1. Accounting for Receivables
Chapter 8
Accounting for Receivables
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2. Discussion to follow: accounts receivable, losses from uncollectible accounts, and the allowance method of accounting for doubtful accounts.
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3. Accounts Receivable
Accounts receivable is the current asset resulting from a sale or service executed (or provided) on a credit basis.
Accounts receivable
100
Sales revenue
To record sale on account.
Cash
100
Accounts receivable
To record collection of cash from customer.
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4. Losses from Accounts Receivable
Businesses extend credit in order to increase their volume of sales relative to a cash-only policy.
Businesses understand, however, that they will likely not collect 100 percent of all of their outstanding accounts receivable.
Credit losses are considered an operating expense and are debited to bad debt expense.
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5. Allowance Method
GAAP requires an estimate be made of bad debt expenses at the time of the revenue recognition even though the actual accounts to be written off are unknown at this time.
This is an example of the matching principle
This process is executed using the allowance method.
The estimate results in an adjusting entry to the contra-asset account Allowance for Doubtful Accounts.
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6. Allowance for Doubtful Accounts—An Example
Assume Scripps Company estimates its bad debts expense for its first year of operations to be $5,000.
Bad debt expense
5,000
Allowance for doubtful accounts
To record bad debt expense for the year.
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7. Reporting Allowance for Doubtful Accounts
The allowance for doubtful accounts is a contra-asset account with a normal credit balance.
On the Balance Sheet, the allowance account is subtracted from gross accounts receivable to yield a net amount.
Assume that Scripps Company has gross accounts receivable of $14,000
Current Assets
Cash
$ 3,000
Accounts receivable
$14,000
Less: Allowance for doubtful accounts
5,000
9,000
Other current assets
1,000
Total Current Assets
$13,000
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8. Writing Off Specific Receivables
After an estimate of bad debts is made and journalized, the company subsequently will write off a receivable when it is determined the amount will not be collected.
However, at that time, the write-off will not affect either expense or total assets, rather the entry simply cleans up the accounts receivable account (remember that the expense occurred at the time of the estimate, not at the time of the write off).
Assume $200 of the outstanding receivables is determined to be uncollectable
Allowance for doubtful accounts
200
Accounts receivable
To write off account deemed uncollectible.
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9. Writing Off Specific Receivables
Let’s review our journal entries:
To set up an allowance of $5,000 for expected future credit losses. This entry recognized an expense of $5,000 related to current period sales.
Bad debt expense
5,000
Allowance for doubtful accounts
To record bad debt expense for the year.
We later learned that one account worth $200 was definitively uncollectable. To capture the actual write off:
Allowance for doubtful accounts
200
Accounts receivable
To write off account deemed uncollectible.
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10. Recovery of Accounts Written Off
Occasionally an account written off will be later collected. Assume the previous $200 write off was actually collected.
Two entries will be recorded
Reverse the original write-off
Collect the cash
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11. Recovery of Accounts Written Off—Example
Assume a $400 account that was written off is later collected.
To write off account:
Allowance for doubtful accounts
400
Accounts receivable
To write off account deemed uncollectible.
To reinstate account:
Accounts receivable
400
Allowance for doubtful accounts
To reinstate previously written-off account.
To record receipt of cash:
Allowance for doubtful accounts
400
Accounts receivable
To record collection of cash on account.
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12. Select the correct answer.
Town Co. began the period with $20,000 of accounts receivable and an allowance for doubtful accounts balance of $1,000. If Town then wrote-off $100 of receivables and then recovered $50 of this amount, what would be the net receivables balance?
.$19,000
$18,900
$18,950
$19,950
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13. The percentage of net sales method and the accounts receivable aging method for estimating a business’s bad debt expense.
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14. Percentage of Sales Method
Estimates bad debt expense as a percentage of credit sales for a given period.
Percentage used is usually based on historical past credit losses.
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15. Percentage of Sales Method—Example
Assume Scripps Company has 2016 credit sales of $700,000 and past experience is that three percent of these sales will not be ultimately collected.
Bad debts expense is calculated as $700,000 x = $21,000
Scripps must monitor the balance in the allowance for doubtful accounts for reasonableness.
Bad debt expense
21,000
Allowance for doubtful accounts
To record bad debt expense estimate for the year.
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16. Accounts Receivable Aging Method
Estimates the allowance for doubtful accounts as a percentage of the outstanding accounts receivable.
Bad debts expense is then determined as the amount necessary to achieve the proper balance in the allowance account.
The allowance for doubtful accounts balance is computed by computing an aging schedule on outstanding accounts receivable partitioned by age of the receivable.
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17. Probability of Noncollection
Aging Method—Example
Scripps 2016 accounts receivable total $30,000 as follows: current $10,000; 0-30 days $8,000; days $5,000; days $3,000; over 90 days $4,000. The following schedule computes the required balance for the allowance for doubtful accounts using historical probabilities of non-collection.
Amount
Probability of Noncollection
Allowance Required
Current
$10,000 3%
$300
0-30 days past due
8,000 4%
320
31-60 days past due
5,000 5%
250
61-90 days past due
3,000
10%
300
Over 90 days past due
4,000
30%
1,200
Total allowance required
$2,370
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18. Aging Method—Example
Assume Scripps had a beginning credit balance in the allowance for doubtful accounts of $400. The required entry would be as follows:
Bad debt expense
1,970
Allowance for doubtful accounts
To record bad debt expense for the period.
Allowance for Doubtful Accounts
$ 400
Beginning balance
1,970
Required entry to obtain desired balance
$2,370
Desired balance per Aging Method
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19. Select the correct answer.
The aging method and the percentage of sales method differ because
.The aging method first estimates the balance in the allowance account and then computes bad debt expense journal entry to bring the balance to the estimate.
The percentage of sales method first estimates the balance in the allowance account and then computes bad debt expense.
There is no difference between the two methods regarding how they estimate the balance in the aging account and compute bad debt expense.
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20. the accounting treatment of credit card sales.
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21. Credit Card Sales
The seller collects cash from the credit card company, and the customer pays cash to the credit card company when billed at a later date.
The issuer of the credit card will charge the seller a fee each time a card is used.
Businesses incur this fee because credit cards provide considerable benefits to the seller.
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22. Credit Card Sale—Example
For cards issued by a financial institution, cash is received immediately upon deposit of the credit card sales slip at the financial institution.
The journal entry to record a $1,000 credit card sale of this type on March 15, with a three percent credit card fee:
Cash
970
Credit card fee expense 30
Sales revenue
1,000
To record credit card sales and collection, less a 3% fee
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23. Learning Objective 4
a promissory note receivable, the calculation of interest on notes receivable, and present journal entries to record notes receivable and interest.
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24. Notes Receivable
Promissory notes receivable are often used in exchange to settle a customer’s accounts receivable that is past due (longer than the day credit period that is typical of accounts receivable. It is also sometimes used initially for a customer with questionable credit credentials.
Key characteristics include:
A certain principal sum to be paid
An interest rate usually stated as an annual rate
A fixed due date or on-demand date called the Maturity Date
When paid by maturity date – called honoring the note
When not paid by maturity date – called dishonored note
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25. Principal x Interest rate x Interest time
Interest Calculation
Interest is calculated according to the following formula:
Principal x Interest rate x Interest time
Assume a 3 month note (90 days) for $10,000 at an annual interest rate of 6 percent is issued as of December 1st in exchange for an overdue accounts receivable:
Interest = $10,000 x 0.06 x 3/12 = $150
** If days are used to prorate the year, then it would be 90/ (note that the denominator is not 365)
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26. Recording Note and Period Interest Income
Recording the journal entry on the Dec. 1st.
On Dec. 31, even though the note is not payable until Mar. 1st of the next year, the company will record interest earned as of Dec. 31st
Notes Receivable
10,000
Accounts Receivable
To accrue interest income.
Interest Receivable 50
Interest income
To record receipt of interest payment
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27. Recording Honored Note
Then, assuming the maker (customer) pays the note plus interest when due (maturity date), then the following journal entry would take place:
Cash
10,150
Interest income (for Jan and Feb)
100
Interest receivable
Notes receivable ,000
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28. Accounts receivable turnover and average collection
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29. Analyzing Receivables
A key measure of analyzing receivables is determining the speed of collection. Two ratios, the accounts receivable turnover and the average collection period are commonly calculated.
Accounts receivable turnover =
Net sales
Average accounts receivable
*Average collection period =
365
Accounts receivable turnover
Note: As you can see above, Accounts receivable turnover must be determined first in order to calculate Average collection period
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30. Select the correct answer.
Savanna Co. reports net sales of $50,000, cost of goods sold of $40,000, and average accounts receivable of $5,000. What is Savanna’s average collection period?
10 times
days
45.6
Cannot be determined from this information.
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31. Factoring and Discounting
A company can speed up the collection of cash on accounts and notes receivable by selling the receivables. This is called factoring the receivable.
The company will receive cash, less a fee (discount), from the buyer.
If the receivables are sold without recourse, the buyer may not request reimbursement for amount ultimately not collected.
If the receivables are sold with recourse, the buyer has the right to return the uncollected receivables to the seller.
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32. Direct write-off method
Appendix 8A
Direct write-off method
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33. Direct Write-Off Method
Under the direct write-off method, doubtful accounts are charged to bad debt expense in the period they are determined to be uncollectible.
No estimate is made for bed debts in the period of the revenue recognition, therefore no allowance for doubtful accounts is used.
Because this violates the matching principle, GAAP does not allow the direct write-off method unless the amounts of bad debts are immaterial.
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34. Corporate Social Responsibility
Many companies include within their mission statements their commitment to being a good corporate citizen.
Commitments to sustainable business practices can reduce expenses and protect the environment by using resources more efficiently, minimizing waste, managing supply chains, and raising awareness.
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