Receivables

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ReceivablesReceivables

Chapter 9Chapter 9Chapter 9Chapter 9

Learning ObjectivesLearning Objectives

1.1.Describe the common classes of Describe the common classes of receivables.receivables.

2.2.Describe the accounting for uncollectible Describe the accounting for uncollectible receivables.receivables.

3.3.Describe the direct write-off method of Describe the direct write-off method of accounting for uncollectible receivables.accounting for uncollectible receivables.

4.4.Describe the allowance method of Describe the allowance method of accounting for uncollectible receivables.accounting for uncollectible receivables.

5.5.Compare the direct write-off and Compare the direct write-off and allowance methods of accounting for allowance methods of accounting for uncollectible accounts.uncollectible accounts.

Learning ObjectivesLearning Objectives

6.6. Describe the accounting for notes Describe the accounting for notes receivable.receivable.

7.7. Describe the reporting of receivables on Describe the reporting of receivables on the balance sheet.the balance sheet.

8.8. Describe and illustrate the use of Describe and illustrate the use of accounts receivable turnover and number accounts receivable turnover and number of days’ sales in receivables to evaluate a of days’ sales in receivables to evaluate a company’s efficiency in collecting its company’s efficiency in collecting its receivables.receivables.


Learning Learning Objective

ObjectiveDescribe the common classes of

Describe the common classes of receivablesreceivables

11

Classification of ReceivablesClassification of Receivables

o Accounts receivable Accounts receivable are normally are normally expected to be collected within a relatively expected to be collected within a relatively short period, such as 30 or 60 days.short period, such as 30 or 60 days.


o Notes receivable Notes receivable are amounts that are amounts that customers owe for which a formal, written customers owe for which a formal, written instrument of credit has been issued.instrument of credit has been issued.


o Other receivables Other receivables expected to be collected expected to be collected within one year are classified as current within one year are classified as current assets. If collection is expected beyond assets. If collection is expected beyond one year, these receivables are classified one year, these receivables are classified as noncurrent assets and reported under as noncurrent assets and reported under the caption Investments. Examples of the caption Investments. Examples of other receivables include:other receivables include: Interest receivableInterest receivable Taxes receivableTaxes receivable Receivables from officers or employeesReceivables from officers or employees



ObjectiveDescribe the accounting for

Describe the accounting for

uncollectible receivables


22

Uncollectible ReceivablesUncollectible Receivables

o Companies often sell their receivables to Companies often sell their receivables to other companies. This is called other companies. This is called factoringfactoring the receivables, and the buyer of the the receivables, and the buyer of the receivables is called a receivables is called a factorfactor. .


o Regardless of how careful a company is in Regardless of how careful a company is in granting credit, some credit sales will be granting credit, some credit sales will be uncollectible. The operating expense uncollectible. The operating expense recorded from uncollectible receivables is recorded from uncollectible receivables is called called bad debt expensebad debt expense, , uncollectible uncollectible accounts expenseaccounts expense, or , or doubtful accounts doubtful accounts expenseexpense..


o Some indications that an account may be Some indications that an account may be uncollectible include the following:uncollectible include the following: The receivable is past due.The receivable is past due.

The customer does not respond to the The customer does not respond to the company’s attempts to collect.company’s attempts to collect.

The customer files for bankruptcy.The customer files for bankruptcy.

The customer closes its business.The customer closes its business.

The company cannot locate the customer.The company cannot locate the customer.


o The The direct write-off methoddirect write-off method of accounting of accounting for uncollectible receivables records bad for uncollectible receivables records bad debt expense only when an account is debt expense only when an account is determined to be worthless. The determined to be worthless. The allowance allowance methodmethod records bad debt expense by records bad debt expense by estimating uncollectible accounts at the estimating uncollectible accounts at the end of the accounting period.end of the accounting period.



ObjectiveDescribe the direct write-off

Describe the direct write-off

method of accounting for

method of accounting for



33

Direct Write-Off MethodDirect Write-Off Method

o On May 10, a $4,200 account receivable On May 10, a $4,200 account receivable from D. L. Ross has been determined to be from D. L. Ross has been determined to be uncollectible.uncollectible.

Direct Write-Off MethodDirect Write-Off Method

o The account written off on May 10 is later The account written off on May 10 is later collected on November 21.collected on November 21.

Reinstatemententry

Receipt of cash entry



ObjectiveDescribe the allowance method

Describe the allowance method

of accounting for uncollectible

of accounting for uncollectible receivablesreceivables

44

The Allowance MethodThe Allowance Method

o On December 31, ExTone Company On December 31, ExTone Company estimates that a total of $30,000 of the estimates that a total of $30,000 of the $200,000 balance of their accounts $200,000 balance of their accounts receivable will eventually be uncollectible.receivable will eventually be uncollectible.

The specific customer accounts cannot be decreased, so a contra account, Allowance for Doubtful

Accounts, is credited.


o The net amount that is expected to be The net amount that is expected to be collected, $170,000 ($200,000 – $30,000), collected, $170,000 ($200,000 – $30,000), is called the is called the net realizable valuenet realizable value (NRV)(NRV) of of the receivables. The adjusting entry the receivables. The adjusting entry reduces receivables to the NRV and reduces receivables to the NRV and matches uncollectible expenses with matches uncollectible expenses with revenues.revenues.


o On January 21, John Parker’s account of On January 21, John Parker’s account of $6,000 is written off because it is $6,000 is written off because it is uncollectible.uncollectible.

Note that the allowance account credited earlier is debited at the write-off, not

Bad Debt Expense.

THE THE ALLOWANCE ALLOWANCE

METHODMETHOD


o During 2014, ExTone Company writes off During 2014, ExTone Company writes off $26,750 of uncollectible accounts, $26,750 of uncollectible accounts, including the $6,000 account of John including the $6,000 account of John Parker. After posting all entries to write off Parker. After posting all entries to write off uncollectible amounts, Allowance for uncollectible amounts, Allowance for Doubtful Accounts will have a credit Doubtful Accounts will have a credit balance of $3,250 ($30,000 – $26,750).balance of $3,250 ($30,000 – $26,750).


o If ExTone Company had written off If ExTone Company had written off $32,100 in accounts receivable during $32,100 in accounts receivable during 2014, Allowance for Doubtful Accounts 2014, Allowance for Doubtful Accounts would have a debit balance of $2,100.would have a debit balance of $2,100.


o Nancy Smith’s account of $5,000, which Nancy Smith’s account of $5,000, which was written off on April 2, is later collected was written off on April 2, is later collected on June 10. Two entries are needed: one to on June 10. Two entries are needed: one to reinstate Nancy Smith’s account and a reinstate Nancy Smith’s account and a second to record receipt of the cash.second to record receipt of the cash.

Receipt of cash entry

Reinstatemententry

Estimating UncollectiblesEstimating Uncollectibles

o The allowance method requires an The allowance method requires an estimate of uncollectible accounts at the estimate of uncollectible accounts at the end of the period. Two methods are used end of the period. Two methods are used to estimate the amount debited to Bad to estimate the amount debited to Bad Debt Expense.Debt Expense. Percent of sales methodPercent of sales method

Analysis of receivables methodAnalysis of receivables method

Percent of Sales MethodPercent of Sales Method

o If ExTone Company’s credit sales for the If ExTone Company’s credit sales for the period are $3,000,000 and it is estimated period are $3,000,000 and it is estimated that 3/4% will be uncollectible, Bad Debt that 3/4% will be uncollectible, Bad Debt Expense is debited for $22,500 Expense is debited for $22,500 ($3,000,000 x .0075). This approach ($3,000,000 x .0075). This approach disregards the balance of $3,250 in the disregards the balance of $3,250 in the allowance account before the adjustment.allowance account before the adjustment.

Percent of Sales MethodPercent of Sales Method

o After the following adjusting entry on After the following adjusting entry on December 31 is posted, Allowance for December 31 is posted, Allowance for Doubtful Accounts will have a balance of Doubtful Accounts will have a balance of $25,750 ($3,250 + $22,500).$25,750 ($3,250 + $22,500).

PERCENT OF PERCENT OF SALES METHODSALES METHOD

Analysis of Receivables MethodAnalysis of Receivables Method

o The longer an account receivable is The longer an account receivable is outstanding, the less likely it is that it will outstanding, the less likely it is that it will be collected. Basing the estimate of be collected. Basing the estimate of uncollectible accounts on how long uncollectible accounts on how long specific amounts have been outstanding is specific amounts have been outstanding is called called aging the receivablesaging the receivables..


o The analysis of receivables method is The analysis of receivables method is applied as follows:applied as follows: Step 1:Step 1: The due date of each account The due date of each account

receivable is determined.receivable is determined.

Step 2:Step 2: The number of days each The number of days each account is past due is determined.account is past due is determined.

Step 3:Step 3: Each account is placed in an aged Each account is placed in an aged class according to its days past due.class according to its days past due.

Step 4:Step 4: The totals for each aged class The totals for each aged class are are determined.determined.


Step 5: Step 5: The total for each aged class is The total for each aged class is multiplied by an estimated percentage of multiplied by an estimated percentage of uncollectible accounts for that class.uncollectible accounts for that class.

Step 6:Step 6: The estimated total of uncollectible The estimated total of uncollectible accounts is determined as the sum of the accounts is determined as the sum of the uncollectible accounts for each aged class.uncollectible accounts for each aged class.


o The preceding steps are summarized in an The preceding steps are summarized in an aging schedule, and this overall process is aging schedule, and this overall process is called called aging the receivablesaging the receivables..

ANALYSIS OF ANALYSIS OF RECEIVABLES RECEIVABLES

METHODMETHOD


o The estimate based on the age of The estimate based on the age of receivables is compared to the balance in receivables is compared to the balance in the allowance account to determine the the allowance account to determine the amount of the adjusting entry.amount of the adjusting entry.


o ExTone Company has an unadjusted credit ExTone Company has an unadjusted credit balance of $3,250 in Allowance for balance of $3,250 in Allowance for Doubtful Accounts. In Exhibit 1, the Doubtful Accounts. In Exhibit 1, the estimated uncollectible accounts totaled estimated uncollectible accounts totaled $26,490. The amount to be added to the $26,490. The amount to be added to the allowance account is $23,240 ($26,490 – allowance account is $23,240 ($26,490 – $3,250). The adjusting entry is as follows:$3,250). The adjusting entry is as follows:


o After the preceding adjusting entry is After the preceding adjusting entry is posted to the ledger, ExTone Company’s posted to the ledger, ExTone Company’s Allowance for Doubtful Accounts will have Allowance for Doubtful Accounts will have an adjusted balance of $26,490. This is the an adjusted balance of $26,490. This is the amount that was determined by aging the amount that was determined by aging the accounts.accounts.

Same amount as the estimated amount determined by the aging process.


o If ExTone Company’s unadjusted balance If ExTone Company’s unadjusted balance of the allowance account had been a debit of the allowance account had been a debit balance of $2,100, the amount of the balance of $2,100, the amount of the adjustment would have been $28,590 adjustment would have been $28,590 ($26,490 + $2,100).($26,490 + $2,100).

COMPARING COMPARING ESTIMATION ESTIMATION METHODSMETHODS



ObjectiveCompare the direct write-off and

Compare the direct write-off and

allowance methods of accounting

allowance methods of accounting

for uncollectible accounts

for uncollectible accounts

55

Comparing MethodsComparing Methods

o The primary differences between the The primary differences between the direct write-off and allowance methods are direct write-off and allowance methods are summarized below.summarized below.



ObjectiveDescribe the accounting for

Describe the accounting for notes receivable

notes receivable

66

Characteristics of Notes ReceivableCharacteristics of Notes Receivable

o A note receivable, or promissory note, is a A note receivable, or promissory note, is a written document containing a promise to written document containing a promise to pay. Characteristics of a promissory note pay. Characteristics of a promissory note are as follows:are as follows: The The makermaker is the party making the promise is the party making the promise

to pay.to pay. The The payeepayee is the party to whom the note is is the party to whom the note is

payable. payable. The The face amountface amount is the amount the note is is the amount the note is

written for on its face.written for on its face.(continued)

Characteristics of Notes ReceivableCharacteristics of Notes Receivable

The issuance date is the date a note is issued.The issuance date is the date a note is issued.

The due date or maturity date is the date the The due date or maturity date is the date the note is to be paid.note is to be paid.

The term of a note is the amount of time The term of a note is the amount of time between the issuance and due dates.between the issuance and due dates.

The interest rate is the rate of interest that The interest rate is the rate of interest that must be paid on the face amount for the term must be paid on the face amount for the term of the note.of the note.

NOTES NOTES RECEIVABLERECEIVABLE

Notes ReceivableNotes Receivable

o The The maturity valuematurity value is the amount that is the amount that must be paid at the due date of the note, must be paid at the due date of the note, which is the sum of the face amount and which is the sum of the face amount and the interest.the interest.

Due Date of a 90-day NoteDue Date of a 90-day Note

o What is the due date of a 90-day note dated What is the due date of a 90-day note dated March 16?March 16? Days in MarchDays in March 3131 Minus issuance date of noteMinus issuance date of note 1616 Days remaining in March Days remaining in March 1515 Add days in AprilAdd days in April 3030 Add days in MayAdd days in May 3131 Add days in June Add days in June

(due date of (due date of June 14June 14)) 1414 Term of note Term of note 90 90

daysdays

9090 daysdays

Answer: June 14Answer: June 14

Alternate ApproachAlternate Approach

o Total days in note Total days in note 90 days90 days Number of days in MarchNumber of days in March 31 31

Issue date of note, March 16Issue date of note, March 16 (16(16))

Remaining days in MarchRemaining days in March daysdays 1515

Number of days in AprilNumber of days in April 3030

Number of days in MayNumber of days in May daysdays 3131

Residual days in JuneResidual days in June (14) days(14) days

DUE DATE OF A DUE DATE OF A 90-DAY NOTE90-DAY NOTE

Accounting for Notes ReceivableAccounting for Notes Receivable

o Received a $6,000, 12%, 30-day note Received a $6,000, 12%, 30-day note dated November 21, 2014, in settlement dated November 21, 2014, in settlement of the account of W. A. Bunn Company.of the account of W. A. Bunn Company.


o On December 21, when the note matures, On December 21, when the note matures, the firm receives $6,060 from W. A. Bunn the firm receives $6,060 from W. A. Bunn Company ($6,000 face amount plus $60 Company ($6,000 face amount plus $60 interest).interest).


o If W. A. Bunn Company fails to pay the If W. A. Bunn Company fails to pay the note on the due date, it is considered a note on the due date, it is considered a dishonored note receivabledishonored note receivable. The note and . The note and interest are transferred back to the interest are transferred back to the customer’s account receivable.customer’s account receivable.


o A 90-day, 12% note dated December 1, A 90-day, 12% note dated December 1, 2014, is received from Crawford Company 2014, is received from Crawford Company to settle its account, which has a balance to settle its account, which has a balance of $4,000.of $4,000.


o Assuming that the accounting period ends Assuming that the accounting period ends on December 31, an adjusting entry is on December 31, an adjusting entry is required to record the accrued interest of required to record the accrued interest of $40 ($4,000 x 0.12 x 30/360).$40 ($4,000 x 0.12 x 30/360).


o On March 1, 2015, $4,120 is received for On March 1, 2015, $4,120 is received for the note ($4,000) and interest ($120).the note ($4,000) and interest ($120).



ObjectiveDescribe the reporting of

Describe the reporting of

receivables on the balance sheet

receivables on the balance sheet

77

REPORTING REPORTING RECEIVABLES RECEIVABLES

ON THE ON THE BALANCE SHEETBALANCE SHEET



ObjectiveDescribe and illustrate the use of

Describe and illustrate the use of

accounts receivable turnover and

accounts receivable turnover and

number of days’ sales in receivables

number of days’ sales in receivables

to evaluate a company’s efficiency

to evaluate a company’s efficiency

in collecting its receivables.

in collecting its receivables.

88

Accounts Receivable TurnoverAccounts Receivable Turnover

o The The accounts receivable turnoveraccounts receivable turnover measures how frequently during the year measures how frequently during the year the accounts receivable are being the accounts receivable are being converted to cash.converted to cash.

Accounts Receivable

Turnover

Net Sales

Average Accounts Receivable

=

ACCOUNTS RECEIVABLE ACCOUNTS RECEIVABLE TURNOVERTURNOVER

Number of Days Sales in ReceivablesNumber of Days Sales in Receivables

o The The number of days’ sales in receivablesnumber of days’ sales in receivables is is an estimate of the length of time the an estimate of the length of time the accounts receivable have been accounts receivable have been outstanding.outstanding.

Number of Days’ Sales in

Receivables

Average Accounts Receivable

Average Daily Sales=

NUMBER OF DAYS SALES IN NUMBER OF DAYS SALES IN RECEIVABLES RECEIVABLES


ReceivablesReceivables

The EndThe EndThe EndThe End

Documents

Receivables