Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD Chapter 10 Receivables

Financial AccountingDave Ludwick, P.Eng, MBA, PMP, PhD

Chapter 10Receivables

In this chapter…Balance Sheet

Current Assets

Cash

Chapter

10000

Current Liabilities

Accounts Payable 5000

Accounts Receivable 10 20000 Wages Payable 25000

Notes Receivable 10 15000 Utilities Payable 2000

Marketable Securities 25000 Long-Term Debt

Inventory 120000 Notes Payable 20000

Capital Assets Bonds Payable 600000

Equipment 250000 Owner’s Equity

Buildings 500000 Common Stock 300000

Goodwill 60000 Retained Earnings

48000

Total Assets 1000000 Total Liabilities + OE 1000000


Accounts Receivable• A receivable is an amount due from another party, the 2 most

common are:– Accounts Receivable – amounts due from customers for credit sales– Notes Receivable – amounts due from parties as a result of investment

• Accounts Receivable (AR) arises from credit sales to customers

Date Account Titles and explanation PR Debit Credit

Jul 3 Accounts Receivable 20000

Sales 20000

Jul 3 COGS 8000

Inventory 8000

July 15 Cash 20000

Accounts Receivable 20000


Accounts Receivable Subledger• As is the case with AP, there is both an AR account in the

General Ledger as well as several AR subledger accounts for each customer– Subledger accounts are required so that the firm can keep track of

what is owned by individual customers

• Credit Sales can be created through the use of trade credit (sales on terms), or the use of credit cards– Credit Cards can be of 2 general types.

• Those issued by the firm itself (Sears, The Bay, Canadian Tire)

• Those issued by 3rd party credit card companies (Enroute, Discovery)

– Credit Cards issued by a 3rd party usually come with expenses that the firm must pay

• Transaction fee (a per transaction fee)

• Monthly fee for equipment rental


Credit Card Sales Transactions• Initial credit card sale

• Cash received from CC Company


July 5 Accounts Receivable – CC Company 20000

Sales 20000

July 5 COGS 8000

Inventory 8000


July 25 Cash 19600

Credit Card Expenses 400

AR – CC Company 20000


Valuing AR• Not all customers will pay their debts.

– Therefore companies need to make allowance for Bad Debt

– Why do companies sell on credit then? Well, like everything, the benefits of selling on credit (more impulse sales) out weigh the costs (a few customers who don’t pay)

• How do we account for Bad Debt– First, we need to estimate the amount we should expect (based on

historical patterns)• We must estimate because we will need to apply an expense caused

by bad debt in the current accounting period (remember, the matching principles says you need to match expenses in the same period as the revenues they helped to generate)

– Once we have an amount, we will create an AR “contra-account”


Estimating Bad Debt• Two methods we can use

– Based on percentage of Sales

– Based on percentage of AR (as calculated as a % of AR or based on AR aging)

• AR aging refers to how old the outstanding invoice is (how long ago the sale was made)

– We’ll cover these calculation methods in more detail later


Recording Estimated Bad Debt• As mentioned earlier, we will create a subledger account for

each customer who buys on credit

• We’ll also create an AR “contra-account” where we can store allowances for doubtful accounts. This contra-account is not named to any one customer as we do not know yet which customer will default on their credit– The Bad Debt expense account is just like any other expense account

– The “Allowance” account is the contra-account. It would be illustrated on the Balance Sheet as shown next…


Dec 31 Bad Debt Expense 200

Allowance for Doubtful Accts 200


Recording Estimated Bad Debt• Notice how the AR account itself is untouched in the

previous journal entry– The T-accounts look like this

Accounts Receivable Sales Revenue

Dec 31 20000 20000 Dec 31

Bad Debt Expense Allowance for Doubtful Accts

Dec 31 200 200 Dec 31


Allowance for Doubtful Accounts• The AFDA account is shown against the AR account

– This contra-account reduces AR to an amount expected to be collected

Balance Sheet

Current Assets

Cash 10000

Current Liabilities 32000


Less: Allowance for

Doubtful Accts

200 19800 Long Term Debt 620000

Other Assets 970000 Owner’s Equity 347800



Allowance for Doubtful Accounts• The Bad Debt Expense account is shown against the

Revenue for the period– The Bad Debt Expense account reduces the revenue by the same

amount that the contra-account reduces AR

Income Statement

Sales Revenue

Expenses

Bad Debt Expense

Net Income

20000

200

19800


Writing off Bad Debt• So lets say our customer defaulted on the payment for a

credit sale:– We would write down a specific accounts receivable subledger

account

– This will write down the overall AR account in the GL

– And reduce the remaining Allowance for Doubtful Accounts

• The Balance Sheet now looks like…


Dec 31 Allowance for Doubtful Accts 20

AR – Dave Ludwick 20


Writing off Bad Debt• After writing down the Dave Ludwick AR subledger account,

we notice that the Net AR account (AR less Allowance for Doubtful Accts) is not changed– That’s because we already allowed for the doubtful account

Balance Sheet

Current Assets

Cash 10000

Current Liabilities 32000


Less: Allowance for

Doubtful Accts

180 19800 Long Term Debt 620000

Other Assets 970000 Owner’s Equity 347800



Recovering Bad Debt• So we assumed a customer would not pay, so we wrote down his

account

• But now he has come back and paid, at least partly.

• The transactions are simply the reverse of the write down:– First, restore the Allowance and the AR subledger

– Then take the cash and run


Aug 31 AR – Dave Ludwick 20

Allowance for Doubtful Accts 20

Aug 31 Cash 20



Estimating Bad Debt Expense• Earlier we said there were 2 ways to calculate Bad Debt

allowance– Based on percentage of Sales

– Based on percentage of AR

• Percent of Sales Approach– This approach applies a percent (based on historical experience) to

the total credit sales to estimate what is expected to be uncollectible

• So if last year you saw that 2% of credit sales remained uncollectible, unless you had info to indicate it would be different this year, you would apply a 2% factor the sales in the reporting period to estimate Bad Debt


Estimating Bad Debt Expense• Percent of Accounts Receivable

– This approach implies that some portion of end of period AR balance is uncollectable

• A bad debt adjusting entry is made to bring the Allowance for Doubtful Accounts balance to the proportion of AR outstanding

• This requires an adjustment that considers the opening balance to the required outcome (We’ll see this by example in a minute)

• Aging Accounts Receivable– The older a receivable is, generally the less likely it will be collected.

– An Aging Analysis groups receivables by age (1-30 days, 30-60 days, 60+ days, as an example), then applies different %ages to different groups to estimate Bad Debt (see Exh 10.14)

• Again, we make the adjustment considering the opening balance and the required outcome (We’ll see this by example in a minute)


Estimating Bad Debt Expense• Direct Write-Off Method

– This method does not use an advance estimate for Bad Debt Expense

– It only expenses Bad Debt as it happens

– So only once a credit sales has been determined as uncollectible does the AR subledger for that customer get written down.

– Like….


Aug 31 Bad Debt Expense 20



Mid Chapter Demo Problem• Lets try the Mid Chapter Demo Problem

• Lets calculate the Bad Debt Expense and Allowance for Doubtful Accounts using – Estimate of total credit sales

– Estimate of outstanding AR

– Aging analysis


Short Term Notes Receivable• Promissory Note: is a written promise to pay some amount

on demand or by some specific date– A Short-term Note Receivable is a promissory note due within the

business’s accounting period

– Usually a note is for non-operational receivables (like shareholder loans)

• Characteristics of a Note:– Principal – the amount owed to the business

– Interest – usually expressed as an annual interest rate

– Time – the amount of time to the required pay date

• Interest calculation– Interest = (Principal) x (Annual Interest rate) x (Time [years])

– As an example…


Short Term Notes Receivable• Someone promises to pay for a $1000 purchase within 6

months (assuming a 12% interest rate)– Principal = 1000

– Annual Interest Rate = 12%

– Time [years] = 6/12 = .5

– Interest owed = (1000)x(.12)x(.5) = 60

• Ok, so what! Big deal! How do we use this in accounting

• Well, we make a loan and eventually receive payment of principal and interest. Here is what it looks like…..


Short Term Notes Receivable• The loan…

• The payment…


June 5 Notes Receivable 1000

Cash 1000


Dec 5 Cash 1060

Notes Receivable 1000

Interest Revenue 60


End of Period Adjustment• If Notes are outstanding at the end of the period, but not

yet “collectable”, we need to make an entry to account for that portion of the interest earned during the period

• Then once payment is made in the new period:


Dec 31 Interest Receivable 30

Interest Revenue 30


Mar 31 Cash 1060

Interest Receivable 30

Interest Revenue 30

Notes Receivable 1000


Sample Problems• Try the following

– Exercise 10-1

– Exercise 10-4

– Exercise 10-7

– Exercise 10-8

– Problem 10-4A

– Problem 10-10A

• Chapter 11


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Financial Accounting Dave Ludwick, P.Eng, MBA, PMP, PhD Chapter 10 Receivables