ACCOUNTING FOR RECEIVABLES Wed, Nov 26 will be Unit 3 Test (covering chapter 7 and 8) CHAPTER 8

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 - amounts owed by customers 2. Notes Receivable – claims for which formal instruments of credit are issued as proof of the debt. (30 days or longer period) 3. Other Receivables – interest receivables, loans (or advances) to employees and recoverable sales and income taxes RECEIVABLESRECEIVABLES

Trade Receivables are notes receivable and accounts receivable which result from sale transactions. The two primary accounting problems associated with accounts receivable are: 1. Recognizing accounts receivable. (When, how) 2. Valuing accounts receivable.(How) RECEIVABLESRECEIVABLES

For a service company, AR is recorded when the service is provided. For a merchandise business, AR is recorded at the point of sale of merchandise on account. In chapter 5, we saw how accounts receivable are reduced by sales returns (and allowances) and by sales discounts. Recognizing AR

July 1 1,000 To record sales on account. 1,000 GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Accounts Receivable - Adorable Junior Sales RECOGNIZING ACCOUNTS RECEIVABLE On July 1, when a business (Periodic inventory system) sells merchandise to a customer on credit with 2/10, n/30, Accounts Receivable is debited and Sales is credited.

100 RECOGNIZING ACCOUNTS RECEIVABLE On July 5, when a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited. GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 5Sales Returns and Allowances Accounts Receivable - Adorable 100 To record merchandise returned.

882 RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 10Cash ($1,000 - $100)*0.98 Accounts Receivable - Adorable 900 Sales Discounts18 To record collection of account. 18 On July 10, when a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

13.50 RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 31Accounts Receivable - Adorable Interest Revenue To record interest on amount due. When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited. In this case, the customer did not pay within 30 days.

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. VALUING ACCOUNTS RECEIVABLE

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

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. (= This method does not honor matching principle) DIRECT WRITE-OFF METHOD

GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Jan. 12Bad Debts Expense Accounts Receivable — E. Schaefer For write-off of E. Schaefer account. 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

The allowance method is required when bad debts are deemed to be material 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. This method honors matching principle. THE ALLOWANCE METHOD

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. THE ALLOWANCE METHOD

ADORABLE JUNIOR GARMET Balance Sheet (partial) Current assets Cash $ 14,800 Accounts receivable$200,000 Less: Allowance for doubtful accounts 24, ,000 Net Realizable Value

GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit Mar. 1Allowance for Doubtful Accounts Accounts Receivable — Nadeau Write-off of Nadeau 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. THE ALLOWANCE METHOD

When there is recovery of an account that has been written off: 1. reverse the entry made to write off the account and... THE ALLOWANCE METHOD GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 1Accounts Receivable — Nadeau Allowance for Doubtful Accounts To reverse write-off of Nadeau account

THE ALLOWANCE METHOD GENERAL JOURNAL DateAccount Titles and ExplanationDebitCredit July 1Cash Accounts Receivable —Nadeau To record collection from Nadeau Record the collection in the usual manner.

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

ILLUSTRATION 9-4 COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES Percentage of Sales Percentage of Receivables Net Realizable Value Allowance Accountsfor ReceivableDoubtful Accounts Emphasis on Income Statement Relationships Emphasis on Balance Sheet Relationships

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. PERCENTAGE OF SALES 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. 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. PERCENTAGE OF RECEIVABLES BASIS

P434 BE8-1, BE8-2, BE8-3, BE8-5, BE8-6 P437 E8-4 Classwork / Homework