Financial Accounting: Receivables and Sales
Recognizing Accounts Receivable
Learning Objective 1: Recognize accounts receivable at the time of credit sales
Credit Sales:
Transfer goods or services to a customer today while bearing the risk of collecting payment from that customer in the future.
At the time of a credit sale, a company will record:
Accounts Receivable: Amounts owed to a company by its customers from the sale of goods or services on account.
Revenue: Recorded immediately upon provision of goods or services, regardless of cash payment, as long as future collection from the customer is probable.
Example of a Credit Sale
On March 1, a company provides services worth $500, recorded as follows:
March 1: Debit Accounts Receivable ……….. $500
Credit Service Revenue …………. $500
(Provide services on account)
Recording the Subsequent Receipt
When the customer pays on March 31:
March 31: Debit Cash ……………………….. $500
Credit Accounts Receivable …….. $500
(Receive cash for services on account)
Key Point
Companies record an asset (accounts receivable) and revenue when they sell goods or services, expecting future collection. Once collected, the balance in accounts receivable is reduced.
Other Types of Receivables
Nontrade Receivables: Receivables originating from sources other than customers (e.g., tax refund claims, interest receivable, loans to other entities).
Notes Receivable: Formal credit arrangements evidenced by written debt instruments (notes).
Concept Check 5–1
What is recorded at the time services are provided?
Answer: Accounts receivable
Explanation: Accounts receivable represent cash to be received from sales or services on account.
Calculating Net Revenues
Learning Objective 2: Calculate net revenues using returns, allowances, and discounts
Net Revenues:
Equal total revenues less amounts for returns, allowances, and discounts.
Components affecting net revenues:
Trade Discounts: Reduction in list price to incentivize bulk purchases.
Sales Returns: Goods returned by the customer. Seller may issue a cash refund or reduce accounts receivable.
Sales Allowances: Issued when goods are not returned but a reduction is agreed upon.
Sales Discounts: Reductions for prompt payment (e.g., terms like 2/10, n/30).
Example of a Trade Discount
Service price for laser eye surgery:
Original: $3,000
Discounted: $2,400
Recorded:
March 1: Debit Accounts Receivable ………….. $2,400
Credit Service Revenue ……………. $2,400
(Provide services on account)
Sales Returns and Allowances
If a customer returns an item:
March 4: Debit Sales Returns …………… $200
Credit Accounts Receivable ………… $200
(Return of goods on account)
If a sales allowance is granted:
March 5: Debit Sales Allowances …………… $400
Credit Accounts Receivable ………… $400
(Allowance for previous credit sale)
Common Mistake
Students may misclassify contra revenue accounts (sales returns/allowances) as expenses.
Contra revenues reduce revenues; expenses are separate costs of generating revenues.
Sales Discounts
Sales Discounts: Encourage quicker payments:
Example: Terms 2/10, n/30 imply a 2% discount if paid in 10 days; full payment is due in 30 days if not taken.
Cash Collection During the Discount Period:
For a service priced at $2,400 with terms 2/10, cash collected on day 10 would be:
March 10: Debit Cash ……………………….. $1,960
Debit Sales Discounts …………….. $40
Credit Accounts Receivable ……….. $2,000
Income Statement Reporting
Partial Income Statement Example:
Service revenue: $3,000
Less: Trade Discount: $600
Sales Returns: $200
Sales Allowances: $400
Sales Discounts: $40
Net Revenue: $1,960
Key Point
Revenues reported are equal to amounts entitled after deductions for trade discounts, returns, allowances, and discounts.
End-of-Period Adjustment for Contra Revenues
Companies must adjust estimates for uncollectible accounts at year-end.
Revenue recognition standard: It must report revenues equal to expected collectible cash amounts.
Common Mistake
Contra asset accounts with a credit balance may be misclassified as liabilities.
Estimating Uncollectible Accounts
Learning Objective 3: Establish an allowance for uncollectible accounts
Uncollectible Accounts: Bad debts accounted through an allowance method as per GAAP.
At year-end, estimate uncollectible accounts and report them as a contra asset to accounts receivable.
Example of Estimating Uncollectible Accounts
For Kimzey:
Owed: $20 million
Estimated uncollectible: 30% → $6 million.
Journal Entry:
Debit Bad Debt Expense …………………………… $6 million
Credit Allowance for Uncollectible Accounts … $6 million
Allowance for Uncollectible Accounts
Classified as a contra asset account.
Represents expected uncollectible amount, affecting net accounts receivable.
Example in Financial Statements
Balance Sheet (partial):
Accounts Receivable: $20m
Less: Allowance for Uncollectible Accounts: $6m
Net Accounts Receivable: $14m
Key Point
Establishing the allowance accurately represents receivables in the balance sheet and reports bad debt expense.
Writing Off Accounts Receivable
Learning Objective 4: Write off accounts receivable as uncollectible
When a customer is deemed unlikely to pay, the company writes off the account:
Example: Customer with $4,000 account written off.
Journal Entry:
Debit Allowance for Uncollectible Accounts … $4,000
Credit Accounts Receivable ……………………… $4,000
Key Point
Write-offs reduce both accounts receivable and the allowance, leaving net receivable unchanged.
Collecting on Accounts Previously Written Off
If payment is later received on a previously written-off account:
Example: Payment of $1,000 received:
Entry for Reestablishment:
Debit Accounts Receivable …………….. $1,000
Credit Allowance for Uncollectible Accounts … $1,000
Entry for Cash Collection:
Debit Cash ……………………………… $1,000
Credit Accounts Receivable …………. $1,000
Common Mistake
Bad debt expense recorded incorrectly at the time of writing off versus when estimating in prior years.
Adjusting the Allowance in Subsequent Years
Learning Objective 5: Adjust the allowance for uncollectible accounts in subsequent years
Observe the adjusted balance for Allowance for Uncollectible Accounts.
Factors influencing adjustment: current year estimates and prior year write-offs.
Accounting for Notes Receivable
Learning Objective 7: Account for notes receivable and interest revenue
Notes Receivable Attributes:
Formal credit arrangements evidenced by notes.
Classified as current or noncurrent based on collection date.
Example of Recording a Notes Receivable
A service worth $10,000 with a 12% interest note:
Entry for Note:
Debit Notes Receivable …………….. $10,000
Credit Service Revenue ……………… $10,000
Interest Calculation and Collection
Interest on a note calculated as:
On six-month note: Interest = $600 (for $10,000 at 12%)
Accruing Interest
Interest accrued must also be accounted for before payment:
Example for 2 months accured:
Debit Interest Receivable …… $200
Credit Interest Revenue …….. $200
Collecting Note Receivable and Interest
Upon collection:
Cash collection includes principal and any accrued interest:
Entry for Cash Collection:
Debit Cash ………………………. $10,600
Credit Notes Receivable ……… $10,000
Credit Interest Revenue ……… $600
Receivables Analysis
Learning Objective 8: Calculate key ratios for managing receivables
Receivables Turnover Ratio: Measures how often receivables are collected in a year.
Average Collection Period: Days the average balance is outstanding.
Example Calculation
Tenet Healthcare vs. CVS Health:
Receivables Turnover: For Tenet: 6.9; For CVS: 13.8.
Average Collection: Tenet: 52.9 days; CVS: 26.4 days.
Key Point
These ratios indicate management’s effectiveness in collecting receivables promptly.
Estimating Uncollectible Accounts Using Percentage-of-Credit-Sales Method
Learning Objective 9: Apply percentage-of-credit-sales method for estimating uncollectible accounts
Percentage-of-Credit Sales Method: Estimates uncollectible accounts from credit sales amount.
Example Adjustments include:
Bad Debt Expense Calculation.
Influence of existing allowance balance considered.
Illustration Effects on Financial Statements
Differentiation in treatment of bad debt expense impacts:
Balance Sheet and Income Statement when adjusting for uncollectible accounts.
Key Point
The methodology and adjustments impact the overall understanding of receivables and their management.