Accounting for Receivables
Chapter 7: Accounting for Receivables
Learning Objectives
CONCEPTUAL
C1: Describe accounts receivable and how they occur and are recorded.
C2: Describe a note receivable, the computation of its maturity date, and the recording of its existence.
C3: Explain how receivables can be converted to cash before maturity.
ANALYTICAL
A1: Compute accounts receivable turnover and use it to help assess financial condition.
PROCEDURAL
P1: Apply the direct write-off method to accounts receivable.
P2: Apply the allowance method to accounts receivable.
P3: Estimate uncollectibles based on sales and accounts receivable.
P4: Record the honoring and dishonoring of a note and adjustments for interest.
Learning Objective C1: Describe Accounts Receivable and How They Occur and Are Recorded
Valuing Accounts Receivable
Definition of Receivable:
A receivable is an amount due from another party.Recording Receivables:
A company must maintain a separate account for each customer to track purchases, payments, and outstanding balances.
Example Illustration:
Exhibit 7.1 shows recent dollar amounts of receivables and their percent of total assets for four well-known companies.
Sales on Credit: Journal Entries
Journal Entry Example (July 1):
Credit Sale:
Debit Accounts Receivable—CompStore $950
Credit Sales $950
Record credit sale.
Collection Example:
Debit Cash $720
Credit Accounts Receivable—RDA Electronics $720
Record collection of prior credit sales.
Sales on Bank Credit Cards and Mobile Payments
Companies allow various payment methods (e.g., bank cards, mobile payments) to facilitate customer transactions.
Advantages of Accepting Payments:
No risk assessment for seller on credit.
Avoidance of non-payment risk.
Faster cash receipt than direct credit.
Expanded credit options for customers.
Credit Card Sale Entry (July 15):
Cash $96, Credit Card Expense $4, Sales $100
Record credit card sale minus fees.
Learning Objective P1: Apply the Direct Write-Off Method to Accounts Receivable
Bad Debts
Definition: Uncollectible amounts from customers; known as bad debts.
Method of Accounting:
Direct Write-Off Method
Allowance Method
Direct Write-Off Example:
January 23:
Debit Bad Debts Expense $520
Credit Accounts Receivable—J. Kent $520
Write off uncollectible account.
Recovering a Bad Debt
Entry (March 11):
Reinstate account:
Debit Accounts Receivable—J. Kent $520
Credit Bad Debts Expense $520
Record payment received:
Debit Cash $520
Credit Accounts Receivable—J. Kent $520
Considerations in Using the Direct Write-Off Method
Expense Recognition Principle:
Requires expenses to be recorded in the same period as the related revenues.
Materiality Constraint:
Direct write-off may be permitted if results approximate those from the allowance method.
Learning Objective P2: Apply the Allowance Method to Accounts Receivable
Allowance Method Overview
Process: At the end of each period, estimate total bad debts expected from sales.
Advantages:
Records bad debts in the same period as sales.
Reports accounts receivable as the expected cash to be collected.
Write-offs do not affect net income or net receivables directly.
Disadvantage:
Requires estimates.
Allowance Method: Recording Bad Debts Expense
Example:
TechCom's Credit Sales: $300,000; $20,000 uncollected; Estimated uncollectible: $1,500.
Entry Dec. 31:
Debit Bad Debts Expense $1,500
Credit Allowance for Doubtful Accounts $1,500
Balance Sheet Presentation
Current Assets:
Accounts Receivable: $20,000
Less: Allowance for Doubtful Accounts $1,500
Net Value: $18,500
Writing Off a Bad Debt with Allowance Method
Example:
January 23:
Debit Allowance for Doubtful Accounts $520
Credit Accounts Receivable—J. Kent $520
Write off uncollectible account.
Recovering a Bad Debt with Allowance Method
Example:
March 11: Reinstate and record payment.
Debit Accounts Receivable—J. Kent $520
Credit Allowance for Doubtful Accounts $520
Debit Cash $520
Credit Accounts Receivable—J. Kent $520
Comparing Allowance vs. Direct Write-Off Method
Direct Write-Off:
No adjustment entry
Includes debit to Bad Debts Expense
Recovery includes credit to Bad Debts Expense
Allowance Method:
Adjusting entry is required
Includes debit to Allowance for Doubtful Accounts
Recovery includes credit to Allowance for Doubtful Accounts
Learning Objective P3: Estimate Uncollectibles Based on Sales and Accounts Receivable
Estimating Bad Debts Expense: Two Methods
Percent of Sales Method
Balance Sheet Methods
Percent of Accounts Receivable
Aging of Accounts Receivable
Percent of Sales Method
Formula:
Example: Musicland's credit sales $400,000; uncollectible estimated at 0.6%; estimated Bad Debts Expense = $2,400.
Journal Entry:
Debit Bad Debts Expense $2,400
Credit Allowance for Doubtful Accounts $2,400
Percent of Receivables Method
Formula:
For example, if year-end accounts receivable is $50,000 and 5% are uncollectible:
Ending balance = $50,000 × 5% = $2,500.
Aging of Accounts Receivable Method
Each receivable is classified based on how long it is past due.
Each age group multiplied by its estimated bad debts percentage to calculate the total.
Practical Example - Musicland Aging Schedule
Table Example of Aging Receivables:
Not Yet Due: Total $5,890
1 to 30 Days: Total $710
31 to 60 Days: Total $10,500
61 to 90 Days: Total $200
Over 90 Days: Total $1,900
Estimated uncollectible = $2,270
Estimating Bad Debts – Summary of Methods
Exhibit describing various methods used to estimate bad debts.
Learning Objective C2: Describe a Note Receivable, the Computation of its Maturity Date, and the Recording of its Existence
Definition of Notes Receivable
A promissory note is a written promise to pay a specified amount, often with interest, either on demand or at a stated future date.
Computing Maturity Date
The maturity date of a note is when it must be repaid, including principal and interest.
Example: TechCom received a $1,000, 90-day, 12% note on July 10; due on October 8.
Formula for Interest Calculation:
For a 90-day note:
Recording Notes Receivable
Notes receivable are recorded in a single account to simplify recordkeeping.
Example Entry for Notes Receivable on July 10:
Debit Notes Receivable $1,000
Credit Sales $1,000
Accepting a Note Receivable to Settle Accounts
Example (Oct. 5):
Debit Cash $232
Debit Notes Receivable $600
Credit Accounts Receivable—J. Cook $832
Learning Objective P4: Record the Honoring and Dishonoring of a Note and Adjustments for Interest
Recording an Honored Note
Example (Dec. 4):
Debit Cash $615
Credit Notes Receivable $600
Credit Interest Revenue $15
*Interest calculated: $600 × 15% × (60/360).
Recording a Dishonored Note
Example (Dec. 4):
Debit Accounts Receivable—J. Cook $615
Credit Interest Revenue $15
Credit Notes Receivable $600
Recording End-of-Period Interest Adjustment
Example (Dec. 31):
Debit Interest Receivable $15
Credit Interest Revenue $15
Formula for Accrued Interest:
Recording Collection on Note at Maturity
Example (Feb. 14):
Debit Cash $3,060
Credit Interest Revenue $45
Credit Interest Receivable $15
Credit Notes Receivable $3,000
Learning Objective C3: Explain How Receivables Can Be Converted to Cash Before Maturity
Disposal of Receivables
Selling Receivables:
Journal Entry Example (Aug. 15):
Debit Cash $19,200
Debit Factoring Fee Expense $800
Credit Accounts Receivable $20,000
Sold accounts receivable for cash less a 4% fee.
Pledging Receivables:
Journal Entry Example (Aug. 20):
Debit Cash $35,000
Credit Notes Payable $35,000
Borrow with a note secured by pledging receivables.
Learning Objective A1: Compute Accounts Receivable Turnover and Use It to Help Assess Financial Condition
Accounts Receivable Turnover
Definition: This ratio evaluates how efficiently a company manages its credit sales and receivables.
Example Data:
Visa:
Net Sales: $32,653 million; Average Accounts Receivable: $2,156 million; Turnover: 15.1
Mastercard:
Net Sales: $25,098 million; Average Accounts Receivable: $3,743 million; Turnover: 6.7.