Accounting PrinciplesSecond Canadian EditionPrepared by: Carole Bowman, Sheridan CollegeWeygandt Kieso Kimmel Trenholm

ACCOUNTING FOR RECEIVABLESCHAPTER9

The term receivables refers to amounts due from individuals and other companies; they are claims expected to be collected in cash. Three major classes of receivables are:

1. Accounts Receivable 2. Notes Receivable 3. Other ReceivablesRECEIVABLES

The three primary accounting problems associated with accounts receivable are:1. Recognizing accounts receivable.2. Valuing accounts receivable.3. Disposing of accounts receivable.ACCOUNTS RECEIVABLE

GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditAccounts Receivable - Adorable JuniorSalesRECOGNIZING ACCOUNTS RECEIVABLEWhen a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited.

100RECOGNIZING ACCOUNTS RECEIVABLEWhen a business receives returned merchandise previously sold to a customer on credit, Sales Returns and Allowances is debited and Accounts Receivable is credited. GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 5Sales Returns and Allowances Accounts Receivable - Adorable100 To record merchandise returned.

900RECOGNIZING ACCOUNTS RECEIVABLEGENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 31Cash ($1,000 - $100) Accounts Receivable - Adorable900 To record collection of account.When a business collects cash from a customer for merchandise previously sold on credit, Cash is debited and Accounts Receivable is credited.

13.50RECOGNIZING ACCOUNTS RECEIVABLEGENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 31Accounts Receivable - Adorable Interest Revenue13.50 To record interest on amount due.When financing charges are added to a balance owing, Accounts Receivable is debited and Interest Revenue is credited.

To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value.Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect.

VALUING ACCOUNTS RECEIVABLE

Two methods of accounting for uncollectible accounts are:

1. Allowance method 2. Direct write-off methodVALUING ACCOUNTS RECEIVABLE

Under the direct write-off method, no entries are made for bad debts until an account is determined to be uncollectible at which time the loss is charged to Bad Debts Expense.No attempt is made to match bad debts to sales revenues or to show the net realizable value of accounts receivable on the balance sheet.

DIRECT WRITE-OFF METHOD

200 200 GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJan. 12Bad Debts Expense Accounts Receivable E. Schaefer For write-off of E. Schaefer account.DIRECT WRITE-OFF METHODPeriera Company writes off E. Schaefers $200 balance as uncollectible on January 12. When this method is used, Bad Debts Expense will show only actual losses from uncollectibles.

The allowance method is required when bad debts are deemed to be material in amount.Uncollectible accounts are estimated and the expense for the uncollectible accounts is matched against sales in the same accounting period in which the sales occurred.

THE ALLOWANCE METHOD

Estimated uncollectible amounts are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts (a contra asset account) at the end of each period.THE ALLOWANCE METHOD

Sheet1

GENERAL JOURNAL

DateAccount Title and ExplanationDebitCredit

Dec. 31Bad Debts Expense24,000

Allowance for Doubtful Accounts24,000

To record estimate of uncollectible accounts.

Sheet2

Sheet3

Current assets Cash $ 14,800Accounts receivable$200,000Less: Allowance for doubtful accounts 24,000 188,000 ADORABLE JUNIOR GARMETBalance Sheet (partial)

500 500 GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditMar. 1Allowance for Doubtful Accounts Accounts Receivable Nadeau Write-off of Nadeau account.Actual uncollectible accounts are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off.THE ALLOWANCE METHOD

500 500 When there is recovery of an account that has been written off: 1. reverse the entry made to write off the account and ...THE ALLOWANCE METHODGENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 1Accounts Receivable Nadeau Allowance for Doubtful Accounts To reverse write-off of Nadeau account.

500 500 THE ALLOWANCE METHODGENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 1Cash Accounts Receivable Nadeau To record collection from Nadeau.2. Record the collection in the usual manner.

Companies use either of two methods in the estimation of uncollectible accounts:

1. Percentage of sales2. Percentage of receivablesBoth bases are GAAP; the choice is a management decision.

BASES USED FOR THE ALLOWANCE METHOD

Emphasis on Income Statement RelationshipsILLUSTRATION 9-4 COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLESPercentage of SalesPercentage of ReceivablesNet Realizable ValueAllowanceAccountsforReceivableDoubtfulAccountsEmphasis on Balance Sheet Relationships

Matching

Sales

Bad Debts

Expense

In the percentage of sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts.Expected bad debt losses are determined by applying the percentage to the sales base of the current period.This basis better matches expenses with revenues.

PERCENTAGE OF SALES BASIS

Under the percentage of receivables basis, management establishes a percentage relationship between the amount of accounts receivable and the required balance in the allowance account.This percentage can be applied to the total accounts receivable balance, or to individual accounts receivable balances stratified by age.

PERCENTAGE OF RECEIVABLES BASIS

The required balance in the allowance account is determined by applying the percentage to the accounts receivable balance at the end of the current period.The amount of the adjusting entry to record expected bad debt losses for the current period is the difference between the required balance and the existing balance in the allowance account.This basis produces the better estimate of net realizable value of receivables.

PERCENTAGE OF RECEIVABLES BASIS

To accelerate the receipt of cash from receivables, owners frequently:1. sell to a factor, such as a finance company or a bank, and2. make credit card sales. DISPOSING OF ACCOUNTS RECEIVABLE

A factor buys receivables from businesses for a fee and collects the payments directly from customers.Credit cards are frequently used by retailers who wish to avoid the paperwork of issuing credit.Retailers can receive cash more quickly from the credit card issuer.

DISPOSING OF ACCOUNTS RECEIVABLE

Three parties are involved when credit cards are used in making retail sales:

1. the credit card issuer,2. the retailer, and3. the customer.The retailer pays the credit card issuer a percentage fee of the invoice price for its services.From an accounting standpoint, sales from bank cards (e.g., Visa and MasterCard) are treated differently than sales from non-bank cars (e.g., American Express).

CREDIT CARD SALES

Sales resulting from the use of VISA and MasterCard are considered cash sales by the retailer.These cards are issued by banks.Upon receipt of credit card sales slips from a retailer, the bank immediately adds the amount to the sellers bank balance.

BANK CARD SALES

965 35 1,000 GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 31CashCredit Card Expense ($1,000 x 3.5%) Sales To record VISA credit card sales.BANK CARD SALESAnita Ferreri purchases a number of compact discs for her restaurant from Karen Kerr Music Co. for $1,000 using her Royal Bank VISA card. The service fee that the Royal charges is 3.5 percent.

Sales using American Express and other non-bank cards are reported as credit sales, not cash sales.Conversion into cash does not occur until American Express remits the net amount to the seller.

NON-BANK CARD SALES

475 25 500 NON-BANK CARD SALESKerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent.GENERAL JOURNALDateAccount Titles and ExplanationDebitCreditJuly 31Accounts ReceivableCredit Card Expense ($500 x 5%) Sales To record American Express credit card sales.

A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.The party making the promise is the maker.The party to whom payment is made is called the payee.

NOTES RECEIVABLE

The basic formula for calculating interest on an interest-bearing note is:

The interest rate specified on the note is an annual rate of interest.

ILLUSTRATION 9-8 FORMULA FOR CALCULATING INTEREST

1,000 1,000RECOGNIZING NOTES RECEIVABLEWilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account.

Like accounts receivable, short-term notes receivable are reported at their net realizable value.The notes receivable allowance account is Allowance for Doubtful Notes.

VALUING NOTES RECEIVABLE

HONOUR OF NOTES RECEIVABLEA note is honoured when it is paid in full at its maturity date.Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5% interest-bearing note, due in 4 months, on September 30. Wolder collects the maturity value of the note from Higley on September 30.

Sheet1

GENERAL JOURNAL

DateAccount Title and ExplanationDebitCredit

Sept. 30Cash10,150

Notes Receivable - Higly10,000

Interest Revenue150

To record collection of Higly note.

Sheet2

Sheet3

DISHONOUR OF NOTES RECEIVABLEA dishonoured note is a note that is not paid in full at maturity. A dishonoured note receivable is no longer negotiable. Since the payee still has a claim against the maker of the note, the balance in Notes Receivable is usually transferred to Accounts Receivable.

Sheet1

GENERAL JOURNAL

DateAccount Title and ExplanationDebitCredit

Sept. 30Accounts Receivable - Higly10,150

Notes Receivable - Higly10,000

Interest Revenue150

To record the dishonour of Higly note.

Sheet2

Sheet3

BALANCE SHEET PRESENTATION OF RECEIVABLESEach of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements.In the balance sheet, short-term receivables are reported within the current assets section below cash and temporary investments.Both the gross amount of receivables and the allowance for doubtful accounts should be reported.

USING THE INFORMATION IN THE FINANCIAL STATEMENTSFinancial ratios are calculated to evaluate the short-term liquidity of a company.These ratios include the

1. current ratio,2. acid test (quick) ratio,3. receivables turnover ratio, and the4. collection period ratio.

CURRENT RATIOThe current ratio (working capital ratio) is a widely used measure for evaluating a companys liquidity and short-term debt-paying ability.

ACID TEST RATIO The acid test ratio (quick ratio) is a measure of a companys short-term liquidity.

ACCOUNTS RECEIVABLE TURNOVER RATIOThe ratio used to assess the liquidity of the receivables is the receivables turnover ratio.

Net Credit Average Net ReceivablesSales Receivables Turnover=

COLLECTION PERIODThe collection period in days is a variant of the receivables turnover ratio and makes liquidity even more evident. The general rule is that the collection period should not exceed the credit term period.

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