ACCOUNTING FOR RECEIVABLES STUDY OBJECTIVES After studying this material, you should understand: Types of receivables F/S Presentation & Analysis Recognition of A/R Valuation of A/R

TYPES OF RECEIVABLES Receivables are amounts due from individuals and other companies. There are three major classes of receivables: A/RN/ROther Owed by customers on account, from credit sales, due in days. Claims supported by a formal credit instrument. Due in days, with interest. Loans to company officers, employee advances, refundable income taxes.

PRIMARY ACCOUNTING ISSUES Recognition Valuation Disposition

RECOGNIZING A/R DateDescriptionDebitCredit July 1A/R—Polo Company1000 Sales1000 (sales on account) July 5Sales returns & allowances100 A/R—Polo Company100 (merchandise returned) July 11Cash882 Sales Discounts18 A/R—Polo Company900 (collection of A/R) A classic general journal sequence for credit sales.

Receivables are current assets on the balance sheet They are stated at net realizable value, the amount expected to be received in cash. Uncollectible A/R are accounted for using two methods VALUATION OF A/R Direct Write-Off Method Allowance Method

No entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to bad debts expense. Bad debt expense shows only actual losses. Not acceptable for financial reporting purposes unless losses are insignificant. DIRECT WRITE-OFF METHOD Bad debts expense Operating expense on the income statement

Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles. DateAccount TitlesDebitCredit General Journal Dec. 12 Bad Debts Expense 200 Accounts Receivable – M.E. Doran 200 DIRECT WRITE-OFF METHOD

The allowance method is required when bad debts are material. Uncollectible accounts are estimated The expense is matched against sales in the same accounting period. ALLOWANCE METHOD Uncollectible accounts expense = bad debts expense

Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts at the end of each period. DateAccount TitlesDebitCredit General Journal Dec. 31 Bad Debts Expense12,000 Allowance for Doubtful Accounts 12,000 ALLOWANCE METHOD RECORDING ESTIMATED UNCOLLECTIBLES ALLOWANCE METHOD RECORDING ESTIMATED UNCOLLECTIBLES

Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off. DateAccount TitlesDebitCredit General Journal Mar. 1 Allowance for Doubtful Accounts 500 Accounts Receivable - R. A. Ware 500 ALLOWANCE METHOD RECORDING A WRITE-OFF ALLOWANCE METHOD RECORDING A WRITE-OFF

To recover an account that has been written off: 1 reverse the write-off entry. DateAccount TitlesDebitCredit General Journal July 1 Accounts Receivable – R. A. Ware 500 Allowance for Doubtful Accounts 500 ALLOWANCE METHOD RECORDING A RECOVERY ALLOWANCE METHOD RECORDING A RECOVERY DateAccount TitlesDebitCredit General Journal July 1 Cash 500 Accounts Receivable record the collection in the usual manner.

Percentage of Sales Percentage of Receivables Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships ALLOWANCE METHOD BASIS FOR ESTIMATING UNCOLLECTIBLES ALLOWANCE METHOD BASIS FOR ESTIMATING UNCOLLECTIBLES Two methods of estimating uncollectible accounts comply with GAAP. Uses aging schedule

Bad debt expense is based on a % of current credit sales estimated to be uncollectible, based on past experience. Matches expenses with revenues. No consideration given to existing balance in the allowance. ALLOWANCE METHOD PERECENTAGE OF SALES BASIS ALLOWANCE METHOD PERECENTAGE OF SALES BASIS Dec.3 1 Bad Debts Expense 8,000 Allowance for Doubtful Accounts 8,000 If net credit sales for the year are $800,000, the estimated bad debts expense is $8,000 (1% X $800,000).

Bad debt expense based on % of the ending balance in A/R. The adjusting entry is the difference between the required balance and the existing balance in the allowance account. Estimates NRV of receivables. ALLOWANCE METHOD PERECENTAGE OF RECEIVABLES BASIS ALLOWANCE METHOD PERECENTAGE OF RECEIVABLES BASIS DateAccount TitlesDebitCredit General Journal Dec. 31 Bad Debts Expense 1,700 Allowance for Doubtful Accounts 1,700 If the existing balance in the allowance account is $500 credit, and the required balance is $2,200, the journal entry to increase the allowance will be for the difference between the required balance and the existing balance.

If the existing balance in the allowance account is $500 debit, and the required balance is $2,200, the journal entry to increase the allowance will be for the sum of the required balance and existing balance. DateAccount TitlesDebitCredit General Journal Dec. 31 Bad Debts Expense 2,700 Allowance for Doubtful Accounts 2,700

Which of the following approaches for bad debts is referred to as a balance sheet method? A.Percentage of receivables method B.Direct write-off method C.Percentage of sales method D.Both a and b REVIEW QUESTION Answer: (A) Percentage of receivables method.

In the balance sheet, short-term receivables are reported in the current assets section below short-term investments. Report both the gross amount of receivables and the allowance for doubtful accounts. FINANCIAL STATEMENT PRESENTATION & ANALYSIS FINANCIAL STATEMENT PRESENTATION & ANALYSIS Accounts receivable$1,200,000 Less: allowance for doubtful accounts(48,000) Accounts receivable, net$1,152,000

Financial ratios are computed to evaluate the liquidity of a company’s accounts receivable. The accounts receivables turnover ratio is used to assess the liquidity of the receivables. The data below is from Cisco Systems: Net Credit Sales Average Net Receivables Accounts Receivable Turnover / = A/R TURNOVER RATIO $18,878 / ( $1,105 + $1,351)/2 = 15.4 times

The average collection period in days is a variant of the turnover ratio that makes liquidity even more evident. This is done by dividing the turnover ratio into 365 days. The general rule is that the collection period should not exceed the credit term period. Cisco System’s turnover ratio is computed as: / = AVERAGE COLLECTION PERIOD Days in year A/R Turn Ratio Average Collection Period 365 / days