1. ACCOUNTING FOR RECEIVABLES
CHAPTER 8
ACCOUNTING FOR RECEIVABLES

2. Agenda Learning goals Vocabulary Types of accounts receivable
Valuing accounts receivable
Recognize notes receivable
Disposing of notes receivable
Statement presentation and management of receivables

3. Learning goals Record accounts receivable transactions
Calculate the net realizable value of accounts receivable and account for bad debt
Account for notes receivable
Demonstrate the presentation, analysis, and management of receivables

4. Vocabulary Income statement approach Accounts receivable
Notes receivable
Percentage of receivables approach
Trade receivables
Aging schedule
Net realizable value
Balance sheet approach
Bad debt expense
Promissory note
Allowance method
Dishonoured note
Percentage of sales approach
Turnover ratio

5. Types of Receivables Amounts due from individuals and other companies
Accounts receivable:
Amounts owed by customers on account
Expected to be collected within 30 days
Notes receivable (trade receivables):
Supported by formal instruments of credit
For periods of 30 days or longer
Interest bearing

6. 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.

7. 1. RECOGNIZING ACCOUNTS RECEIVABLE
When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.
Date
Particulars
Debit
Credit
July 1
Accounts Receivable – Adorable Junior 1,000
Sales ,000

8. 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)
When a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited.
Date
Particulars
Debit
Credit
July 5
Sales Returns and Allowances
Accounts Receivable

9. 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)
When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.
Date
Particulars
Debit
Credit
July 31
Cash ($1,000 – $100)
900
900
Accounts Receivable

10. 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)
When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited.
Date
Particulars
Debit
Credit
July 31
Accounts Receivable (18% or 1.5% per month on $900)
13.50
13.50
Interest Revenue

11. 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)
When discount is provided due to early payment Cash and Sales Discount are debited and Accounts Receivable is credited .
Date
Particulars
Debit
Credit
July 31
Cash [($1000-$100)*98%]
Sales Discount [($1000-$100)*2%]
882 18
900
Accounts Receivale

12. 1. RECOGNIZING ACCOUNTS RECEIVABLE (cont.)
Sales on credit cards that are not directly associated with a bank are reported as credit sales, not cash sales.
Unlike bank credit card sales - treated as cash sales
Receipt of cash from nonbank credit cards is recorded as follows

13. Practice
Do the practice question on page 412

14. 2. VALUING ACCOUNTS RECEIVABLE
To ensure that receivables are not overstated, 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.

15. 2. VALUING ACCOUNTS RECEIVABLE
When receivables are written down to their net realizable value due to credit losses, owner’s equity must also be reduced.
Done by recording bad debt expense

16. ACCOUNTS RECEIVABLE (cont.)
2. VALUING
ACCOUNTS RECEIVABLE (cont.)
Two methods of accounting for uncollectible accounts are:
1. Allowance method
2. Direct write-off method

17. DIRECT WRITE-OFF METHOD
Under the direct write-off 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.
No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet.

18. DIRECT WRITE-OFF METHOD
Periera Company writes off E. Schaefer’s $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.
Date
Particulars
Debit
Credit
Jan. 12
Bad Debt Expense
200
200
Accounts Receivable – E. Schaefer

19. THE ALLOWANCE METHOD (2 Steps)
The allowance method is required when bad debts are deemed to be material (significant) in amount.
Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred.
Why?

20. Step 1-Record Estimated Uncollectible
THE ALLOWANCE METHOD
Step 1-Record Estimated Uncollectible
Estimated uncollectible amounts are debited to Bad Debts Expense (operating expense)and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.
Date
Particulars
Debit
Credit
Dec. 31
Bad Debts Expense
24,000
24,000
Allowance for Doubtful Accounts

21. ADORABLE JUNIOR GARMET Balance Sheet (partial)
Current assets
Cash $ 14,800
Accounts receivable $200,000
Less: Allowance for doubtful accounts , ,000
Why not just show the Net Realizable Value, and omit the rest?
Net Realizable Value

22. Step 2: Recording the Write-Off of an Uncollectible Account
THE ALLOWANCE METHOD
Step 2: Recording the Write-Off of an Uncollectible 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.
Date
Particulars
Debit
Credit
Mar. 1
Allowance for Doubtful Accounts
500
500
Accounts Receivable - Nadeau

23. THE ALLOWANCE METHOD- Recovery of an Uncollectible
When there is recovery of an account that has been written off:
Reverse the entry made to write off the account
Date
Particulars
Debit
Credit
July 1
Accounts Receivable – Nadeau
Allowance for Doubtful Accounts
Record the collection in the usual manner.
Date
Particulars
Debit
Credit
July 1
Cash
Accounts Receivable

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

25. A. PERCENTAGE OF SALES BASIS
In the percentage of sales basis (income statement approach), management establishes what amount of net CREDIT sales are expected to be uncollectible (usually from past experience).
Bad Debt Expense is then determined by applying the percentage to the sales base of the current period. The TOTAL amount is charged to Bad Debt. Observe…
This basis better matches expenses with revenues.
Date
Particulars
Debit
Credit
Dec. 31
Bad Debt Expense ,000
Allowance for Doubtful Accounts 3,000

26. B. PERCENTAGE OF AGED RECEIVABLES BASIS
Under this method, management estimates what the TOTAL value of bad debt currently is by applying a percentage to the actual, existing accounts receivable balances at the end of the period.
Also known as the balance sheet approach
This percentage can be applied to
The total receivable balance, or
To accounts receivable balances grouped by age. (see pg 416)

27. B. PERCENTAGE OF AGED RECEIVABLES BASIS (cont.)
The amount of the adjusting entry is the difference between the required balance in the allowance account, and the current balance.
This basis produces the better estimate of net realizable value of receivables. Observe…
Desired Balance

28. B. PERCENTAGE OF AGED RECEIVABLES BASIS (cont.)
So, if the balance in the Allowance account is already $2,200, then the adjusting entry to bring the Allowance up to the present estimated of Net Realizable Receivables is…
Date
Particulars
Debit
Credit
Dec. 31
Bad Debt Expense ($3,245 - $2,200) ,045
Allowance for Doubtful Accounts 1,045

29. Two Methods for Estimating the Allowance:
Percentage of Sales:
Calculates bad debt expense as a percentage of net credit sales
Based on past experience and company’s credit policy
Example: 2% of credit sales of $1,200,000 = $24,000
Better matches revenues and expenses
Also called the income statement method
Percentage of Receivables
Calculates the percentage of receivables that are estimated to be uncollectible
Based on past experience and credit policy
Can be applied to total receivables balance or amounts grouped by age
Requires an aging schedule to be prepared
Better estimate of net realizable value
Also called the balance sheet method

30. Comparison of Approaches
Percentage of Sales
Matching
Sales
Bad Debts Expense
Percentage of Receivables
Net Realizable Value
Allowance for Doubtful Accounts
Accounts Receivable
Income Statement Approach
Balance Sheet Approach

31. Do the following starting on page 434:
BE8-6, 7, 8
E8-3, E8-4
P8-5A

32. 3. 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.

33. 3. DISPOSING OF ACCOUNTS RECEIVABLE (cont.)
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.

34. 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.

35. 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.

36. BANK CARD SALES
We purchase a CDs for our restaurant from Karen Kerr Music Co. for $1,000 using our Royal Bank VISA card.
The service fee that the Royal charges is 3.5 percent.
Date
Particulars
Debit
Credit
July 31
Cash
Credit Card Expense ($1,000 x 3.5%)
Sales ,000

37. 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.

38. Accounts Receivable/ Notes Receivable
Accounts receivable – is an informal promise to pay
Results from credit sale
Due in a short period of time
Doesn’t incur interest unless overdue
Note receivable – is a written promise to pay, which gives the payee a stronger legal claim.
Results from: financing a purchase, lending money, or extending an A/R
Incurs interest for the entire time
Both are credit instruments, valued at their net realizable values, and can be sold to a 3rd party

39. IMPORTANT TERMS Interest rate Face Value Term Maturity
The cost of borrowing others’ money. It is an expense, not the repayment of debt
Face Value
The price of a note or bond, written on the actual contract (note)
Term
The length of the note or bond before it is due
Maturity
When the note/bond’s face value is due, along with any outstanding interest

40. IMPORTANT TERMS Interest is always calculated as follows: Principal
of Note X =
Annual
Interest
Rate
Time in
Terms of
One Year
$10, X % X / = $200
Monthly interest is $200/4 = $50

41. NOTES RECEIVABLE
We now will look at the following three procedures for dealing with notes:
Acquisition
Adjustment/valuation
Disposal/termination
Note: these three steps are similar to many things we will look at this semester. Best to look for trends and processes.

42. RECOGNIZING NOTES RECEIVABLE
Acquisition
Wilma Company receives a $1,000, 6% promissory note, due in two months (July 1) from Brent Company to settle an open account.
Date
Particulars
Debit
Credit
May 1
Notes Receivable
1,000
1,000
Accounts Receivable – Wilma Company
If a note is exchanged for cash instead of A/R, credit cash

43. 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.

44. VALUING NOTES RECEIVABLE Adjustment/Valuation
Recording interest
If they do not, no entry will be recorded until the note matures and pays interest.
Date
Particulars
Debit
Credit
May 31
Interest Receivable 5 5
Interest Revenue

45. VALUING NOTES RECEIVABLE Disposal/Termination
Notes are normally held to their maturity date, at which time the principal plus any unpaid interest is collected – known as honouring the notes.
Date
Particulars
Debit
Credit
May 31
Cash
1,010 5
Interest Receivable 5
Interest Revenue
1,000
Notes Receivable - Wilma Company
When the note is honoured it is paid in full at its maturity date. The amount due at maturity is the principal of the notes plus interest for the length of time the note is outstanding.

46. VALUING NOTES RECEIVABLE Disposal/Termination
If Wilma company does NOT adjust monthly, the journal entry will look like this:
Date
Particulars
Debit
Credit
May 31
Cash
1,010 10
Interest Receivable
1,000
Notes Receivable - Wilma Company

47. DISHONOUR OF NOTES RECEIVABLE
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.
Date
Particulars
Debit
Credit
Sept. 30
Accounts Receivable - Wilma Company
1,010
1,000
Notes Receivable - Wilma Company 10
Interest Revenue

48. If interest was accrued during the duration of the note
Date
Particulars
Debit
Credit
Sept. 30
Accounts Receivable - Wilma Company
1,010
Accounts Receivable - Wilma Company
1,000 5
Interest Revenue
Interest Receivable
If interest was accrued during the duration of the note

49. DISHONOUR OF NOTES RECEIVABLE
Allowance for Doubtful Accounts
Notes Receivable – Highly
Interest Receivable
To record dishonouring of not that
will not be collected
1010
1000 50
Date
Particulars
Debit
Credit
Sept. 30

50. BALANCE SHEET PRESENTATION OF RECEIVABLES
Both the gross amount of receivables and the allowance for doubtful accounts should be reported.
Why?

51. Management of Receivables
Receivables turnover ratio:
= Net Credit Sales ÷ Average Gross Receivables
Measures the number of times that receivables are collected in a period
Higher the number, the more liquid are receivables
Collection period:
= 365 ÷ Receivables Turnover Ratio
Calculates the average number of days that accounts receivable are outstanding
Should not be longer than the credit term period (time allowed for payment)

52. Management of Receivables
Operating Cycle:
= Days Sales in Inventory + Collection Period
Calculates the number of days to complete the operating cycle
Average time that it takes to purchase inventory, sell it on account, and then collect cash from customers.

53. USING THE INFORMATION IN THE FINANCIAL STATEMENTS
Financial ratios are calculated to evaluate the short-term liquidity of a company.
Recall these ratios:
1. current ratio,
2. acid test (quick) ratio,
3. receivables turnover, and the
4. A/R collection period (in days).

54. Do the following starting on page 435:
BE8-9 to 12
P8-8A
P8-10A