1. ACCT 201 FINANCIAL REPORTING Chapter 9
Dr. Lale Guler
Office: CAS 102

2. CHAPTER9
Accounting for Receivables

3. Claims for which formal instruments of credit are issued
Types of Receivables
Amounts due from individuals and other companies that are expected to be collected in cash.
Amounts owed by customers that result from the sale of goods and services.
Claims for which formal instruments of credit are issued
as proof of debt.
“Nontrade” (interest, loans to officers, advances to employees, and income taxes refundable).
Accounts Receivable
Notes Receivable
Other Receivables

4. Accounts Receivables Recognizing Accounts Receivable
Three accounting issues:
Recognizing accounts receivable.
Valuing accounts receivable.
Disposing of accounts receivable
Recognizing Accounts Receivable
Service organization - records a receivable when it provides service on account.
Merchandiser - records accounts receivable at the point of sale of merchandise on account.

5. Accounts Receivables
Illustration: Assume that Jordache Co. on July 1, 2012, sells merchandise on account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this transaction on the books of Jordache Co.
Jul. 1

6. Accounts Receivables
Illustration: On July 5, Polo returns merchandise worth $100 to Jordache Co.
Jul. 5
Illustration: On July 11, Jordache receives payment from
Polo Company for the balance due.
Jul. 11

7. Accounts Receivables On the Balance Sheet, Accounts Receivables
are classified as current asset.
Uncollectible Accounts Receivable
Sales on account raise the possibility of accounts not being collected.
Seller records losses that result from extending credit as Bad Debts Expense.
In conformity with the matching principle, bad debt expense should be recorded in the same accounting period in which the sales related to the uncollectible account were recorded.

8. Uncollectible Accounts Receivable
Most businesses record an estimate of the bad debt expense by an adjusting entry at the end of the accounting period.
Normally classified as a selling expense and closed at year-end.
Contra asset account to Accounts Receivable.
Bad debts expense is a cost of extending credit. It is normally classified as a selling expense and, along with other expenses, closed at the end of the accounting period.
We do not want to run the risk of overstating our asset, accounts receivable, knowing that some of the receivables will ultimately become uncollectible. Allowance for uncollectible accounts is a contra-asset account with a normal credit balance that enables us to reduce accounts receivable to the amount that we actually think we will collect.

9. Accounts Receivables
Example : Hampson Furniture has credit sales of $1,200,000 in 2012, of which $200,000 remains uncollected at December 31. The credit manager estimates that $12,000 of these sales will prove uncollectible.
Dec. 31

10. Accounts Receivables

11. Uncollectible Accounts
As accounts become uncollectible, the following entry is made:
Now, let’s see what happens when we determine that a specific customer will not be able to pay the amounts owed. When using the allowance method, we write off an uncollectible account to allowance for uncollectible accounts, with a debit to allowance for uncollectible accounts and a credit to accounts receivable.
Now let’s see what we do if someone pays on an account receivable that has been written off.
So what happens if someone pays after a write-off of the accounts receivable?

12. Collection of Previously Written-Off Accounts
When a customer makes a payment after an account has been written off, two journal entries are required.
Sometimes, after an account receivable has been written off, a customer will send in a payment. When this happens, two entries are necessary. The first entry is required to reverse the write-off and re-establish the account receivable. This entry includes a debit to accounts receivable and a credit to allowance for uncollectible accounts.
The second entry records the receipt of cash with a debit to cash and a credit to accounts receivable.

13. Accounts Receivables Recording Write-Off of an Uncollectible Account
Example: The vice-president of finance of Hampson Furniture on March 1, 2013, authorizes a write-off of the $500 balance owed by R. A. Ware. The entry to record the write-off is:
Mar. 1
Illustration 9-4

14. Accounts Receivables
Recovery of the Account that had been previously written off
Example: On July 1, R. A. Ware pays the $500 amount that Hampson had written off on March 1. Hampson makes these entries:
July 1 1

15. Estimating Bad Debts
How does a company arrive at the estimate for the bad debt expense at the end of the year? Two alternative methods:
Income Statement Approach
Balance Sheet Approach
Composite Rate
Aging of Receivables
How does a company arrive at the estimate for the bad debt expense adjusting entry at the end of the year? There are two methods from which to choose:
 The income statement approach (percentage of credit sales method).
 The balance sheet approach (percentage of accounts receivable method).
Under the balance sheet approach, there are actually two separate methods a company can use: percent of accounts receivable and aging of accounts receivable.
Let’s look at the income statement approach first.

16. Income Statement Approach
Focuses on past credit sales to make estimate of bad debt expense.
Emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales.
Using the income statement approach, bad debt percentage is based on records of actual uncollectible accounts from prior years’ credit sales. The focus is on determining the amount to record on the income statement as bad debt expense. The income statement approach emphasizes the matching principle by estimating the bad debt expense associated with the current period’s credit sales.

17. Income Statement Approach
In 2006, MusicLand has credit sales of $400,000 and estimates that 0.6% of credit sales are uncollectible.
What is Bad Debts Expense for 2006?
In 2006, MusicLand has credit sales of $400,000 and estimates that 0.6 percent of credit sales are uncollectible.
What is bad debts expense for 2006?

18. Income Statement Approach
MusicLand computes estimated Bad Debts Expense of $2,400.
MusicLand’s bad debt expense is 2,400, determined by multiplying the credit sales of $400,000 times 0.6 percent.
Now let’s make the adjusting entry to recognize bad debts expense.
We debit bad debts expense and credit allowance for uncollectible accounts for $2,400.

19. Balance Sheet Approach
Focuses on the collectibility of accounts receivable to make the estimate of uncollectible accounts.
Involves the direct computation of the desired balance in the allowance for uncollectible accounts.
When using the balance sheet approach, we focus on the collectibility of accounts receivable to make an estimate of uncollectible accounts. We compute the desired balance in allowance for uncollectible accounts using a percentage of accounts receivable.

20. Balance Sheet Approach Composite Rate
(1) Compute the desired balance in the Allowance for Uncollectible Accounts.
(2) Bad Debts Expense is computed as:
First, we compute the desired balance in allowance for uncollectible accounts by multiplying the year-end accounts receivable balance times an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends.
Second, because the allowance for uncollectible accounts is a permanent account, it will always have an existing balance. The estimated bad debts expense is the difference between the desired balance in allowance for uncollectible accounts and the existing balance in allowance for uncollectible accounts. After determining the estimated bad debts expense, we make the entry for the amount needed to arrive at the desired balance.
Let’s look at an example.

21. Balance Sheet Approach Composite Rate
On Dec. 31, 2006, MusicLand has $50,000 in Accounts Receivable and a $200 credit balance in Allowance for Uncollectible Accounts.
Past experience suggests that 5% of receivables are uncollectible.
What is MusicLand’s Bad Debts Expense for 2006?
On December 31, 2006, MusicLand has a $50,000 balance in accounts receivable and a $200 credit balance in allowance for uncollectible accounts.
Past experience suggests that 5% of receivables are uncollectible.
What is MusicLand’s bad debts expense for 2006?

22. Balance Sheet Approach Composite Rate
Desired balance in Allowance for Uncollectible Accounts
First, we must determine the desired balance in allowance for uncollectible accounts. To do this, we multiply the accounts receivable balance of $50,000 times the five percent that is expected to be uncollectible to obtain a $2,500 desired balance in allowance for uncollectible accounts.
Remember that allowance for uncollectible accounts is a permanent account that has an existing $200 credit balance. So, if we want the balance to be $2,500, we only need to credit this account for $2,300.
The entry would be a debit to bad debts expense and a credit to allowance for uncollectible accounts for $2,300.

23. Balance Sheet Approach Aging of Receivables
Year-end Accounts Receivable is broken down into age classifications.
Each age grouping has a different likelihood of being uncollectible.
Compute desired uncollectible amount.
Compare desired uncollectible amount with the existing balance in the allowance account.
First we classify accounts receivable by age. Second, for each age group we determine the likelihood of the accounts being uncollectible. Third, for each age group we calculate a separate allowance amount and add up all the allowance amounts to give us the desired balance in allowance for uncollectible accounts. Fourth, we compare the desired balance in allowance for uncollectible accounts with the existing balance in the account. The difference in the two balances is the amount necessary for the bad debts adjusting entry.
Let’s see an example of how the aging of accounts receivable works.

24. Balance Sheet Approach Aging of Receivables
At December 31, 2006, the receivables for EastCo, Inc. were categorized as follows:
Let’s use our four-step aging process for EastCo. First, we group Eastco’s accounts receivable into age categories such as current, 1 to 30 days past due, 31 to 60 days past due, and so on. Second, for each of these age groups, we determine how much we estimate to be uncollectible. For the current age group, one percent is expected to be uncollectible. For the 1 to 30 days past due age group, three percent is expected to be uncollectible, and so on. Notice that the older the age group the higher the uncollectible percentage. Third, we multiply the balance of each age group by its uncollectible percentage. Then, we add the uncollectible amounts for each age category and get a total of $1,350. This is the balance we want in the allowance for uncollectible accounts.

25. Balance Sheet Approach Aging of Receivables
EastCo’s unadjusted balance in the allowance account is $500.
Per the previous computation, the desired balance is $1,350.
EastCo’s unadjusted, existing balance in allowance for uncollectible accounts is $500. Our aging procedure in steps one through three resulted in a $1,350 desired balance in allowance for uncollectible accounts. In step four of the process, we compare the desired balance with the existing balance. The difference in the two balances is the amount of our bad debts adjusting entry that results in the desired balance in allowance for uncollectible accounts.
Now let’s prepare the entry to record bad debts expense.
Prepare the entry to record bad debts expense at Dec. 31, 2006.

26. Balance Sheet Approach Aging of Receivables
EastCo’s unadjusted balance in the allowance account is $500.
Per the previous computation, the desired balance is $1,350.
So, if we want the balance to be $1,350, we only need to credit the allowance for uncollectible accounts for $850.
We debit bad debts expense and credit allowance for uncollectible accounts for $850.

27. Direct Write-off Method
If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account).
Example : Assume that Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December 12. Warden’s entry is:
If uncollectible accounts are immaterial, bad debts are simply recorded as they occur (without the use of an allowance account). When using the direct write-off method, customers’ accounts receivable are written off to bad debts expense at the time the company becomes aware that the customer will not be able to pay the amounts owed.
The direct write-off method does not attempt to match bad debts expense in the period that the sale occurred. As a result, this method can not be used when preparing financial statements using generally accepted accounting principles unless there is an immaterial impact on the financial statements.
As a result, most companies preparing financial statements using generally accepted accounting principles use one of the two allowance methods to account for bad debts.

28. Allowance for Doubtful Accounts
Accounts Receivables
Example a: Journal entry for credit sale of $100?
Allowance for Doubtful Accounts
Accounts Receivable
Beg
Beg.

29. Allowance for Doubtful Accounts
Accounts Receivables
Example b: Collected $333 on account?
Allowance for Doubtful Accounts
Accounts Receivable
Beg
Beg.
Sale

30. Allowance for Doubtful Accounts
Accounts Receivables
Example c: Adjustment of $15 for estimated bad debts?
Allowance for Doubtful Accounts
Accounts Receivable
Beg
Beg.
Sale
Coll.
End.

31. Allowance for Doubtful Accounts
Accounts Receivables
Example d: Write-off of uncollectible accounts for $10?
Allowance for Doubtful Accounts
Accounts Receivable
Beg
Beg.
Sale
Coll.
Est.

32. Allowance for Doubtful Accounts
Accounts Receivables
Example e: Write-off of uncollectible accounts for $10?
Allowance for Doubtful Accounts
Accounts Receivable
Beg
Beg.
Sale
Coll.
Est.
End.
End.

33. Accounts Receivables

34. Notes Receivables
Companies may grant credit in exchange for a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.
Promissory notes may be used
when individuals and companies lend or borrow money,
when amount of transaction and credit period exceed normal limits, or
in settlement of accounts receivable.

35. Notes Receivables
To the Payee, the promissory note is a note receivable.
To the Maker, the promissory note is a note payable.

36. Notes Receivables Determining the Maturity Date Computing Interest
Note expressed in terms of
Months
Days
Computing Interest

37. Notes Receivables Computing Interest
When counting days, omit the date the note is issued, but include the due date.
Terms of Note Interest Computation
Face x Rate x Time = Interest
$ 730, 18%, 120 days
$ 1000, 15%, 6 months
$ 2000, 12%, 1 year

38. Notes Receivables Recognizing Notes Receivable
Illustration: Calhoun Company wrote a $1,000, two-month, 12% promissory note dated May 1, to settle an open account. Prepare entry would Wilma Company makes for the receipt of the note.
May 1

39. Notes Receivables Valuing Notes Receivable
Report short-term notes receivable at their cash (net) realizable value.
Estimation of cash realizable value and bad debts expense are done similarly to accounts receivable.
Allowance for Doubtful Accounts is used.

40. Notes Receivables Disposing of Notes Receivable
Notes may be held to their maturity date.
Maker may default and payee must make an adjustment to the account.
Holder speeds up conversion to cash by selling the note receivable.

41. Notes Receivables Disposing of Notes Receivable
Honor of Notes Receivable
Maker pays it in full at its maturity date.
Dishonor of Notes Receivable
Not paid in full at maturity.
No longer negotiable.

42. Notes Receivables Honor of Notes Receivable
Illustration: Wolder Co. lends Higley Co. $10,000 on June 1, accepting a five-month, 9% interest note. If Wolder presents the note to Higley Co. on November 1, the maturity date, Wolder’s entry to record the collection is:
Nov. 1

43. Notes Receivables Accrual of Interest Receivable
Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30. The adjusting entry by Wolder is for four months ending Sept. 30.
Sept 30

44. Notes Receivables Accrual of Interest Receivable
Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on November 1.
Nov. 1

45. Notes Receivables Dishonor of Notes Receivable
Illustration: Assume that Higley Co. on November 1 indicates that it cannot pay at the present time. If Wolder Co. does expect eventual collection, it would make the following entry at the time the note is dishonored (assuming no previous accrual of interest).
Nov. 1

46. Statement Presentation and Analysis
Identify in the balance sheet or in the notes each major type of receivable.
Report short-term receivables as current assets.
Report both gross amount of receivables and allowance for doubtful account.
Report bad debts expense and service charge expense as selling expenses.
Report interest revenue under “Other revenues and gains.”
B/S
I/S