8

Receivables

Learning Objective 13-1

Describe the nature of the adjusting process.

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Insert Chapter Objectives

Receivables

1 Describe the common classes of receivables.

2 Describe the accounting for uncollectible receivables.

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

After studying this chapter, you should be able to:

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Receivables (continued)

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

6 Describe the accounting for notes receivable.

7 Describe the reporting of receivables on the balance sheet.

4 Describe the allowance method of accounting for uncollectible receivables.

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8-4

Describe the common classes of receivables.

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8-5

The term receivables includes all money claims against other entities, including people, business firms, and other organizations.

1

Classification of Receivables

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

1

Classification of Receivables

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

1

Classification of Receivables

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Other receivables expected to be collected within one year are classified as current assets.

1

Classification of Receivables

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If collection is expected beyond one year, these receivables are classified as noncurrent assets and reported under the caption Investments.

1

Classification of Receivables

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Describe the accounting for uncollectible receivables.

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8-11

Companies often sell their receivables to other companies. This transaction is called factoring the receivables, and the buyer of the receivables is called a factor.

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Factoring

8-12

Regardless of how careful a company is in granting credit, some credit sales will be uncollectible. The operating expense account is called bad debt expense, uncollectible accounts expense, or doubtful accounts expense.

2

Uncollectible Receivables

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The direct write off method records bad debt expense only when an account is judged to be worthless. The allowance method records bad debt expense by estimating uncollectible accounts at the end of the accounting period.

Uncollectible Receivables

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8-14

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

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8-15

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

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Uncollectible Receivables

8-16

The amount written off is later collected on November 21.

3

Reinstatement Entry

Receipt of Cash Entry

Uncollectible Receivables

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Example Exercise 8-13

Direct Write-off MethodJournalize the following transactions using the direct write-off method of accounting for uncollectible receivables.

July 9 Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as uncollectible.

Oct. 11 Reinstated the account of Jay Burke and received $3,900 cash in full payment.

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Example Exercise 8-1 (continued)

July 9 Cash………………………………………….. 1,200

Bad Debt Expense………………………..... 3,900

Accounts Receivable—Jay Burke… 5,100

Oct. 11 Accounts Receivable—Jay Burke……….. 3,900

Bad Debt Expense………………........ 3,900

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For Practice: PE 8-1A, PE 8-1B

3

Follow My Example 8-1

11 Cash…………………………………………… 3,900

Accounts Receivable—Jay Burke… 3,900

8-19

Describe the allowance method of accounting for uncollectible receivables.

4

8-19

8-20

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

4

Uncollectible Receivables

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

4

Uncollectible Receivables

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Write-Offs to the Allowance Account

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

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4

8-24

During 2010, ExTone Company writes off $26,750 of uncollectible accounts, including the $6,000 account of John Parker. After posting all entries to write-off uncollectible amounts, Allowance for Doubtful Accounts will have a credit balance of $3,250 ($30,000 – $26,750).

4

Allowance Method Example

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4

Allowance Method Example

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If ExTone Company had written off $32,100 in accounts receivable during 2010, Allowance for Doubtful Accounts would have a debit balance of $2,100.

4

Allowance Method Example

8-27

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

4

Allowance Method Example

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Reinstatement Entry

Receipt of Cash Entry

4

Allowance Method Example

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Example Exercise 8-24

Allowance Method

Journalize the following transactions using the allowance method of accounting for uncollectible receivables.

July 9 Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as uncollectible.

Oct. 11 Reinstated the account of Jay Burke and received $3,900 cash in full payment.

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Example Exercise 8-2 (continued)

July 9 Cash…………………………………………… 1,200

Allowance for Doubtful Accounts……….. 3,900

Accounts Receivable—Jay Burke……. 5,100

11 Cash……………………………………………. 3,900Accounts Receivable—Jay Burke…….. 3,900

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For Practice: PE 8-2A, PE 8-2B

Oct. 11 Accounts Receivable—Jay Burke………... 3,900

Allowance for Doubtful Accounts…….. 3,900

4

Follow My Example 8-2

8-31

Estimating Uncollectibles

2. Analysis of receivables method.

The allowance method uses two ways to estimate the amount debited to Bad Debt Expense.1. Percent of sales method.

4

8-32

Percent of Sales Method

If credit sales for the period are $3,000,000 and it is estimated that ¾% will be uncollectible, Bad Debt Expense is debited for $22,500 ($3,000,000 × .0075). This approach disregards the balance of $3,250 in the allowance account before the adjustment.

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8-33

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

4

Percent of Sales Method

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4

Percent of Sales Method

8-35

Example Exercise 8-3

Percent of Sales MethodAt the end of the current year, Accounts Receivable has a balance of $800,000; Allowance for Doubtful Accounts has a credit balance of $7,500; and net sales for the year total $3,500,000. Bad debt expense is estimated at ½ of 1% of net sales.

Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense; and (c) the net realizable value of accounts receivable.

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4

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4Example Exercise 8-3 (continued)

(a) $17,500 ($3,500,000 × .005)Adjusted Balance

(b) Accounts Receivable…………………. $800,000Allowance for Doubtful Accounts ($7,500 + $17,500)…………………… 25,000Bad Debt Expense……………………... 17,500

(c) $775,000 ($800,000 – $25,000)

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For Practice: PE 8-3A, PE 8-3B

Follow My Example 8-3

8-37

Aging of Receivables

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

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4Aging of Receivables Schedule December 31, 2010

Exhibit 1

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

4

Percent of Sales Method

8-40

ExTone has an unadjusted credit balance of $3,250 in Allowance for Doubtful Accounts. In Exhibit 1 the estimated uncollectible accounts totaled $26,490.

4

Percent of Sales Method

8-41

The amount to be added to the allowance account is $23,240 ($26,490 – $3,250). The adjusting entry is as follows:

4

Percent of Sales Method

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4

Percent of Sales Method

8-43

4

The Commercial Collection Agency Section of the Commercial Law League of America reported the following collection rates by number of months past due:

8-44

Percent of Sales Method

If the unadjusted balance of the allowance account had been a debit balance of $2,100, the amount of the adjustment would have been $28,590.

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Example Exercise 8-44

Analysis of Receivable Method

At the end of the current year, Accounts Receivable has a balance of $800,000; Allowance for Doubtful Accounts has a credit balance of $7,500; and net sales for the year total $3,500,000. Using the aging method, the balance of Allowance for Doubtful Accounts is estimated as $30,000.

Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense, and (c) the net realizable value of accounts receivable.

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4Example Exercise 8-4 (continued)

(a) $22,500 ($30,000 – $7,500)Adjusted Balance

(b) Accounts Receivable…………………. $800,000Allowance for Doubtful Accounts….. 30,000Bad Debt Expense…………………….. 22,500

(c) $770,000 ($800,000 – $30,000)

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For Practice: PE 8-4A, PE 8-4B

Follow My Example 8-4

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4

Differences Between Estimation MethodsExhibit 2

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

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5Comparing Direct Write-Off and Allowance Methods

(continued)

Exhibit 3

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5

Direct Write-Off Method Allowance Method

Comparing Direct Write-Off and Allowance Methods (continued)Exhibit 3

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8-52

Describe the accounting for notes receivable.

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8-53

Characteristics of Notes Receivable

(continued)

• The maker is the party making the promise to pay.

A note receivable, or promissory note, is a written document containing a promise to pay:

• The payee is the party to whom the note is payable.

• The face amount is the amount the note is written for on its face.

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

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Characteristics of Notes Receivable (continued)

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

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

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

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6

Promissory NoteExhibit 4

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What is the due date of a 90-day note dated March 16?

Days in March 31 daysMinus issuance date of note 16Days remaining in March 15 daysAdd days in April 30Add days in May 31Add days in June (due date of

June 14) 14Term of note90 days

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Total days in note 90 daysNumber of days in March 31Issue date of note March 16Remaining days in March –15 days

75 daysNumber of days in April –30 days

45 daysNumber of days in May –31 daysResidual days in June 14 days

Answer: June 14

An Alternate Approach

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8-59

Accounting for Notes Receivable

Received a $6,000, 12%, 30-day note dated November 21, 2010 in settlement of the account of W. A. Bunn Co.

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8-60

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

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Accounting for Notes Receivable

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

6

Accounting for Notes Receivable

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A 90-day, 12% note dated December 1, 2010, is received from Crawford Company to settle its account, which has a balance of $4,000.

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Accounting for Notes Receivable

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

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Accounting for Notes Receivable

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On March 1, 2011, $4,120 is received for the note ($4,000) and interest ($120).

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Accounting for Notes Receivable

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Example Exercise 8-56

Same Day Surgery Center received a 120-day, 6% note for $40,000, dated March 14 from a patient on account.

a. Determine the due date of the note.

b. Determine the maturity value of the note.

c. Journalize the entry to record the receipt of the payment of the note at maturity.

Note Receivable

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6Example Exercise 8-5 (continued)

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For Practice: PE 8-5A, PE 8-5B

a. The due date of the note is July 12, determined as follows:

March 17 days (31 – 14)April 30 daysMay 31 daysJune 30 daysJuly 12 days Total 120 days

b. $40,800 [$40,000 + ($40,000 × 6% × 120/360)]

c. Cash………………………………………........ 40,800Notes Receivable……………………..40,000Interest Revenue……………………...800

Follow My Example 8-5

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Describe the reporting of receivables on the balance sheet.

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

Accounts Receivable Turnover

Net salesAverage Accounts Receivable=

Accounts Receivable Turnover

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Federal Express Corporation—2006

Accounts Receivable

Turnover

$21,296$2,782

=

= 7.7

*[($2,860 + $2,703)/2]

2007 2006 2005

Net sales $22,527 $21,296 --- Accounts receivable 1,429 2,860 $2,703Average accounts receivable 2,145 2,782

*

*

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Accounts Receivable

Turnover

$22,527$2,145

=

= 10.5

*[($1,429 + $2,860)/2]

Net sales $22,527 $21,296 --- Accounts receivable 1,429 2,860 $2,703Average accounts receivable 2,145 2,782

*

*

Federal Express Corporation—2007

2007 2006 2005

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Number of Days’ Sales in Receivables

Average Accounts ReceivableAverage Daily Sales

Number of Days’ Sales in Receivables =

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

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Number of Days’ Sales in

Receivables

$2,78258.3

=

2007 2006

Net sales $22,527$21,296

Average accounts receivable 2,1452,782

Average daily sales 61.758.3

*

*$21,296/365

= 47.7

Federal Express Corporation—2006

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*$22,527/365

*

Net sales $22,527$21,296

Average accounts receivable 2,1452,782

Average daily sales 61.758.3Number of Days’

Sales in Receivables

$2,14561.7

=

= 34.8

Federal Express Corporation—2007

2007 2006

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