Chapter 8 Receivables

Control account and Subsidiary accounts of Accounts Receivable

Businesses maintain different A/R accounts (called subsidiary accounts) for each customer. The control account, Accounts Receivable, shows a balance which should be equal to (and on the same side) the total of the individual customer accounts in the subsidiary ledger.

What are common types of receivables, and how are credit sales recorded?

A receivable occurs when a business sells goods or services to another party on account (on credit). A receivable is a monetary claim against a business or an individual. A receivable is a right to receive cash in the future from a current transaction. A creditor is the party who receives a receivable. A debtor is the party to a credit transaction who is obligated to pay later. There are 3 types of receivables: Accounts Receivable, Notes Receivable, and Other Receivables

Other Receivables

Any other type of receivable is considered other receivables. Receivables are classified as either current or long-term, depending on whether they will be received in one year or less. Examples include: Dividends receivable Interest receivable Taxes receivable

Accounts Receivable

Accounts receivable, also called trade receivables, represents the right to receive cash in the future from customers for goods or services performed. Generally collected within 30 to 60 days Reported as a current asset on the balance sheet

Accruing Interest Revenue and Recording Honored Notes Receivable

Adjusting JE for the accrual of interest revenue: Dr. Interest Receivable Cr. Interest Revenue

Recovery of Accounts Previously Written Off—Direct Write-off Method

After the company has written off an account, it is possible the customer will still make a payment on their account. In this case, the company needs to: (1) reverse the earlier write-off and (2) record the cash collection. Reestablishing the A/R and then recording the payment provides accurate records and restores the customer's credit history. JE for recovery of accounts previously written off: Dr. Accounts Receivable Cr. Bad Debt Expense (reverse the accounts for writing off the account, the reverse reestablish the customer's accounts receivable) Since the recovery requires the customer paying us back, another JE associated with recovery would be: Dr. Cash Cr. Accounts Receivable

Computing Interest on a Note

Amount of Interest = Principal x Interest Rate x Time In the formula, time represents the portion of a year that interest has accrued on the note. It may be expressed as a fraction of a year in months (number of months/12) Or a fraction of a year in days (number of days/365) or (number of days/360) Interest rates are always annual. Time is always a fraction of a year.

Estimating and Recording Bad Debts Expense—Allowance Method

Companies estimate bad debts expense based upon: Past experience The industry in which they operate Other variables There are three methods to estimate uncollectibles using the allowance method: Percent-of-sales Percent-of-receivables Aging-of-receivables Adjusting JE for estimation: Dr. Bad Debt Expesne Cr. Allowance for Bad Debt

Options to decrease collection time while transferring the risk of noncollection on Accounts Receivable to a third party include:

Credit Card and Debit Card Sales Factoring (selling) and Pledging (using as collateral on a loan) Receivables

How do we record the issue of notes receivable?

Dr. Notes Receivable Cr. Cash the amount would be at its principal amount

Comparison of Accounting for Uncollectibles

Income Statement approach: percentage of sales: net credit sales*% Balance Sheet approach: percentage of receivable method aging-of-receivables method

Recovery of Accounts Previously Written Off—Allowance Method

JE for recovery of accounts previously written off under allowance method: Dr. Allowance for Bad Debt Cr. Bad Debt Expense (reverse the accounts for writing off the account, the reverse reestablish the customer's accounts receivable) Since the recovery requires the customer paying us back, another JE associated with recovery would be: Dr. Cash Cr. Accounts Receivable

How are uncollectible accounted for when using the allowance method?

JE for write-off under allowance method: Dr. Allowance for Bad Debt Cr. Accounts Receivable The Allowance account is a contra-asset account for the Accounts Receivable Instead of recording a debit to Bad Debts Expense (as in the Direct Method), the company records a debit to Allowance for Bad Debts. 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 (balance sheet) nor does it effect net income (income statement).

What is net realizable value of Accounts Receivable?

Net realizable value is the net value the company expects to collect from its accounts receivable. NRV=A/R-Allowance for Bad Debt

Notes Receivable

Notes receivable usually have longer terms than accounts receivable. Notes receivable are sometimes called promissory notes. A note receivable represents a promise to pay a fixed amount of principle plus interest by a certain due date. The maturity date is the date on which a note receivable is due. Reported as a current asset if due within one year. Reported as a long-term asset if due beyond one year.

How are notes receivable accounted for? -continued from last flashcard

Principal —The amount loaned by the payee and borrowed by the maker of the note. Interest —The revenue to the payee for loaning money. Interest is an expense to the debtor and revenue to the creditor. 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. Interest rate —The percentage rate of interest specified by the note. Interest rates are almost always stated for a period of one year. Maturity date —As stated earlier, this is the date when final payment of the note is due. Also called the due date. Maturity value —The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back.

How are notes receivable accounted for?

Promissory note — A written promise to pay a specified amount of money at a particular future date, usually with interest. 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. 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.

Identifying Maturity Date

Some notes specify the maturity date. Other notes state the period of the note in days or months. 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. When the period is given in days, the maturity date is determined by counting the actual days from the date of issue. Count the maturity date Omit the issue date

Aging-of-Receivables Method

The aging-of-receivables method is similar to the percent-of-receivables method. In the aging method, businesses group individual accounts based on how long the receivable has been outstanding. Different percentages are applied to each category. The procedure for recording the year-end adjusting entry under the aging-of-receivables method is similar to the percent-of-receivables method.

Recording and Writing Off Uncollectible Accounts—Direct Write-off Method

The direct write-off method is a method of accounting for uncollectible receivables in which the company records bad debts expense when a customer's account receivable is uncollectible. Primarily used by small, nonpublic companies. Accounts receivable are written off when the business determines that it will never collect from a specific customer. Once an account receivable is written off, the company stops pursuing the collection. JE for write-off under direct write off method: Dr. Bad Debt Expense Cr. Accounts Receivable

Limitations of the Direct Write-off Method

The direct write-off method violates the matching principle Example: A company records sales revenue in 2017 and related bad debts expense in 2018. This results in: Overstated net income in 2017 Understated net income in 2018 Overstated Accounts Receivable in 2017 Not GAAP (the direct write-off method is only acceptable for companies that have very few uncollectible receivables).

Percent-of-Receivables Method

The percent-of-receivables method computes bad debts expense as a percentage of accounts receivable.

Percent-of-Sales Method

The percent-of-sales method computes bad debts expense as a percentage of net credit sales. Some companies use all sales, not just credit sales. This method is also called the income-statement approach.

Maturity value of Notes Receivable

The sum of the principal plus interest due at maturity.

Recording Dishonored Notes Receivable

When a maker dishonors a note, the dishonored note and the unpaid interest are transferred to Accounts Receivable. Later, the Accounts Receivable can be written off under the direct write-off method or the allowance method.

What are the two ways of accounting for uncollectibles on Accounts Receivable?

direct write-off method (not allowed under GAAP, violates matching principal): Allowance method (GAAP method)

Direct write-off method vs. Allowance method

write-off of an uncollectible account: Direct write off: Dr. Bad Debt Expense Cr. Accounts Receivable Allowance method: Dr. Allowance for Bad Debt Cr. Accounts Receivable Recovery of accounts previously written off: Direct write off: Dr. Accounts Receivable Cr. Bad Debt Expense Allowance method: Dr. Accounts Receivable Cr. Allowance for Bad Debt both methods will also record the receipt of cash, and reduce in A/R as follows: Dr. Cash Cr. Accounts Receivable Adjusting entry to recognize bad debts; direct write-off: No adjusting entry recorded. allowance method: Dr. Bad Debt Expense Cr. Allowance for Bad Debt