Intermediate I – Chapter 6 Part 1: Receivables Study Notes
Chapter 6: Receivables Detailed Notes
I. Short-term, Non-Note Receivables
A. Classifications
1. Trade Receivables:
Referred to as “Accounts Receivable.”
2. Non-Trade Receivables:
Should have another account title, examples include:
a. Advances to Suppliers
b. Receivable for Deposits
c. Interest Receivable
d. Dividends Receivable
e. Income Tax Refund Receivable
f. Receivables for NSF (Non-Sufficient Funds) Check
g. Receivable from Employees
h. Non-Trade Receivables
3. Certain Short-term Receivables Not Shown as Current Assets:
a. Loans to Related-Party Individuals or Companies:
1) To officers or board members of a corporation.
2) To relatives of the owner of a partnership or sole proprietorship.
3) To subsidiaries or to parent companies.
Note: These related-party receivables should always be reported as “Other Assets.”
b. Short-term receivables restricted for payment of a long-term liability:
Note: These restricted assets, referred to as “restricted receivables,” should be reported as “Other Assets.”
4. Other Receivables:
a. Installment Receivables Due in More Than One Year:
1) If installment sales are a major portion of the business, these receivables should be shown as current because the firm’s operating cycle is greater than a year.
2) If installment sales are not a major portion of the business, these receivables should be shown as a “Long-term Investment.”
b. Receivables with a Credit Balance (from an overpayment by a customer) should be shown as a liability, not netted with other receivables.
B. Discounts
1. Handling Trade Discounts:
a. A trade discount is an arbitrary reduction in the sales price of an item.
b. A trade discount is disregarded in accounting for the sale of the item.
c. Example: A gallon of paint listed to sell for $20 is sold to a painter for $16:
Entry:
db. Cash $16
cr. Sales Revenue $16
2. Cash Discounts (Sales Discounts):
a. To compute the true annual interest rate being paid by not taking the discount:
multiplied by:
Example: For a sale with a “2/10; net/30” discount:
b. Entries Using Gross Method:
1) Sale:
db. Accounts Receivable $1,000
cr. Sales Revenue $1,000
2) Collection within the discount period:
db. Cash $980
db. Sales Discounts $20
cr. Accounts Receivable $1,000
3) Collection after the discount period:
db. Cash $1,000
cr. Accounts Receivable $1,000
Note: The net method utilizes an “Allowance for Sales Discounts” and “Sales Discounts Forfeited” accounts, but is rarely used in practice.
C. Credit Card Sales
Retailers have the technology to process credit card transactions as cash transactions.
Entry:
db. Cash (amount of the sale minus the retailer's charge for customer’s use of the credit card)
db. Financing Expense (for the sales total multiplied by the percentage charged for card use)
cr. Sales Revenue (for the gross sale amount)
D. Returns and Allowances
1. Theoretical Accrual:
Should accrue on balance sheet dates with the following adjusting entry:
db. Sales Returns & Allowances
cr. Allowance for Estimate of Sales Returns & Allowances
2. Practical Accounting:
Generally accounted for when they occur:
db. Sales Returns & Allowances
cr. Cash or Accounts Receivable
Second Entry for Merchandise Return with Perpetual Inventory System:
db. Merchandise Inventory
cr. Cost of Goods Sold
E. Financial Statement Disclosures
1. Segregate different types of receivables if material.
2. Ensure valuation accounts offset against the proper receivable accounts.
3. Confirm that receivables classified as current assets will convert to cash within one year or the operating cycle (whichever is longer).
4. Disclose any loss contingencies related to receivables.
5. Disclose if receivables are designated or pledged as collateral.
6. Disclose significant concentrations of credit risk arising from receivables.
F. Analysis of Accounts Receivable
1. Accounts Receivable Turnover:
Equation:
Measured In: Times
Measurement of: Operating Efficiency
2. Days in Accounts Receivable:
Equation:
Measured In: Days
Measurement of: Operating Efficiency
G. Other Points Concerning Accounts Receivable
1. Collection Expense:
a. Accounting for future collection fees as an expense, which aligns with matching principle:
db. Collection Fee Expense
cr. Allowance for Collection Expenses on Customer Accounts
b. Financial Reporting:
1) Collection Fee Expense appears on income statement as operating expense.
2) Allowance for Collection Expenses appears on balance sheet as contra asset account to accounts receivables.
2. Imputed Interest on Accounts Receivable:
a. Receivables collected later must include imputed interest in face amount of the payment unless stated otherwise.
b. For receivables due in a year or less, accountants typically overlook recording imputed interest, even though financial principles dictate that interest income has been earned.
II. Accounting for Receivables
A. Direct Write-off Method
1. General Principle:
Considered unacceptable since it does not match revenues with expenses; nonetheless, some companies justify use due to materiality.
2. Entries:
a. At year-end: NO ENTRY.
b. Write-off of specific receivable:
db. Bad Debt Expense
cr. Accounts Receivable
c. Recovery of previously written-off specific account:
db. Accounts Receivable
cr. Bad Debt Expense and
db. Cash
cr. Accounts Receivable.
Note: Direct write-off is accepted for tax purposes only.
B. Allowance Method
1. General Principle:
Accepted method as it adheres to the matching principle.
2. Entries:
a. Year-end adjustment:
db. Bad Debt Expense
cr. Allowance for Uncollectibles (contra-account to Accounts Receivable).
Note: This entry computation can be calculated through two methods:
1) Income Statement Approach:
Based on a percentage of sales.
2) Balance Sheet Approach:
Based on a percentage of total outstanding accounts receivable.
b. Write-off specific receivable:
db. Allowance for Uncollectibles
cr. Accounts Receivable
c. Recovery of previously written-off account:
db. Accounts Receivable
cr. Allowance for Uncollectibles and
db. Cash
cr. Accounts Receivable.
III. Financing Through Accounts Receivable
A. Pledging
1. Definition:
A company uses Accounts Receivable as general collateral to obtain a loan without specifically designating which receivables are pledged.
2. Recording Entry:
db. Cash xxx
cr. Notes Payable xxx
3. Disclosure:
The pledging of receivables is disclosed in notes, but no journal entries are made for the pledging.
B. Assignment of Accounts Receivable
1. Definition:
Specific accounts receivable designated as collateral for a loan, with legal obligations for payments defined by collections.
2. Initial Setup Entries:
db. Cash xxx
db. Financing Expense [upfront fee] xxx
cr. Notes Payable xxx
3. Collection Entry:
db. Cash xxx
cr. Accounts Receivable xxx
4. Repayment:
db. Notes Payable xxx
db. Interest Expense xxx
cr. Cash xxx.
C. Securitization of Accounts Receivable
1. Process:
Group of receivables sold as a financial instrument to investors.
2. Responsibilities:
An agent collects receivables and pays investors; if any receivables are uncollected, the selling company is not liable.
3. Quality:
Typically, securitized receivables are of higher quality than assigned receivables, leading to lower costs of securitization.
D. Factoring Accounts Receivable
1. Definition:
The selling of accounts receivable to a bank or a factor.
2. Factored Without Recourse:
a. Accounts receivable sold (usually at loss), with banks or factors collecting.
b. Initial cash withholding to cover potential adjustments.
Entry:
db. Cash xxx
db. Due from Factor xxx
db. Loss on Sale of Receivables xxx
cr. Accounts Receivable xxx.
3. Factored With Recourse:
a. Accounts receivable not fully sold as the seller retains liability if customers default.
b. The transaction is acknowledged as a sale only if three criteria are fulfilled:
1) The asset has been isolated.
2) Right to pledge or exchange is granted to the transferee.
3) Transferor does not maintain effective control.
Entry Example:
db. Cash xxx
db. Financing Charge Expense xxx
db. Due from Factor xxx
db. Loss on Sale of Receivables xxx
cr. Accounts Receivable xxx
cr. Recourse Liability xxx.
Note: Recourse liability is the estimated amount to cover defaults.
IV. Notes Receivable
A. Notes with Market Rate Equal to Stated Rate
1. Issuance Entry:
db. Notes Receivable xxx
cr. Cash or relevant asset xxx.
2. Interest Payment Dates:
Depending on accrual status, entries will vary for interest recognition.
B. Notes with No Stated Rate or Stated Rate That Is Unreasonable
1. Expected Outcomes:
Discounts or premiums recorded, amortized using the effective-interest-rate method.
2. Maturity Accounting:
a. If maturity is less than one year, same treatment as above.
b. If greater than one year, distinct treatment due to potential discount or premium.
C. Summary of Notes Receivable Treatment
1. Definition of Zero Interest Rate Notes:
Treated as clearly unreasonable with market rate determined by fair value assessment or imputed if unknown.
2. Dishonoring Notes Receivable:
a. Updating notes for accrued interest and discount/premium amortization.
b. Recording the dishonored note with relevant accounts adjusted accordingly.
D. Reporting Notes Receivable
1. Possible Valuation Methods:
a. Historical Cost
b. Amortized Cost
c. Net Realizable Value
d. Fair Value
e. Impaired Value
2. Financial Reporting Examples:
a. Historical Cost: Notes Receivable $50,000.
b. Amortized Cost: Notes Receivable $50,000 + Premium $2,000 = $52,000.
c. Net Realizable Value: Notes Receivable $600,000 less Allowance $18,000 = $582,000.
d. Fair Value Reporting based on current dates and assessments may incur unrealized holding losses based on value changes.