Chapter 8 – Accounting for Receivables

LO 1 – Recognizing Accounts Receivable

• Definition of Receivables
• Amounts due from individuals/companies, expected to be collected in cash.
• Three classes
• Accounts Receivable – results from credit sales of goods/services.
• Notes Receivable – written promises that bear interest; usually longer term.
• Other Receivables – interest, loans to officers, advances to employees, income-tax refunds, etc.

• Importance in Corporate Balance Sheets (selected company data: Receivables ÷ Total Assets)
• Ford Motor $43.2\%$
• General Electric $41.5\%$
• 3M $12.7\%$
• DuPont $11.7\%$
• Intel $3.9\%$

• Three Core Accounting Issues

1. Recognizing receivables

2. Valuing receivables

3. Disposing of receivables

• Journal Entries—Basic Credit Sale Cycle
• Sale on account (example: Jordache → Polo, $1{,}000$, terms $2/10\,,\ n/30$)
• Dr Accounts Receivable $1{,}000$ / Cr Sales Revenue $1{,}000$
• Sales return (July 5)
• Dr Sales Returns & Allowances $100$ / Cr Accounts Receivable $100$
• Cash collection with discount (July 11)
• Dr Cash $(900-18)=882$
• Dr Sales Discounts $(900×0.02)=18$
• Cr Accounts Receivable $900$

• DO IT 1 (Wilton/Bates) highlights same mechanics; emphasis on trade-discount interaction with returns.

• Anatomy of a Fraud (Tasanee Case)
• Combined custody, record-keeping, depositing, and reconciliation allowed $1.5\text{ million}$ theft.
• Missing controls: segregation of duties; independent internal verification.
• Result: controller terminated.

LO 2 – Valuing & Disposing of Accounts Receivable

• Cash (realizable) value = gross A/R – Allowance for Doubtful Accounts.

• Two Methods for Bad Debts
• Direct Write-Off (DW)
• Record loss when specific account proves uncollectible.
• Violates matching; assets overstated; NOT GAAP except for immaterial amounts.
• Entry example (Warden Co.): Dr Bad Debt Expense $200$ / Cr A/R $200$.
• Allowance Method (GAAP-required)
• Estimate future uncollectibles; provides better matching + net realizable presentation.
• Year-end adjusting entry: Dr Bad Debt Expense / Cr Allowance for Doubtful Accounts (AFDA).
• Write-off: Dr AFDA / Cr A/R → affects ONLY balance-sheet accounts; NRV unchanged.

• Initial Estimate Example (Hampson Furniture)
• Credit sales $1{,}200{,}000$; $200{,}000$ still open; estimated uncollectible $12{,}000$.
• Dec 31: Dr Bad Debt Expense $12{,}000$ / Cr AFDA $12{,}000$.

• Recovery of a Write-off (two-step)

1. Reinstate: Dr A/R $500$ / Cr AFDA $500$

2. Collect: Dr Cash $500$ / Cr A/R $500$

• Estimation Techniques
• Percentage-of-Receivables
• Management sets % × ending A/R = required AFDA balance.
• Aging Schedule
• Stratifies receivables by days outstanding; multiply each age-bucket by expected % loss.
• Adjust AFDA to reach the schedule’s required ending balance.
• Example: Required $2{,}228$; unadjusted AFDA credit $528$ ⇒ Adjusting entry $1{,}700$.
• If unadjusted AFDA has debit $500$ ⇒ Entry $2{,}728$ (because need to offset debit plus reach target credit).

• DO IT 2a (Brule Corp.)
• End A/R $30{,}000$. Desired AFDA $3{,}000$ ($10\%$). Current AFDA debit $2{,}000$.
• Adjustment: Dr Bad Debt Expense $5{,}000$ / Cr AFDA $5{,}000$.

• Selling (Factoring) Receivables
• Reasons: need immediate cash; avoid billing/collection costs.
• Factor (finance company/bank) assumes collection risk, charges $1–3\%$ fee.
• Entry (Hendredon Furniture): Dr Cash $588{,}000$, Dr Service Charge Expense $12{,}000$, Cr A/R $600{,}000$.

• National Credit Card Sales
• Treated like cash sales.
• Issuer remits cash net of 2–4 % fee.
• Example (Visa sale): Dr Cash $970$, Dr Service Charge Expense $30$, Cr Sales Revenue $1{,}000$.

• Bank Reconciliation Insight (Nordstrom)
• Unprocessed credit-card batches = deposits in transit.

• DO IT 2b (Kell factoring $125{,}000$ @ 1 %)
• Dr Cash $123{,}750$ / Dr Service Charge $1,250$ / Cr A/R $125,000$.

LO 3 – Notes Receivable

• Promissory Note: written promise to pay $\text{principal} + \text{interest}$ either on demand, at stated date, or after stated period.

• Typical Uses
• Lending/borrowing transactions.
• Large or lengthy credit sales.
• Settlement of past-due A/R.

• Parties
• Maker – issues the note, records Notes Payable.
• Payee – holds the note, records Notes Receivable.

• Determining Maturity
• On demand, stated date, or stated period (# days/months).
• Day count rule: exclude issue date, include due date.

• Interest Computation
$\text{Interest} = \text{Face} \times \text{Rate} \times \frac{\text{Time (days)}}{360 \text{ or } 365}$

• Recognition Example
• Receive $1,000, 2-month, 12 % note May 1: Dr Notes Receivable $1,000$ / Cr A/R $1,000$.

• Honoring a Note
• Example: $10,000, 5-month, 9 % (Wolder → Higley). Collection Nov 1:
• Dr Cash $10,375$ / Cr Notes Receivable $10,000$ / Cr Interest Revenue $375$.

• Accruing Interest (financial-statement date before maturity)
• Sept 30 (4 of 5 months elapsed) interest receivable $300$ ($10,000×9\%×4/12$).
• Dr Interest Receivable $300$ / Cr Interest Revenue $300$.
• At maturity collect: Dr Cash $10,375$ / Cr Notes Receivable $10,000$ / Cr Interest Receivable $300$ / Cr Interest Revenue $75$.

• Dishonor
• If expect eventual collection: convert to A/R incl. interest.
• Dr A/R $10,375$ / Cr Notes Receivable $10,000$ / Cr Interest Revenue $375$.
• If hopeless: write-off via AFDA.

• DO IT 3 (Gambit/L. Co.; $3,400, 90-day, 6 % note dated May 10)
• Maturity Aug 8 (count 90 days).
• Interest $3,400×6\%×90/360 = 51$.
• Collection entry Aug 8: Dr Cash $3,451$ / Cr Notes Receivable $3,400$ / Cr Interest Revenue $51$.

LO 4 – Statement Presentation and Analysis

• Balance Sheet
• List each major receivable class separately (trade, financing, subsidiary, etc.).
• Present current receivables under current assets.
• Show gross A/R and AFDA.

• Income Statement
• Bad Debt Expense & Service-Charge Expense → Operating Expenses.
• Interest Revenue → “Other revenues and gains.”

• Deere & Co. (partial, $\text{in millions}$)
• Gross receivables $37,007$ – AFDA $175$ = Net $36,832$.

• Receivables Ratios
• Accounts Receivable Turnover $= \dfrac{\text{Net Credit Sales}}{\dfrac{\text{Beginning A/R}+\text{Ending A/R}}{2}}$
• Cisco example: $\frac{37,750}{(5,157+5,344)/2}=7.06$ times.
• Average Collection Period $= \dfrac{365}{\text{A/R Turnover}}$ → interprets days to collect.

• DO IT 4 (Lebron James Co.)
• Turnover $= 923,795 / ((38,275+35,988)/2)=24.2$ times.
• Collection period $=365/24.2≈15\text{ days}$.

LO 5 – GAAP vs. IFRS Highlights

• Similarities
• Recording receivables, sales returns/discounts, allowance method, and the term “impairment” align.
• Both Boards debate fair-value measurement.

• Differences
• IFRS lacks explicit rule to segregate receivables with different characteristics on B/S.
• Factoring test:
• IFRS – risks & rewards + control; permits partial derecognition.
• GAAP – primarily loss of control; no partial derecognition.
• Self-Test answers:
• False statement: “Receivables include equity securities purchased.”
• Factoring: “IFRS allows partial derecognition.”
• Entry for estimated uncollectibles identical under both.

Ethical & Practical Insights

• Fraud example underscores need for strong internal controls: segregation of duties and careful bank-reconciliation review.

• Countrywide “liars’ loans” illustrates credit-risk evaluation; banks should verify income (tax returns, employer contacts) and asset ownership (statements, appraisals).

• Nike’s disclosure shows continual reassessment of AFDA based on historical credit losses & customer creditworthiness; estimates may vary with future economic changes.

Key Formulas & Quick Reference

• Cash Realizable Value $= \text{A/R} - \text{AFDA}$
• Bad Debt Expense (percentage-receivables)
$\text{Adjustment} = \text{Required AFDA} - \text{Existing AFDA balance}$ (consider sign)
• Service Charge (factoring/credit card) $= \text{Fee \%} \times \text{Receivables Sold or Sales}$
• Interest on Notes $= \text{Face} \times \text{Annual Rate} \times \dfrac{\text{Time}}{12 \text{ or 360}}$
• A/R Turnover $= \dfrac{\text{Net Credit Sales}}{\text{Average A/R (net)}}$
• Average Collection Period $= \dfrac{365}{\text{A/R Turnover}}$

Internal Control Checklist for Receivables Cycle

• Segregate sales approval, billing, cash handling, and recording.
• Use prenumbered sales invoices; match with shipping and order docs.
• Perform independent monthly bank reconciliations.
• Maintain proper authorization for write-offs and factoring.
• Conduct periodic aging review to trigger collection action.