Accounting Chapter 8
Receivable
occurs when a business sells goods or services to another party on account. It is a monetary claim against a business or an individual. The receivable is the seller's claim for the amount of the transaction.
Problem: Based on prior experience, the company's bad debts expense is normally 0.5% of net credit sales, which totaled $60,000 for the year. The accountant calculates bad debts expense using the percent-of-sales method
60000 * .005 = 300
Example - computing interest: Promissory note for 2000 with 10% interest for nine months.
= Principal x Interest Rate x Time = 2000 * .10 * 9/12 = $150
Computing maturity value on a note interest was 1000 * .06 * 12/12 = 60
= principle + interest = 1060
Allowance for bad debts (or allowance for doubtful accounts) (or allowance for uncollectible accounts)
A contra asset account, related to accounts receivable, that holds the estimated amount from uncollectible accounts. When using the allowance method, companies estimate bad debts expense at the end of the period and then record an adjusting entry
allowance method
A method of accounting for uncollectible receivables in which the company estimates bad debts expense instead of waiting to see which customers the company will not collect from.
Accounts receivable turnover ratio
A ratio that measures the number of times the company collects the average accounts receivable balance in a year. Net credit sales / Average net accounts receivable
Notes receivable - Promissory note
A written promise to pay a specified amount of money at a particular future date, usually with interest.
Notes receivable - Maturity date
As stated earlier, this is the date when final payment of the note is due. Also called the due date
Computing Interest on a note
Amount of Interest = Principal x Interest Rate x Time (#months/12 months or #days/365days)
We will not cover the direct Write-off method because
It's not in accordance with GAAP
What happens when a promissory note reaches it's maturity date EX:
On the maturity date of the note, Smart Touch Learning will receive cash for the principal amount plus interest. The company considers the note honored and makes the follow-ing entry:
other receivables
Other receivables make up a miscellaneous category that includes any other type of receivable where there is a right to receive cash in the future. Common examples include dividends receivable, interest receivable, and taxes receivable.
Recovery of an Account Receivable Previously Written Off
Sometimes people have better financial times and they actually do pay off some of their debt so then you have to open the written off account.
debtor
The party to a credit transaction who takes on an obligation/payable
Factoring and pledging receivables
When a company needs cash they can sell their accounts receivable to a finance company or bank (called a Factor). The business immediately receives cash but less money than they would have received from the account receivable. The business can also pledge their accounts receivable which is when they take out a loan and put their accounts receivable up as collateral.
Read page 8-17 for Aging of receivables method problem
do it
percent of sales method (Income statement approach)
computes bad debts expense as a percentage of net credit sales. This method is also called the income-statement approach because it focuses on the amount of expense that is reported on the income statement Bad debts expense = net credit sales * %
allowance for bad debts
contra account for accounts receivable. Normal balance credit.
If a promissory note will mature into the next year, what do you do?
you make an adjusting entry on Dec 31st to account for how much interest has been accrued so far.
Types of Receivables
1. Accounts receivable 2. Notes receivable 3. Other receivables
Problem using acid test Amazon.com, Inc.'s acid-test ratio of 0.85 as of December 31, 2018, means that the business has $0.85 of quick assets to pay each $1.00 of current liabilities
Acid-test ratio =(Cash including cash equivalents +Short-term investments +Net current receivables) / Total current liabilities =($31,750 +$9,500+$16,677) / $68,391 =0.85
Recovery of accounts previously written off
After a company has previously written off an account, the company stops attempting to collect on the receivable. Customers will occasionally make payment on receivables that have already been written off. A business will need to reverse the write-off to the Allowance for Bad Debts account and then record the receipt of cash. In reversing the write-off, the business is reestablishing the receivable account and reversing the write-off from the Allowance for Bad Debts account. unexpectedly receives $25 cash from Clark. The entries to reverse the write-off and record the receipt of cash are as follows:
Credit and Debit cards
For businesses, the drawbacks to customers using credit and debit cards are that they are charged a processing fee by the credit card company but the benefit is that it attracts more customer, and when a customer pays with a credit card, the business is transferring that liability to the credit card company to collect the cash from the customer, whereas with accounts receivable businesses are the ones responsible for collecting that money from the customers.
Recording Dishonored Notes Receivable
If the maker of a note does not pay at maturity, the maker dishonors a note (also called defaulting on a note). Because the note has expired, it is no longer in force. But the debtor still owes the payee. The payee can transfer the note receivable amount to Accounts Receivable.
Problem: Assume that at December 31, 2026, the company's unadjusted accounts receivable balance is $6,375. Smart Touch Learning estimates that 4% of its accounts receivable will be uncollectible.
Step 1: the company determines the target balance for the Allowance for Bad Debts account: $255 ($6,375 *0.04). Step 2: its accountant determines the amount of the bad debts expense adjustment: $255 -$55 =$200
Notes receivable - Principal
The amount loaned by the payee and borrowed by the maker of the note.
Bad Debts Expense
The cost to the seller of extending credit. It arises from the failure to collect from some credit customers
Notes receivable - Maker of the note (debtor)
The entity that signs the note and promises to pay the required amount; the maker of the note is the debtor.
Notes receivable - Payee of the note (creditor)
The entity to whom the maker promises future payment; the payee of the note is the creditor. The creditor is the company that loans the money
writing off an account
debit allowance for bad debts credit accounts receivable. It's a debt that someone is not going to pay you so you wright off the debt.
If a company has a debit balance before the adjustment... (Percent of receivables method)
the calculation for bad debts expense is a little different. Instead of subtracting the unadjusted balance of the Allowance for Bad Debts from the target balance, the unadjusted balance will be added to the target balance. Notice that when the allowance account has an unadjusted debit balance, the target balance must be added to the unadjusted balance of the Allowance for Bad Debts to determine the bad debts expense adjustment.
Notes Receivable
usually have longer terms than accounts receivable. Notes receivable, sometimes called promissory notes, represent a written promise that a customer (or another individual or business) will pay a fixed amount of principal plus interest by a certain date in the future—called the maturity date.
What does the entry to write off a receivable effect
The entry to write off a receivable reduces the amount of the Allowance for Bad Debts account and also the Accounts Receivable account, but it does not affect the net realizable value shown on the balance sheet. This is because both Allowance for Bad Debts (contra asset) and Accounts Receivable (asset) were reduced by the amount of the write-off. In addition, the write-off of a receivable does not affect net income because the entry does not involve revenue or expenses.
maturity date
The maturity date is the date on which the notes receivable is due.
net realizable value
The net value a company expects to collect from its accounts receivable. Accounts Receivable less Allowance for Bad Debts
Notes receivable - Interest rate
The percentage rate of interest specified by the note. Interest rates are almost always stated for a period of one year.
Notes receivable - Interest period
The period of time during which interest is computed. It extends from the original date of the note to the maturity date. Also called the note term.
Days' Sales in Receivables
The ratio of average net accounts receivable to one day's sales. The ratio tells how many days it takes to collect the average level of accounts receivable. 365 days / Accounts receivable turnover ratio
Percent of receivables method (Balance Sheet approach)
In the percent-of-receivables method, the business once again determines a percentage of uncollectible accounts based on past experience. This method is different than the percent-of-sales method because it multiplies the percentage by the ending unadjusted balance in the Accounts Receivable account instead of by net credit sales. The calculation is a two-step process. First, the company determines the target balance of Allowance for Bad Debts. Then, it uses the target balance to determine the amount of the bad debts expense
Acid Test Ratio
The ratio of the sum of cash, cash equivalents, short-term investments, and net current receivables to total current liabilities. The ratio tells whether the entity could pay all its current liabilities with it's assets. (Cash including cash equivalents+Short-term investments +Net current receivables) / Total current liabilities. The acid-test ratio is a more stringent measure than the current ratio but it is not as stringent as the cash ratio. The higher the acid-test ratio, the more able the business is to pay its current liabilities
Notes receivable - Interest
The revenue to the payee for loaning money. Interest is an expense to the debtor and revenue to the creditor
Notes receivable - Maturity value
The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back.
subsidiary accounts
These separate customer accounts receivable. The sum of all balances in subsidiary accounts receivable equals a control account balance. In this case, Accounts Receivable serves as the control account.
Writing Off Uncollectible Accounts
To write off accounts receivable that are uncollected the company will record a debit to Allowance for Bad Debts. Bad Debts Expense is not debited when a company writes off an account receivable because the company has already recorded the Bad Debts Expense as an adjusting entry. The entry to write off an account under the allowance method has no effect on net income at the time of entry
Notes receivable - Figuring out the maturity date
When the period is given in months, the note's maturity date falls on the same day of the month as the date the note was issued. For example, a six-month note dated February 16, 2025, would mature on August 16, 2025. When the period is given in days, the maturity date is determined by counting the actual days from the date of issue. A 180-day note dated February 16, 2025, matures on August 15, 2025,
Estimating and recording bad debts expense:
When using the allowance method, companies must estimate the amount of bad debts expense at the end of the period and then record an adjusting entry. Companies use their past experience as well as consider the economy, the industry they operate in, and other variables in order to estimate the amount of uncollectible accounts. In short, they make an educated guess, called an estimate.
A factor
a company that provides short-term financing to firms by purchasing their accounts receivables at a discount
Aging of receivables method (Balance Sheet approach)
similar to the percent-of-receivables method. However, in the aging method, businesses group individual accounts (Broxson, Andrews, and so on) according to how long the receivable has been outstanding. Then they apply a different percentage uncollectible to each aging category.
