1. Prepared by: Keri Norrie, Camosun College
ACCOUNTING PRINCIPLES
Third Canadian Edition
Prepared by: Keri Norrie, Camosun College

2. ACCOUNTING FOR RECEIVABLES
CHAPTER 8
ACCOUNTING FOR RECEIVABLES

3. RECEIVABLES
The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash.
Three major classes of receivables are:
1. Accounts Receivable
2. Notes Receivable
3. Other Receivables

4. ACCOUNTS RECEIVABLE
The three primary accounting problems associated with accounts receivable are:
1. Recognizing accounts receivable.
2. Valuing accounts receivable.
3. Disposing of accounts receivable.

5. RECOGNIZING ACCOUNTS RECEIVABLE Account Titles and Explanation
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 1
Accounts Receivable - Zellers
Sales
To record sales on account.
1,000
1,000
When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.

6. RECOGNIZING ACCOUNTS RECEIVABLE Account Titles and Explanation
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 5
Sales Returns and Allowances
100
Accounts Receivable - Zellers
100
To record merchandise returned.
When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited.

7. RECOGNIZING ACCOUNTS RECEIVABLE Account Titles and Explanation
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 31
Cash ($1,000 - $100)
900
Accounts Receivable- Zellers
900
To record collection of account.
When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

8. RECOGNIZING ACCOUNTS RECEIVABLE
RELATIONSHIP OF GENERAL LEDGER AND SUBSIDIARY LEDGER
General
Ledger
Customer B C
Accounts
Receivable
The control account in the general ledger shows the total accounts receivable while the subsidiary ledger provides the detail by customer.
Subsidiary
Ledger
Customer A

9. RECOGNIZING ACCOUNTS RECEIVABLE Account Titles and Explanation
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 31
Accounts Receivable - Zellers
13.50
Interest Revenue
13.50
To record interest on amount due.
When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited.

10. VALUING ACCOUNTS RECEIVABLE
To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value.
Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect.

11. VALUING ACCOUNTS RECEIVABLE
Assets
Liabilities
Owner’s Equity = +
At the end of each period, a company estimates the amount of credit losses using the allowance method.
The allowance method reduces the accounts receivable asset to its net realizable value and reduces owner’s equity through recording bad debts expense.
The recording of the bad debts expense in the same period as the related revenue results in better matching on the income statement.

12. THE ALLOWANCE METHOD
How much of accounts receivable will not be collected?
Which customers won’t pay?
To reduce accounts receivable to its net realizable value, it is not feasible to credit the accounts receivable account directly for two reasons:
1. We don’t know which individual customers will not pay their receivable balance in the future.
2. The amount that will not be collected can only be estimated now.
As a result, a contra asset account, Allowance for Doubtful Accounts, is credited for the estimated uncollectible amount.

13. THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Account Title and Explanation
Debit
Credit
Dec. 31
Bad Debts Expense
24,000
Allowance for Doubtful Accounts
24,000
To record estimate of uncollectible accounts.
Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.

14. ADORABLE JUNIOR GARMET Balance Sheet (Partial)
Current assets
Cash $ 14,800
Accounts receivable $200,000
Less: Allowance for doubtful accounts , ,000
Net Realizable Value

15. BASES USED FOR THE ALLOWANCE METHOD
Companies use either of two methods in the estimation of uncollectible accounts:
1. Percentage of sales
2. Percentage of receivables
Both bases are GAAP; the choice is a management decision.

16. COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES (Illustration 8-4)
Percentage of Receivables
Percentage of Sales
Net Realizable Value
Accounts
Allowance for Doubtful Accounts
Receivable
Emphasis on Income Statement Relationships
Emphasis on Balance Sheet Relationships

17. PERCENTAGE OF SALES BASIS
In the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts.
Expected bad debt losses are determined by applying the percentage to the sales base of the current period.
This basis better matches expenses with revenues.

18. PERCENTAGE OF RECEIVABLES BASIS
Under the percentage of receivables basis, management establishes a percentage relationship between the amount of accounts receivable and the required balance in the allowance account.
This percentage can be applied to the total accounts receivable balance, or to individual accounts receivable balances stratified by age.

19. PERCENTAGE OF RECEIVABLES BASIS
The required balance in the allowance account is determined by applying the percentage to the accounts receivable balance at the end of the current period.
The amount of the adjusting entry to record expected bad debt losses for the current period is the difference between the required balance and the existing balance in the allowance account.
This basis produces the better estimate of net realizable value of receivables.

20. THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Mar. 1
Allowance for Doubtful Accounts
4,500
Accounts Receivable — Kids Online
4,500
Write-off of Kids Online account.
Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.

21. Account Titles and Explanation Allowance for Doubtful Accounts
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 1
Accounts Receivable — Kids Online
4,500
Allowance for Doubtful Accounts
4,500
To reverse write-off of Kids Online
account.
When there is recovery of an account that has been written off:
1. reverse the entry made to write off the account and ...

22. Account Titles and Explanation Accounts Receivable — Kids Online
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
July 1
Cash
4,500
Accounts Receivable — Kids Online
4,500
To record collection from Kids Online
2. Record the collection in the usual manner.

23. DISPOSING OF ACCOUNTS RECEIVABLE
To accelerate the receipt of cash from receivables, owners frequently:
1. sell to a factor, such as a finance company or a bank, and
2. make credit card sales.

24. DISPOSING OF ACCOUNTS RECEIVABLE
A factor buys receivables from businesses for a fee and collects the payments directly from customers.
Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit.
Retailers can receive cash more quickly from the credit card issuer.

25. CREDIT CARD SALES
Three parties are involved when credit cards are used in making retail sales:
1. the credit card issuer,
2. the retailer, and
3. the customer.
The retailer pays the credit card issuer a percentage fee of the invoice price for its services.
From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express).

26. BANK CARD SALES
Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.
These cards are issued by banks.
Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the seller’s bank balance.

27. Account Titles and Explanation To record VISA credit card sales.
BANK CARD SALES
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Oct 21
Cash
965
Credit Card Expense ($1,000 x 3.5%) 35
Sales
1,000
To record VISA credit card sales.
Anita Ferreri purchases a number of compact discs for her restaurant from Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent.

28. NON-BANK CARD SALES
Sales using American Express and other non-bank cards are reported as credit sales, not cash sales.
Conversion into cash does not occur until American Express remits the net amount to the seller.

29. Account Titles and Explanation
NON-BANK CARD SALES
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Oct 24
Accounts Receivable
475
Credit Card Expense ($500 x 5%) 25
Sales
To record American Express
credit card sales.
500
Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent.

30. NOTES RECEIVABLE
A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.
The party making the promise is the maker.
The party to whom payment is made is called the payee.

31. RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
Notes Receivable - Higly
10,000
May 31
Accounts Receivable — Higly
10,000
To record acceptance of Higly note.
Wolder Company receives a $10,000, 4.5% promissory note, due in four months (Sept 30) from Higly Inc. to settle an open account.

32. FORMULA FOR CALCULATING INTEREST Illustration 8-7
The basic formula for calculating interest on an interest-bearing note is:
The interest rate specified on the note is an annual rate of interest.
Principal
of Note
Annual
Interest
Rate
Time in Terms of
One Year
Interest X X =

33. RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Titles and Explanation
Debit
Credit
June 30
Interest Receivable
Interest Revenue ($10,000 x 4.5% x 1/12)
To accrue interest on Higly note receivable.
An adjusting entry is recorded at the June 30 year end to accrue one month of interest on the Highly note receivable.

34. VALUING NOTES RECEIVABLE
Like accounts receivable, short-term notes receivable are reported at their net realizable value.
The notes receivable allowance account is Allowance for Doubtful Notes.

35. HONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Debit
Credit
Sept. 30
Cash
10,150
Notes Receivable - Higly
10,000.00
Interest Revenue
112.50
Interest Receivable
37.50
To record collection of Higly note.
A note is honoured when it is paid in full at its maturity date.
Wolder Co. collects the principal amount of $10,000, the one month of interest accrued already at June 30, and three months additional interest revenue ($10,000 x 4.5% x 3/12) for the loan period of July 1 – September 30.

36. DISHONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Debit
Credit
Sept. 30
Accounts Receivable - Higly
10,150
Notes Receivable - Higly
10,000.00
Interest Revenue
112.50
Interest Receivable
37.50
To record the dishonouring of Higly note.
A dishonoured note is a note that is not paid in full at maturity.
A dishonoured note receivable is no longer negotiable.
Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.

37. BALANCE SHEET PRESENTATION OF RECEIVABLES
Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements.
In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments.
Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

38. USING THE INFORMATION IN THE FINANCIAL STATEMENTS
Financial ratios are calculated to evaluate the short-term liquidity of a company.
These ratios include the receivables turnover ratio and the collection period ratio.

39. ACCOUNTS RECEIVABLE TURNOVER RATIO
The ratio used to assess the liquidity of the receivables is the receivables turnover ratio.
Net Credit Average Net Receivables
Sales Receivables Turnover  =

40. Days in Year Receivables Collection (365) Turnover Period in Days
COLLECTION PERIOD
The collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident.
The general rule is that the collection period should not exceed the credit term period.
Days in Year Receivables Collection
(365) Turnover Period in Days  =

41. COPYRIGHT
Copyright © 2004 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.