Chapter 9 – Accounting for Receivables Objectives: Identify types of receivables Identify types of receivables Valuing receivables Valuing receivables A.Direct Write-off Method B.Allowance Method There are 2 “bases” to estimate the allowance for doubtful (uncollectible) accounts include: 1.Percentage of Sales 2.Percentage of Receivables Notes Receivable: Notes Receivable: A.Maturity Dates B.Computing interest

Types of Receivables “Receivables” refers to amounts due from individuals or companies. “Receivables” refers to amounts due from individuals or companies. 3 Main Classifications /Types of Receivables: 3 Main Classifications /Types of Receivables: 1.Accounts Receivable 2.Notes Receivable 3.Miscellaneous or “Other” receivables A/R – amounts owed by customers on account N/R – claims for which formal instruments (i.e. written promissory agreement) of credit are issued as proof of debt. Other – interest receivable (interest earned but uncollected), advances or loans to employees, tax refund receivable.

Valuing Accounts Receivable When a company sells to customers “on account” there is an exchange made between parties – a product or service is provided IN EXCHANGE FOR a promise to pay a specified amount in the future. (A/R) When a company sells to customers “on account” there is an exchange made between parties – a product or service is provided IN EXCHANGE FOR a promise to pay a specified amount in the future. (A/R) When a company makes a loan (either to a company or individual) there is an exchange – cash provided FOR a promise to pay back the amount borrowed plus interest. (N/R) When a company makes a loan (either to a company or individual) there is an exchange – cash provided FOR a promise to pay back the amount borrowed plus interest. (N/R) Discussion Point: Imagine you have a $10,000 accounts receivable balance, how much of this would you expect to collect?? Discussion Point: Imagine you have a $10,000 accounts receivable balance, how much of this would you expect to collect?? A/R must be reported at its net realizable value ~ the amount reasonably expected to be collected A/R must be reported at its net realizable value ~ the amount reasonably expected to be collected

Valuing Accounts Receivable The amount of receivables determined to be uncollectible are called “bad debt”. The amount of receivables determined to be uncollectible are called “bad debt”. Bad Debt is a cost or expense to the company. Bad Debt is a cost or expense to the company. 2 “Methods” Used to Determine Bad Debt Expense: 2 “Methods” Used to Determine Bad Debt Expense: 1.Direct Write off Method – actual amount of bad debt 2.Allowance Method – estimated amount of bad debt

Direct Write off Method This method is NOT GAAP when receivables are considered to be a material (significant) amount, and therefore is not commonly used by companies that sell on account. This method is NOT GAAP when receivables are considered to be a material (significant) amount, and therefore is not commonly used by companies that sell on account. The Direct write off method shows only ACTUAL losses from uncollectible receivables. The Direct write off method shows only ACTUAL losses from uncollectible receivables. For example: Johnny B Good called Best Buy and informed them that due to financial constraints and bankruptcy, he will be unable to pay the $500 balance owed on account. Therefore, Best Buy would need to make the following journal entry: For example: Johnny B Good called Best Buy and informed them that due to financial constraints and bankruptcy, he will be unable to pay the $500 balance owed on account. Therefore, Best Buy would need to make the following journal entry: Dr.Bad Debt Expense$500 Cr.A/R – Johnny B Good$500 Notice bad debt expense is recorded (debited) ONLY when a specific customer’s account is determined to be uncollectible. Notice bad debt expense is recorded (debited) ONLY when a specific customer’s account is determined to be uncollectible. QUESTION: Is this method is a good application of the matching principle? QUESTION: Is this method is a good application of the matching principle?

Allowance Method Involves estimating bad debt (uncollectible receivables) and recording bad debt expense at the end of each period. Involves estimating bad debt (uncollectible receivables) and recording bad debt expense at the end of each period. Better use of matching principle (than direct write off)– recognizing bad debt expense in the same period that the corresponding revenues were recognized. Better use of matching principle (than direct write off)– recognizing bad debt expense in the same period that the corresponding revenues were recognized. New account: Allowance for uncollectible accounts (contra-asset). New account: Allowance for uncollectible accounts (contra-asset). *Note: Sometimes the allowance for uncollectible accounts is called allowance for doubtful accounts. Receivables are reported (on the Balance Sheet/Statement) at “net realizable value” = A/R balance LESS the balance in the allowance account. Receivables are reported (on the Balance Sheet/Statement) at “net realizable value” = A/R balance LESS the balance in the allowance account. QUESTION: So, how would you determine the amount that you estimate will become uncollectible? QUESTION: So, how would you determine the amount that you estimate will become uncollectible?

Allowance Method 2 “Bases” To Calculate (estimate) The Amount Expected to become Uncollectible: 1.Percentage of Sales – income statement approach, management estimates (using past experience) how much of its total credit sales (as a %) for the period are expected to become uncollectible. 2.Percentage of receivables –balance sheet approach, management estimates (based on the age) how much of its accounts receivable are expected to become uncollectible. *Note: The journal entry for the estimated amount is the same, but the different bases result in different amounts depending on which base management chooses to use to estimate the uncollectible amount. Dr.Bad Debt Expense Cr.Allowance for Uncollectible Accounts

Example - Allowance Method (% of Sales) Percentage of Sales: Percentage of Sales: Example: Nordstrom estimates that 3% of net credit sales end up to be uncollectible. For July, Nordstrom had $300,000 of net credit sales. The journal entry required is: Dr. ________________________ $____________ Cr. ______________________$____________ (____% X $___________) KEY: Using the % of Sales base there is NO consideration given to the current balance of the allowance account. What happens when Joe Jackson, a customer that owes Nordstrom calls and says that he is filing for bankruptcy and actually cannot pay the $500 balance due. The necessary adjusting entry is: Dr.________________$___________ Cr._____________________$____________

Allowance Method - % of A/R Percentage of Receivables – This approach requires the preparation of a receivables “Aging” schedule. How to Prepare an Aging Schedule: Customer A/R balances are classified or categorized based upon the length of time they have been outstanding (unpaid) The usual categories are; 0-30 days; days, days etc.) ________________________________________________________________ Customer A/R balances are classified or categorized based upon the length of time they have been outstanding (unpaid) The usual categories are; 0-30 days; days, days etc.) ________________________________________________________________ Once an aging schedule has been prepared, management estimates the amount of bad debt by multiplying the sum for each category by a percentage of that amount that is expected to be uncollectible. ________________________________________________________________ Once an aging schedule has been prepared, management estimates the amount of bad debt by multiplying the sum for each category by a percentage of that amount that is expected to be uncollectible. ________________________________________________________________ The resulting amount of each category are added together and compared to the current balance in the allowance for uncollectible accounts. The difference is the amount that is recorded in the adjusting entry. The resulting amount of each category are added together and compared to the current balance in the allowance for uncollectible accounts. The difference is the amount that is recorded in the adjusting entry.________________________________________________________________ The percentage of receivable approach requires recognition of the current balance in the allowance for doubtful (uncollectible) accounts to determine the appropriate amount for the journal entry. The percentage of receivable approach requires recognition of the current balance in the allowance for doubtful (uncollectible) accounts to determine the appropriate amount for the journal entry.

Notes Receivable A note receivable (N/R) is usually referred to as a written promissory note (or agreement) that has a specific payment date and involves interest. A note receivable (N/R) is usually referred to as a written promissory note (or agreement) that has a specific payment date and involves interest. Q: How would you define what interest is? Q: Interest rates are reported for what typical period of time? Maturity Date = the date the note and related interest must be paid to the lender. Maturity Date = the date the note and related interest must be paid to the lender. Maturity Date can be expressed in days, months, or years. Maturity Date can be expressed in days, months, or years. Notes Receivable are recorded when: Notes Receivable are recorded when: A.Individuals/companies lend or borrow money. B.To settle overdue accounts receivable.

Notes Receivable Journal entries for recording notes receivable are required when: A. The note is issued (dr. note receivable and cr. Cash) B. Accrual of interest (dr. interest receivable and cr. Interest revenue). C. Honor (payment) of note at maturity (includes cash proceeds to include the amount loaned and the interest)

Notes Receivable - Issuance When a note is established (issued) in order to settle a current (open) balance in accounts receivable, the following journal entry must be made. Dr.Note Receivable – Jefferson Cr.A/R – Jefferson When a note is recognized (issued) due to a loan being established, the following journal entry must be made: Dr.Note Receivable - Jefferson Cr.Cash

Notes Receivable Remember: The maturity date of a note (the date the amount is expected to be paid) can be expressed in terms of days OR months OR years. Calculating Interest: Face Value of Note X Annual Interest Rate X Time = Interest. Time depends on how the note was expressed. If the note is a 10 day note, the time would be 10/360 (360 is used for accounting rather than 365). If the note is a 6 month note, the time would be 6/12. Remember, interest rates (unless stated otherwise) are expressed in annual amounts. Q: What are “accruals”?? Q: What do accruals have to do with notes receivable??

Notes Receivable - Example On March 1 st, Timmy Toys issued a 4 month, 5% note to Joey Jungle Gym for $10,000. Make the journal entry for Timmy Toys to record the issuance of the note, as well as, all related journal entries for the note: On March 1 st, Timmy Toys issued a 4 month, 5% note to Joey Jungle Gym for $10,000. Make the journal entry for Timmy Toys to record the issuance of the note, as well as, all related journal entries for the note:

Notes Receivable - Example 3/1 - Issuance: 3/1 - Issuance: Dr.Note Receivable$10,000 Cr.Cash$10,000 3/30, 4/30, 5/31, 6/30 – Accrue Interest (recorded every month): 3/30, 4/30, 5/31, 6/30 – Accrue Interest (recorded every month): Dr.Interest Receivable$42 Cr.Interest Revenue$42 (10,000 X 5% X 1/12) 7/1 – Honor of note receivable (paid in full): 7/1 – Honor of note receivable (paid in full): Dr.Cash$10,168 Cr.Note Receivable$10,000 Cr.Interest Receivable$ 168