Chapter 9: Accounting for Receivables

Accounts Receivable Methods

(uses balance sheet relations to estimate)—desired credit balance in Allowance for Doubtful Accounts is computed: a. As a percentage of outstanding receivables (simplified approach) or b. By aging accounts receivable. c. The amount in the adjustment is calculated by determining the amount necessary to bring allowance account to a credit balance equivalent to the estimated uncollectibles.

Methods of Estimating Bad Debts Expense

-Percent of Sales Method -Accounts Receivable Methods (Aging of accounts receivable, Percent of outstanding receivables)

selling receivables

1. Buyer, called a factor, charges the seller a factoring fee and then collects the receivables as they come due. 2. Entry: debit Cash (amount received), and Factoring Fee Expense (amount charged) and credit Accounts Receivable (amount sold).

Pledging Receivables

1. Company borrows money by pledging its receivables as security. 2. Borrower retains ownership of the receivables. 3. If borrower defaults, the lender has right to be paid from receipts on accounts receivable when collected. 4. The pledge should be disclosed in financial statement footnotes. 5. The loan is recorded as a debit to Cash and a credit to Notes Payable.

Accounts Receivable Turnover

A measure of the liquidity of accounts receivable, computed by : net sales / average accounts receivable.

Computations for Notes

A. Computations for Notes 1. Maturity date is the date the note must be repaid. 2. Amount to be repaid is principal plus interest (maturity value). 3. The period of the note is the time from the note's date to its maturity date. 4. Formula for computing annual interest: Principal x Annual interest rate x time of note expressed in years = Interest

Valuing Accounts Receivable

Accounts of customers who do not pay are uncollectible accounts, commonly called bad debts. Two methods are used to account for uncollectible accounts: Direct Write off method and Allowance Method

Accounts Receivable

Amounts due from customers for credit sales. They occur when a customer uses credit cards issued by third parties and when a company gives credit directly to customers.

Installment Sales and Receivables

Amounts owed by customers from credit sales where payment is required in periodic amounts over an extended time period. 1. Customer is usually charged interest. 2. Should be classified as current assets even if credit period exceeds year if the company regularly offers customers such terms.

disposing of receivables

Companies can convert receivables to cash before they are due. Reasons for this include the need for cash or a desire to not be involved in collection activities.

Recording a Dishonored Note

Debit Accounts Receivable, Credit Interest Revenue and Notes Receivable

Sales On Credit

Increase (debit) Accounts Receivable for the full amount of the sale and increase (credit) Sales. a. The General Ledger continues to keep a single (total) accounts receivable. b. A supplementary record, called the Accounts Receivable (subsidiary) Ledger, maintains a separate account receivable for each customer. c. A Schedule of Accounts Receivable shows that the sum of the individual accounts in the subsidiary ledger equals the debit balance of the Accounts Receivable account in the general ledger.

Allowance Method

Matches the estimated loss from uncollectibles against the sales they helped produce. a. At the end of each accounting period, bad debts expense is estimated and recorded in an adjusting entry. b. To record estimate of bad debt expense, Debit Bad Debt Expense, credit a contra-asset account called Allowance for Doubtful Accounts. c. Advantages of method: i. Satisfies the matching principle because expense is charged in the period of the corresponding sale. ii. Reports accounts receivable on balance sheet at the estimated amount of cash to be collected. d. To write-off an uncollectible: debit Allowance for Doubtful Accounts, credit Accounts Receivable. e. Writing off an uncollectible does not change the estimated amount of cash to be collected (realizable value of accounts receivable). f. If a written off account is later recovered (collected) , this results of a reversal of the write off (see d above) and a normal collection of account entry.

Notes Receivable

Promissory note that is a written promise to pay a specified amount of money (principal) either on demand or on a definite future date. Most notes are interest bearing. Promissory notes are notes payable to the maker (person promising to pay) and notes receivable to the payee (person to be paid).

direct write-off method

Records the loss from an uncollectible account receivable when it is determined to be uncollectible. a. To write off uncollectible and recognize loss: debit Bad Debt Expense, credit Accounts Receivable. b. If a written off account is later collected, this results in a reversal of the write-off (see above) and a normal collection of account entry. c. This method violates the matching principle since it frequently results in expense being charged in a period after that of the credit sale. d. Materiality constraint states that an amount can be ignored if its effect on the financial statements is unimportant to users' decisions. This constraint permits use of direct write-off when bad debts expenses are very small in relation to other financial statement items such as sales and net income.

percent of sales method

a. Sales figure chosen as base is usually credit sales but it can be total or net sales if cash sales are small. b. The estimate is used in the adjusting entry. Note that the resulting reported allowance account balance is rarely equal the reported expense because the allowance account was not likely to be zero prior to adjustment.

Credit Card Sales

a. advantages: (1) eliminates the company's need to evaluate each customer's credit standing (2) avoids seller's risk (3) seller receives cash sooner than when they grant credit directly (4) more credit options potentially increase sales. b. Credit card sales (when cash is received upon deposit of sales receipt) results in debit to Cash for the amount of sale less the credit card company charge, debit to Credit Card Expense for this fee and credit to Sales for full invoice amount. c. Credit card sales (when cash receipt is delayed until payment is made by credit card) results in debit to Accounts Receivable for the amount to be collected, and a debit to Credit Card expense for the amount of the fee and credit to Sales for full invoice. Later, when payment is received, debit Cash and credit Accounts Receivable.

Recording an Honored Note

debit Cash; credit Notes Receivable and Interest Revenue

Recognizing Notes Receivable

debit Notes Receivable for principal or face amount of note. Credit will vary; depends on reason note is received. Note that interest is not recorded until earned.

Collection entry if some interest accrued

debit to Cash for full amount received, credits to Interest Receivable (amount previously accrued), Interest Revenue (amount earned since accrual date) and Notes Receivable (face amount of note).

Recording End-of-Period Interest Adjustment

record accrued interest by debiting Interest Receivable and crediting Interest Revenue.