1. Accounts and Notes Receivable
Chapter 7
Accounts and Notes Receivable
Up to this point in the course, we have unrealistically assumed that we would collect all of our Accounts Receivable. We all know that in reality we will not receive payment for some Accounts Receivable.
In this chapter, we will learn how to account for the fact that we will not collect all Accounts Receivable owed to us.
We will also learn about credit card sales and notes receivable.

2. Conceptual Learning Objectives
Self-Study:
C1: Describe accounts receivable and how they occur and are recorded.
C2: Describe a note receivable and the computation of its maturity date and interest.
C3: Explain how receivables can be converted to cash before maturity.
7-2

3. Analytical Learning Objectives
A1: Compute accounts receivable turnover and use it to help assess financial condition.
7-3

4. Procedural Learning Objectives
P1: Apply the direct write-off and allowance methods to account for accounts receivable.
P2: Estimate uncollectibles using methods based on sales and accounts receivable.
P3: Record the receipt of a note receivable.
P4: Record the honoring and dishonoring of a note and adjustments for interest.
7-4

5. Accounts Receivable Credit sales require:
Amounts due from customers for credit
sales (2/10, n/30).
Credit sales require:
Maintaining a separate account receivable for each customer.
Accounting for bad debts that result from credit sales.
Accounts Receivable arise from credit sales to customers. We will create a separate subsidiary accounts receivable ledger for each customer. This helps us keep track of how much each customer owes us individually.
Selling on credit also creates a need to account for the bad debts that will result from customers not fulfilling their obligation to pay their Accounts Receivable.
7-5

6. Recognizing Accounts Receivable
$4.3 Mil.
$9.392 Mil.
$118 Mil.
$109 Mil.
Percentage of total assets
As this slide indicates, Accounts Receivable can be a major component of the total assets of a company. Proper valuation of Accounts Receivable is important.
7-6

7. Accounts Receivable
Sales on Credit => A/R Credit sales are recorded by increasing (debiting) Accounts Receivable.
a. The General Ledger Account continues to keep a single Accounts Receivable account.
b. A supplementary record, called the accounts receivable ledger account, is created to maintain a separate account for each customer.
c. The sum of the individual (subsidiary) accounts in the accounts receivable ledger equals the debit balance of the Accounts Receivable account in the general ledger (Master Account).

8. C 1
Sales on Credit
On July 16, Barton, Co. sells $950 of merchandise on credit to Webster, Co., and $1,000 of merchandise on account to Matrix, Inc.
Part One
Let’s prepare the entries to record these sales to Webster Company and Matrix Incorporated.
Part Two
Both sales were sold on credit and include a debit to Accounts Receivable and a credit to Sales. Also notice that the specific customer is noted in the transaction so we can make the proper entry in the customer’s Accounts Receivable subsidiary ledger.
7-8

9. Sales on Credit C 1 Part One
After the previous entries, this is what the Accounts Receivable subsidiary ledgers would look like.
Part Two
A Schedule of Accounts Receivable is a complete listing of the balances in the Accounts Receivable subsidiary ledgers.
Part Three
As you can see, the balances from Webster Company and Matrix Incorporated are included on the Schedule of Accounts Receivable.
Part Four
The total balance in the Accounts Receivable control account in the General Ledger agrees to the total on the Schedule of Accounts Receivable.
7-9

10. C 1
Sales on Credit
On July 31, Barton, Co. collects $500 from Webster, Co., and $800 from Matrix, Inc. on account.
Part One
Let’s prepare the entries to record these two collections on account from Webster Company and Matrix Incorporated.
Part Two
When cash is collected on accounts, we debit Cash and credit Accounts Receivable. Notice that the specific customer is noted in the transaction so we can make the proper entry in the customer’s Accounts Receivable subsidiary ledger.
7-10

11. Sales on Credit C 1 Part One
After the previous entries, this is what the Accounts Receivable subsidiary ledgers would look like.
Part Two
The Schedule of Accounts Receivable would include the new balances in the Accounts Receivable subsidiary ledgers.
Part Three
The total balance in the Accounts Receivable control account in the general ledger agrees to the total on the Schedule of Accounts Receivable.
7-11

12. Exercise 2

13. Credit Card Sales
C 1
Advantages of allowing customers to use credit cards:
Customers’ credit is evaluated by the credit card issuer.
Sales increase by providing purchase options to the customer.
Most companies allow customers to use credit cards for sales on credit at their company. There are several advantages to this arrangement.
First, the credit card company evaluates the customer’s credit worthiness for the company making the sale.
Second, when customers can delay payment, they purchase more.
Third, the credit card company carries the risk related to the customers’ bad debts.
Fourth, cash collections are quicker because the selling company receives payment from the credit card company and does not have to wait for the customer to make a payment.
Of course, in exchange for all of these advantages, companies pay a percentage of the sale to third-party credit card companies as payment for using their services.
Cash collections are quicker.
The risks of extending credit are transferred to the credit card issuer.
7-13

14. Credit Card Sales
C 1
With bank credit cards, the seller deposits the credit card sales receipt in the bank just like it deposits a customer’s check.
The bank increases the balance in the company’s checking account.
With bank credit cards, the seller includes the credit card sales receipts in their bank deposits. This prompts the bank to increase the seller’s account for the amount of the credit card sales receipts. Sellers usually pay a fee between one percent and five percent for this service.
To avoid this fee, some companies issue their own credit cards to customers. These credit cards can only be used in the specific businesses that issued the card.
The company usually pays a fee of 1% to 5% for the service.
7-14

15. Credit Card Sales (Immediate receipt of cash)
On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 2%. The cash is received immediately.
Part One
Let’s see how to record a credit card sale for Barton Company. The credit card sale was for five hundred dollars and the bank charges a processing fee of two percent.
Part Two
Barton would credit Sales for the entire amount of the sale of five hundred dollars. However, Barton will debit Cash for four hundred ninety dollars, which represents how much cash they will collect from the bank. The difference of ten dollars is the two percent fee that Barton must pay for allowing customers to use the third-party credit card. The ten dollars would be debited to Credit Card Expense.
7-15

16. Credit Card Sales (Delayed receipt of Cash)
On July 16, 2009, Barton, Co. has a bank credit card sale of $500 to a customer. The bank charges a processing fee of 1%. Barton remits the credit card sale to the credit card company and waits for the payment that is received on July 28.
Part One
Let’s see how to record a credit card sale for Barton Company when there is a period of time between processing the sale and payment. The credit card sale was for five hundred dollars and the bank charges a processing fee of two percent.
Part Two
On the date of the sale, Barton would credit Sales for the entire amount of the sale of five hundred dollars. However, Barton will debit Accounts Receivable for four hundred ninety dollars, which represents how much cash they will ultimately collect from the bank. The difference of ten dollars is the two percent fee that Barton must pay for allowing customers to use the third-party credit card. The ten dollars would be debited to Credit Card Expense.
On the collection date, Barton would debit Cash and credit Accounts Receivable for four hundred ninety dollars.
7-16

17. Quick Study 1
Exercise 1

18. Installment Accounts Receivable
Amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. The customer is usually charged interest.
Sometimes companies agree to allow customers to make periodic payments for credit sales over an extended period of time. In these cases, the customer is usually charged interest.
7-18

19. The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.

20. Valuing Accounts ReceivableP1
Some customers may not pay their account. -Uncollectible amounts are referred to as bad debts. -There are two methods of accounting for bad debts:
Direct Write-Off Method (Violates MATCHING)
Allowance Method (Based on MATCHING) - % of Sales method => I/S Approach - % of Receivables method => B/S Approach
Companies must account for the fact that some customers may not be able to pay the amounts they owe. There are two basic methods used to account for bad debts: the direct write-off method and the allowance method.
First, let’s look at the direct write-off method.
7-20

21. Direct Write-Off Method
The direct write-off method: Records the loss from an uncollectible account receivable when it is determined to be uncollectible || Violates MATCHING Principle
Entry to write off uncollectible and recognize loss: Debit: Bad Debt Expense Credit: Accounts Receivable.
b. If a written off account is later collected, this results in a reversal of the write off (see a.) and a normal collection of account entry.

22. Direct Write-Off Method
On August 4th, 2009, Barton determines it cannot collect $350 from Martin, Inc., a credit customer. Note: Sales to Martin occurred on November 10th, 2008.
Part One
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.
In this transaction, Barton determines that Martin Incorporated can’t pay the three hundred fifty dollars it owes. Can you prepare the entry for this transaction?
Part Two
Barton would debit Bad Debts Expense and credit Accounts Receivable for three hundred fifty dollars. Notice that the specific customer is noted in the transaction so we can make the proper entry in the customer’s Accounts Receivable subsidiary ledger.
7-22

23. Direct Write-Off Method
On September 9th, 2010, Martin decides to pay $200 that was previously written off.
Part One
Now assume that Martin sends Barton a partial payment of two hundred dollars after Barton made the write-off entry. Should Barton return the two hundred dollars since they have written off Martin’s account receivable? Of course not.
Part Two
Since Barton had written off Martin’s account receivable, the first entry is required to reverse the write-off and re-establish part of Martin’s account receivable. This entry includes a debit to Accounts Receivable and a credit to Bad Debts Expense.
The second entry is a debit to Cash and a credit to Accounts Receivable for the amount of cash received.
If a written off account is later collected, this results in a reversal of the write off (see Aug. 4th, 2009 entry) and a normal collection of account entry.
7-23

24. Matching vs. MaterialityP1
The Matching Principle requires expenses to be reported in the same accounting period as the sales they help to produce.
The Materiality Constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users’ business decisions.
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 cannot 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 the allowance method to account for bad debts.
7-24

25. Matching vs. Materiality
Under the matching principle, the direct write-off method usually does not best match sales and expenses.
But, the materiality constraint permits the use of the direct write-off method when bad debts expenses are very small in relation to a company’s other financial statement items.

26. Allowance Method At the end of each period, estimate total
bad debts expected to be realized from
That period’s sales.
There are two advantages to the allowance method:
1. It records estimated bad debts expense in the period when the related sales are recorded.
=> Proper matching of Expenses with Income on I/S;
It reports accounts receivable on the balance sheet at the estimated amount (Realizable value) of cash to be collected.
=> Proper VALUATION of A/R on Balance Sheet.
The allowance method does attempt to match Bad Debts Expense in the period with the related revenue.
This method requires that an estimate of bad debts be made and recorded at the end of each period. This method has two advantages:
First, it adheres to the matching principle because the Bad Debts Expense is recorded in the period of the sale, and
Second, it reports accounts receivable on the balance sheet at the estimated amount of cash to be collected.
Let’s see how the allowance method works.
7-26

27. Recording Bad Debts Expense
At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.
Contra-asset account
Part One
At the end of the period, a company estimates how much of its accounts receivable will not be collected. This estimate is based on past collection history and current economic information. Remember that when we make this estimate, we do not know specifically WHO will not pay us. If we knew WHO would not pay us, we would never have sold to them on credit in the first place—right?
At the end of the period, Barton Company estimates that three thousand dollars of its accounts receivable will not be collected. The total balance in accounts receivable is two hundred seventy-eight thousand dollars.
Let’s prepare the entry to record this estimate of bad debts.
Part Two
The entry requires a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts for the estimated amount. Why can’t we just credit Accounts Receivable in this entry? Remember, we are recording an estimate of uncollectible accounts and we do not know WHO specifically will not pay us. If we tried to credit Accounts Receivable, which customer’s subsidiary account would we use? The answer is we would not know which one to use. As a result, we credit the Allowance for Doubtful Accounts account.
Part Three
Allowance for Doubtful Accounts is a contra-asset account. It has a normal credit balance. It is reported on the balance sheet as a subtraction from the Accounts Receivable balance to arrive at the amount of accounts receivable we actually think we will collect. Assuming no beginning balance, after posting this entry, the Allowance for Doubtful Accounts would have a three thousand dollar credit balance.
7-27

28. Recording Bad Debts Expense
At the end of its first year of operations, Barton Co. estimates that $3,000 of its accounts receivable will prove uncollectible. The total accounts receivable balance at December 31, 2009, is $278,000.
On the balance sheet, the Allowance for Doubtful Accounts is subtracted from the Accounts Receivable balance. The reported value of two hundred seventy-five thousand dollars is called net realizable value. It is the amount of Accounts Receivable that we actually think we will collect.
7-28

29. Allowance Method of estimating Bad Debts Expenses
Two Methods
Percent of Sales Method
2. Accounts Receivable Methods
Percent of Accounts Receivable Method
Aging of Accounts Receivable Method
How does a company come up with the estimate for the entry at the end of the year? Well, there are two methods from which to choose:
The Percent of Sales Method and the Accounts Receivable Method.
Under the Accounts Receivable Method, there are actually two separate methods a company can use: percent of accounts receivable and aging of accounts receivable.
Let’s look at the Percent of Sales Method first. (This is also referred to as the income statement method.)
7-29

30. Percent of Sales Method
Bad debts expense is computed as follows:
Barton has credit sales of $1,400,000 in Management estimates 0.5% of credit sales will eventually prove uncollectible.
What is Barton’s Bad Debts Expense for 2009?
When using the Percent of Sales Method, the estimate at the end of the period is determined by taking current period sales and multiplying by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. Also, the sales transactions included in this computation are typically only the credit sales. There are not any collection issues to consider for cash sales transactions.
Let’s look at an example.
Barton has credit sales of one million four hundred thousand dollars in the year Management estimates that point five percent of credit sales will eventually prove to be uncollectible. What is Barton’s Bad Debts Expense for the year 2009?
7-30

31. Percent of Sales Method
Barton’s accountant computes estimated Bad Debts Expense of $7,000.
Part One
Barton’s Bad Debt Expense would be seven thousand dollars. This is determined by multiplying the credit sales of one million four hundred thousand dollars by point five percent.
What would be the entry Barton would prepare to record Bad Debts Expense?
Part Two
Barton would debit Bad Debts Expense and credit Allowance for Doubtful Accounts for seven thousand dollars.
7-31

32. Percent of Sales Method
Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on Dec.31, What is the balance in AFDA on Dec. 31, 2009?
Prepare the ‘T’ accounts for A/R and AFDA showing the balances as of 12/31/09.

33. Percent of Sales Method
Quick Study 4;
Exercise 4: -% of Sales; -Partial B/S
Exercise 9a: -% of Sales; -Partial B/S. Exercise 9b: -% of Sales; -Partial B/S

34. Percent of Accounts Receivable Method
Compute the estimate of the Allowance for Doubtful Accounts:
Bad Debts Expense is computed as:
Now, let’s switch our focus to the Percent of Accounts Receivable Method. Let’s first look at the method that uses a percent of the accounts receivable balance to arrive at bad debts expense.
First, when using the Percent of Accounts Receivable Method, the estimate at the end of the period is determined by taking the Accounts Receivable balance and multiplying by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. This computation provides the company with the balance desired in the Allowance for Doubtful Accounts.
Second, because the Allowance for Doubtful Accounts is a permanent account, it will always have a balance in it. As a result, when we determine the desired balance in step one, we have to then look and see what balance is already in the Allowance for Doubtful Accounts and make the entry for the amount needed to arrive at the desired balance.
Let’s look at an example to see how this works.
7-34

35. Percent of Accounts Receivable
Barton has $100,000 in accounts receivable and a $900 credit balance in Allowance for Doubtful Accounts on December 31, 2009.
Past experience suggests that 4% of receivables are uncollectible.
What is Barton’s Bad Debts Expense for 2009?
What is the balance in AFDA on Dec. 31, 2009?
At the end of 2009, Barton has one hundred thousand dollars in Accounts Receivable and a nine hundred dollar credit balance in Allowance for Doubtful Accounts. Barton’s past experience indicates that four percent of the receivables are uncollectible. What is Barton’s Bad Debt Expense for 2009?
7-35

36. Percent of Accounts Receivable
Desired balance in Allowance for Doubtful Accounts.
Part One
First, we must determine the desired balance in the Allowance for Doubtful Accounts. To do this, Barton multiplies the Accounts Receivable balance of one hundred thousand dollars by the four percent that is expected to be uncollectible. Four thousand dollars is the desired balance in Allowance for Doubtful Accounts.
Part Two
Remember that Allowance for Doubtful Accounts is a permanent account and already has a nine hundred dollar credit balance. So, if we want the balance to be four thousand, we only need to credit this account for three thousand one hundred dollars.
The entry would be to debit Bad Debts Expense and credit Allowance for Doubtful Accounts for three thousand one hundred dollars. This adjustment assumes there were no accounts written off during the year.
What would happen if there were three hundred dollars in write offs during the year? Would this change your answer? Yes it would! See if you can determine the amount of the adjustment.
Beginning with the credit balance from the end of last year of nine hundred dollars, the write offs would cause the allowance balance to go down by three hundred dollars to be six hundred dollars. If the allowance balance should be four thousand dollars, then our adjustment would be for three thousand, four hundred dollars.
7-36

37. Percent of Accounts Receivable

38. Percent of Accounts Receivable
Quick Study 3;
Exercise 5: -% of A/R; -Partial B/S; Exercise 7: -% of A/R; -Partial B/S;
Exercise 9c: -% of A/R; -Partial B/S.

39. Aging of Accounts Receivable Method
Each receivable is grouped by how long it is past its due date.
Each age group is multiplied by its estimated bad debts percentage.
A second method used to determine the amount of bad debt expense is the Aging of Accounts Receivable Method. This method uses both past and current receivables information to estimate the allowance amount. When using this method, first we classify the Accounts Receivable by age. Second, for each age group we determine the likelihood of being uncollectible. Third, for each age group we calculate a separate allowance amount. Then, we add up all the allowance amounts and that gives us the desired balance in the Allowance for Doubtful Accounts.
Let’s see an example of how the aging of accounts receivable works.
Estimated bad debts for each group are totaled.
7-39

40. Aging of Accounts ReceivableP2
First, we broke Barton’s accounts receivable up into aged categories such as current, one to thirty days past due, thirty-one to sixty days past due, and so on. Then, for each of these age groups, we determined how much we thought would be uncollectible. So, for the current age group, one percent is expected to be uncollectible. For the one to thirty 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. Next, we multiplied the balance of each age group by its uncollectible percentage. Then, we added all the uncollectible amounts up to five thousand, three hundred twenty dollars. This is the balance we want in the Allowance for Doubtful Accounts.
7-40

41. Aging of Accounts ReceivableP2
Barton’s unadjusted balance in the allowance account is $900.
We estimated the proper balance to be $5,320.
Part One
Remember that Barton already had a nine hundred dollar balance in Allowance for Doubtful Accounts.
Part Two
So, if we want the balance to be five thousand three hundred twenty dollars, we only need to credit this account for four thousand, four hundred twenty dollars.
The entry would be debit Bad Debts Expense and credit Allowance for Doubtful Accounts for four thousand, four hundred twenty dollars.
7-41

42. Aging of Accounts Receivable
Exercise 6: a, b & c

43. Writing Off a Bad Debt under the Allowance Method
With the allowance method, when an account is determined to be uncollectible, the debit goes to Allowance for Doubtful Accounts.
Barton determines that Martin’s $300 account is uncollectible.
Part One
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 Doubtful Accounts.
Assume that Barton determines that Martin’s three hundred dollar account receivable is uncollectible. What entry would Barton make?
Part Two
Barton would debit Allowance for Doubtful Accounts and credit Accounts Receivable. Now that we know the specific customer involved, the customer is noted in the transaction, so we can make the proper entry in the customer’s Accounts Receivable subsidiary ledger.
7-43

44. P2
Recovery of a Bad Debt
Subsequent collections on accounts written off require that the original write-off entry be reversed before the cash collection is recorded.
Part One
Now assume that Martin sends Barton payment of three hundred dollars after Barton made the write-off entry. Should Barton return the three hundred dollars since they have written off Martin’s account receivable? Of course not.
Part Two
Since Barton had written off Martin’s account receivable, the first entry is required to reverse the write-off and re-establish Martin’s account receivable. This entry includes a debit to Accounts Receivable and a credit to Allowance for Doubtful Accounts.
The second entry is a debit to Cash and a credit to Accounts Receivable for the amount of cash received.
7-44

45. Exercise 6 & 8

46. Emphasis on Realizable Value Emphasis on Realizable Value
Summary
% of Sales
Emphasis on Matching
Sales
Bad Debts Exp.
% of Receivables
Emphasis on Realizable Value
Accts. Rec.
All. for Doubtful Accts.
Aging of Receivables
Emphasis on Realizable Value
Accts. Rec.
All. for Doubtful Accts.
Here is a summary of the allowance methods we just discussed.
The focus of the Percent of Sales Method is on matching Bad Debts Expense with the related revenues.
The focus of the two Percent of Accounts Receivable Methods is on valuing accounts receivable at net realizable value on the balance sheet.
Both methods do a better job than the Direct Method of matching and reporting accounts receivable at net realizable value on the balance sheet.
Income Statement Focus
Balance Sheet Focus
Balance Sheet Focus
7-46

47. Notes Receivable Julia Browne the order ofP3
Term
$1,000.00
July 10, 2009
Payee
Principal
Ninety days
after date I promise to pay to
the order of
Barton Company, Los Angeles, CA
One thousand and no/
Dollars
Payable at
First National Bank of Los Angeles, CA
Maker
Interest Rate
Value received with interest at per annum
Now, let’s change our discussion to notes receivable.
A note is a written promise to pay a specific amount at a specific future date.
Part One
Here is an example of a note.
Part Two
The following information is included in a note: term of the note, the payee, and the maker. The payee on the note is the recipient of the cash at maturity. The maker on the note is the debtor who owes the money. Notes also include information about the principal, interest rate and due date.
12%
Julia Browne
No Due 42
Oct. 8, 2009
Due Date
7-47

48. Interest Computation P3
Even for maturities less than one year, the rate is annualized.
If the note is expressed in days, base a year on 360 days.
Interest is calculated as Principal times Rate times Time. Remember that interest rates are reported for a year. So, if we just took Principal times Rate, we would get the interest for an entire year. We need to continue to multiply by Time to get the interest for the portion of the year the note was outstanding. Remember that accountants use a year based on three hundred sixty days rather than three hundred sixty-five days.
Let’s look at an example.
7-48

49. Computing Maturity and Interest
On March 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix gave Office Supplies a 9% note due in 90 days in payment for the copier.
What is the maturity date of the note?
Matrix Incorporated purchased a copier from Office Supplies Incorporated on March first for twelve thousand dollars. Matrix gave a nine percent note due in ninety days as payment for the copier.
What is the maturity date of the note?
7-49

50. Computing Maturity and Interest
The maturity date is May thirtieth. To determine this date, we start with the number of days in the month the note originated and subtract the date of the note. This gives the number of days in the originating month to count toward the maturity date. In this example, it was thirty days. Then, we add the days from the next two months until they add up to the note term. In this example we would add thirty days in April and another thirty days in May to add up to the note term of ninety days.
How much interest will Matrix pay Office Supplies Incorporated on the ninety day note?
The note is due and payable on May 30, 2009.
How much interest will Matrix pay to Office Supplies, Inc. on this note?
7-50

51. Computing Maturity and Interest
Principal
of the
note ×
Annual
interest
rate
Time
expressed
in years =
Interest
$ 12,000 9%
90/360 $
Total interest due at May 30.
Matrix will pay two hundred seventy dollars in interest. Principal of twelve thousand dollars times a nine percent interest rate times the term the note was outstanding of ninety days over three hundred sixty days.
7-51

52. Recognizing Notes ReceivableP3
Recognizing Notes Receivable
Here are the entries to record the note on March 1, and the settlement on May 30, 2009.
Here are the entries for Office Supplies Incorporated to record the sale of the copier on March first and the receipt of cash on May thirtieth.
On March first, Office Supplies Incorporated would debit Notes Receivable and credit Sales for twelve thousand dollars.
On May thirtieth, Office Supplies Incorporated would debit Cash for twelve thousand, two hundred seventy dollars. That is the original note amount of twelve thousand dollars plus the interest of two hundred seventy dollars. They would credit Interest Revenue for two hundred seventy dollars, and Notes Receivable for twelve thousand dollars.
7-52

53. Recording a Dishonored NoteP4
Recording a Dishonored Note
On May 30, 2009, Matrix informs us that the company is unable to pay the note or interest.
Part One
Assume that on May thirtieth, Matrix informs Office Supplies Incorporated that they are unable to pay the note and the interest. Prepare the entry for Office Supplies Incorporated to record this transaction.
Part Two
On May thirtieth, Office Supplies Incorporated would debit Accounts Receivable for twelve thousand, two hundred seventy dollars. That is the original note amount of twelve thousand dollars plus the interest of two hundred seventy dollars that Matrix owes. They would credit Interest Revenue for two hundred seventy dollars and Notes Receivable for twelve thousand dollars.
7-53

54. Recording End-of-Period Interest Adjustments
On December 1, 2009, Matrix, Inc. purchased a copier for $12,000 from Office Supplies, Inc. Matrix issued a 9% note due in 90 days in payment for the copier. What adjusting entry is required on December 31, the end of the company’s accounting period?
$12,000 × 9% × 30/360 = $90
When a note receivable is outstanding at the end of an accounting period, the company must prepare an adjusting entry to accrue interest income on the note.
Part One
Let’s use the same purchase of a copier between Matrix and Office Supplies Incorporated that we just reviewed. But, let’s change the date of the note to December first instead of March first.
Now, what adjusting entry is required by Office Supplies Incorporated on December thirty first to record interest on the note?
Part Two
First, determine the amount of interest we need to record. Using the formula Principal times Rate times Time, we determine that ninety dollars of interest has accrued on this note by December thirty first.
Part Three
The adjusting entry includes a debit to Interest Receivable and a credit to Interest Revenue of ninety dollars.
What is the maturity date of this ninety day note if it originated on December first?
7-54

55. Recording End-of-Period Interest Adjustments
Recording collection on note at maturity.
Part One
The maturity date of the note is March first of the next year.
Let’s look at the entry Office Supplies Incorporated would make on March first.
Part Two
On March first, Office Supplies Incorporated would debit Cash for twelve thousand, two hundred seventy dollars. That is the original note amount of twelve thousand dollars plus the interest of two hundred seventy dollars. They would credit Notes Receivable for twelve thousand dollars. The interest is divided between two accounts. Interest Receivable is credited for ninety dollars. Remember this is removing the Interest Receivable we created in the previous adjusting entry. Interest Revenue is credited for one hundred eighty dollars. This is the interest revenue Office Supplies Incorporated earned in the current year.
7-55

56. Notes Receivable
Quick Study: 5 & 6 Exercise: 10 & 11
Exercise: 12

57. Disposing of Receivables
Companies sometimes want to convert receivables to cash before they are due.
They can sell or factor receivables.
They may pledge receivables as security for a loan.
Companies can convert receivables to cash before they are due. Companies may do so if they need the cash or do not wish to be involved the collection activities. Converting receivables is usually done by either selling them or using them as security for a loan. In some industries this is common practice. Certain financial statement disclosures are required when this takes place.
7-57

58. Accounts Receivable Turnover
This ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue.
Net sales
Average accounts receivable
The Accounts Receivable Turnover ratio provides useful information for evaluating how efficient management has been in granting credit to produce revenue. It is calculated as Net Sales divided by Average Accounts Receivable. Average Accounts Receivable is determined by adding together the beginning Accounts Receivable balance and the ending Accounts Receivable balance and dividing this total by two.
This ratio measures how often, on average, receivables are received and collected during the period. If a company offers terms of net 30 on their sales, then one would expect the turnover to be approximately twelve times per year. This ratio should be monitored closely from period to period and should also be used to compare collection trends with that of competitors.
7-58

59. Days’ Sales Uncollected
How much time is likely to pass before
we receive cash receipts from credit sales.
Days’
Sales
Uncollected
Accounts Receivable
Net Sales
× 365 =
The Days’ Sales Uncollected ratio indicates how much time is likely to pass before we receive cash receipts from credit sales. It is calculated as Accounts Receivable divided by Net Sales times three hundred sixty-five.
6-59

60. End of Chapter 7
In this chapter we learned about credit card sales, two methods to account for bad debts, and notes receivable.
In the next chapter we will learn about plant assets, natural resources and intangibles.
7-60