

Accounts Receivable

Money owed to a company by its customers for goods or services delivered.

Allowance Method

A method for accounting for uncollectible accounts by estimating uncollectible amounts and recording them as an allowance.

Uncollectible Accounts Receivable

Accounts receivable that are not expected to be collected.

Allowance for Doubtful Accounts

A contra-asset account that reduces the total accounts receivable to reflect the amount expected to be collected.

Write-off of an Uncollectible Account

The process of removing an uncollectible account from the accounts receivable and adjusting the allowance account.

Cash Realizable Value

The amount of cash expected to be collected from accounts receivable, calculated as accounts receivable minus the allowance for doubtful accounts.

Credit Sales

Sales made on credit, where payment is expected at a later date.

Estimated Uncollectibles

The amount of accounts receivable that a company estimates will not be collected.

Adjusting Entry

An entry made at the end of an accounting period to update the accounts to reflect the correct balances.

Balance Sheet

A financial statement that summarizes a company's assets, liabilities, and equity at a specific point in time.

Current Assets

Assets that are expected to be converted into cash or used up within one year.

Inventory

Goods and materials that a business holds for the purpose of resale.

Supplies

Items used in the operation of a business that are not intended for resale.

Percentage of Outstanding Receivables

A method used to estimate the allowance for doubtful accounts based on a percentage of total accounts receivable.

Recovery of an Uncollectible Account

The process of reinstating a previously written-off account when payment is received.

Financial Reporting

The process of providing financial information to various stakeholders, including investors and regulators.

Contra-Asset Account

An account that is used to reduce the value of an asset on the balance sheet.

Debit

An accounting entry that increases an asset or expense account or decreases a liability or equity account.

Credit

An accounting entry that decreases an asset or expense account or increases a liability or equity account.

Cash

Money in the form of coins and banknotes, or funds held in bank accounts.

Accounts Receivable (Net)

The net amount of accounts receivable after deducting the allowance for doubtful accounts.

Percentage-of-receivables basis

Management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts.

Aging schedule

A company often prepares an aging schedule to accurately estimate the ending balance in the allowance account.

Allowance method

Adjusting entry prepared from an aging schedule.

Bad Debt Expense

The expense recorded to reflect the estimated uncollectible receivables.

Allowance for Doubtful Accounts

An account that reflects the estimated amount of receivables that will not be collected.

Disposing of accounts receivables

Companies sell receivables for two major reasons: Receivables may be the only reasonable source of cash, and billing and collection are often time-consuming and costly.

Sale of receivables to a factor

A finance company or bank that buys receivables from businesses and collects payments directly from customers.

Service charge

Typically charged as a fee to the company selling the receivables, ranging from 1-3% of the receivables purchased.

Illustration of factoring

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

National credit card sales

Recorded the same as cash sales, with the retailer paying a fee of 2-4% of the invoice for its services.

Accounting for credit card sales

Anita Ferreri purchases $1,000 of compact discs using her Visa First Bank Card, with a service fee of 3%.

Deposits in transit

Credit card receipts that have not been processed by the bank and are treated as such on bank reconciliation.

Promissory note

A written promise to pay a specified amount of money on demand or at a definite time.

Uses of promissory notes

Used when individuals and companies lend or borrow money, when transaction amounts and credit periods exceed normal limits, or in settlement of accounts receivable.

Cash entry for notes receivable

The maker, Calhoun Company, debits Cash and credits Notes Payable.

Adjusting entry example 1

For an unadjusted trial balance with a credit balance of $528, the adjusting entry for uncollectible receivables of $2,228 results in a Bad Debt Expense of $1,700.

Adjusting entry example 2

For an unadjusted trial balance with a debit balance of $500, the adjusting entry for uncollectible receivables of $2,228 results in a Bad Debt Expense of $2,728.

Service Charge Expense in factoring

Calculated as $600,000 × 2% = $12,000.

Retailer fee for credit card sales

The retailer pays a fee of 2-4% of the invoice for credit card services.

Cash entry for credit card sale

For a $1,000 sale, the cash entry is $970 after a service charge of $30.

Payee

The entity that receives payment, in this case, Wilma Company.

Maturity Date

The date when the note is due, which can be on demand, at the end of a stated period, or on a stated date.

Interest Rate

The annual rate specified for computing interest on notes receivable.

Counting Days

When counting days for interest, omit the date the note is issued but include the due date.

Notes Receivable Entry

The accounting entry made when a note is received, such as debiting Notes Receivable and crediting Accounts Receivable.

Valuing Notes Receivable

Short-term notes receivable are reported at their cash (net) realizable value.

Allowance for Doubtful Accounts

An account used to estimate bad debt expense and cash realizable value for receivables.

Disposing of Notes Receivable

Options include holding to maturity, adjusting for default, or selling the note.

Honor of Notes Receivable

When the maker pays the note in full at its maturity date.

Dishonor of Notes Receivable

When the note is not paid at maturity and is no longer negotiable.

Interest Revenue Calculation

For a $10,000 note at 9% for 5 months, interest revenue is calculated as $10,000 × 9% × 5/12 = $375.

Accrual of Interest Receivable

An adjusting entry to recognize interest earned but not yet received.

Cash Receipt Entry

The entry made when cash is received for a note, including interest receivable.

Dishonor Entry

The entry made when a note is dishonored, transferring amounts to Accounts Receivable.

Bad Loans

Loans that result from inaccurate financial information provided on loan applications.

Loan Verification Steps

Banks should request recent income tax forms and verify income with employers.

Receivables Presentation

Major types of receivables should be identified in the balance sheet or notes, with short-term receivables as current assets.

Income Statement Reporting

Bad debt expense and service charge expense are reported as operating expenses.

Accounts Receivable Turnover

A measure of how effectively a company collects its receivables, calculated using net sales and average accounts receivable.

Average Collection Period

A variant of the accounts receivable turnover ratio expressed in days.

Cisco Systems Sales

Cisco Systems had net sales of $37,750 million for the year.

Beginning Accounts Receivable

Cisco's beginning accounts receivable (net) balance was $5,157 million.

Ending Accounts Receivable

Cisco's ending accounts receivable (net) balance was $5,344 million.