ACCOUNTING FOR ACCOUNTING FOR RECEIVABLESRECEIVABLES

Monday, Dec 1 will be Unit 3 Test Monday, Dec 1 will be Unit 3 Test (covering chapter 7 and 8) (covering chapter 7 and 8)

CHAPTERCHAPTER

88

• Two methods of accounting for

uncollectible accounts are:

1. Allowance method

2. Direct write-off method

VALUINGVALUING

ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

VALUINGVALUING

ACCOUNTS RECEIVABLEACCOUNTS RECEIVABLE

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

1. Percentage of sales

2. Percentage of receivables

• Both bases are GAAP; the choice is a management decision.

BASES USED FOR THE BASES USED FOR THE ALLOWANCE METHODALLOWANCE METHODBASES USED FOR THE BASES USED FOR THE ALLOWANCE METHODALLOWANCE METHOD

• Under this approach, you always subtract the beginning balance of the Allowance for DA from the estimated number.

• For example, The CK’s AR is 240,000 and they estimate that 10% will be uncollectible in the future. Then they should muliply 0.1 * 240,000 = 24000 (ending balance must be 24000)

• But they realized that beginning balance of Allowance for DA is 1000 then the difference is 23000.

PERCENTAGE OF PERCENTAGE OF RECEIVABLES BASISRECEIVABLES BASIS

PERCENTAGE OF PERCENTAGE OF RECEIVABLES BASISRECEIVABLES BASIS

ILLUSTRATION ILLUSTRATION 9-49-4 COMPARISON OF BASES OF COMPARISON OF BASES OF

ESTIMATING UNCOLLECTIBLESESTIMATING UNCOLLECTIBLES

ILLUSTRATION ILLUSTRATION 9-49-4 COMPARISON OF BASES OF COMPARISON OF BASES OF

ESTIMATING UNCOLLECTIBLESESTIMATING UNCOLLECTIBLES

Percentage of Sales Percentage of ReceivablesNet Realizable Value

AllowanceAccounts for

Receivable DoubtfulAccounts

Emphasis on Income Statement Relationships

Emphasis on Balance Sheet Relationships

• Companies use various methods for collecting past due accounts including letters, calls, and legal actions.

• Some companies hire collection agency to collect.

• When everything was tried and it still seems impossible to collect then the account should be written off.

• Again, Internal control Purpose : Only manager should authorize write off, otherwise, employees can steal company’s cash.

Collection ProcessCollection ProcessCollection ProcessCollection Process

March 1 Allowance for DA 4500

AR – Kids online 4500

Writing off AR – Kids online

• We do not increase bad debt expense, but we increase ADA account and decrease AR.

Collection ProcessCollection ProcessCollection ProcessCollection Process

NON-BANK CARD SALESNON-BANK CARD SALESNON-BANK CARD SALESNON-BANK CARD SALES

• Sales using American Express and other non-bank cards are reported as credit sales, (=debit AR) not cash sales.

• Conversion into cash does not occur until American Express remits the net amount to the seller.

NON-BANK CARD SALESNON-BANK CARD SALESNON-BANK CARD SALESNON-BANK CARD SALES

Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent.

Kerr Music Co. accepts an AMERICAN EXPRESS card for a $500 sale. The service fee that AMERICAN EXPRESS charges is 5 percent.

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

July 31 Accounts ReceivableCredit Card Expense ($500 x 5%) Sales To record American Express credit card sales.

475 25 500

• A promissory note is a written promise to pay a specified amount of money on demand (or at a definite time.)

• Promissory note is used

1. When individuals (or companies) lend or borrow money.

2. When the amount of the transaction and the credit period are long term or

3. In settlement of accounts receivable

NOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLE

• The party making the promise is the maker.(=borrower)

• The party to whom payment is made is called the payee. (=lender)

– The same promissory note is a note payable for maker and it is a note receivable for the payee.

NOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLE

• The promissory note gives these details:1. Name of the maker and payee

2. Amount of the loan

3. Loan period (such as 1 year or 5 years)

4. Interest rate (such as 8%)

5. How interest will be paid = Whether interest is repayable monthly or fully paid at maturity along with the principal

6. Whether any security is pledged as collateral for the loan and what happens if the maker defaults.

NOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLENOTES RECEIVABLE

• AR is informal promise to pay, whereas NR is more formal written promise.

• The lender has stronger legal claim under NR.

• NR is a negotiable instrument, which means it can be sold or transferred to another person or company by endorsement.

• AR results from a credit sale transaction whereas NR results from financing a purchase (such as when buying a car), lending money, or extending AR for a longer period.

Difference between NOTES Difference between NOTES RECEIVABLE and ARRECEIVABLE and AR

Difference between NOTES Difference between NOTES RECEIVABLE and ARRECEIVABLE and AR

• AR is usually due in a short period of time (e.g. 30 days) while a note can extend for longer periods of time.

• AR does not normally incur interest expense (unless the account is overdue.)

• A NR usually bears interest for the entire period.

Difference between NOTES Difference between NOTES RECEIVABLE and ARRECEIVABLE and AR

Difference between NOTES Difference between NOTES RECEIVABLE and ARRECEIVABLE and AR

• Both are credit instruments.

• Both are valued at their net realizable values.

• Both can be sold to another party.

• The basic issues in accounting for notes receivable are the same as those for AR as follows:

1. Recognizing NR

2. Disposing NR

Similarities of NOTES Similarities of NOTES RECEIVABLE and ARRECEIVABLE and ARSimilarities of NOTES Similarities of NOTES RECEIVABLE and ARRECEIVABLE and AR

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.

For example 1000 * 0.06 * 6/12 = 30$ for 6 months

ILLUSTRATION ILLUSTRATION 9-89-8 FORMULA FOR FORMULA FOR

CCALCULATALCULATING INTERESTING INTEREST

ILLUSTRATION ILLUSTRATION 9-89-8 FORMULA FOR FORMULA FOR

CCALCULATALCULATING INTERESTING INTEREST

Face Valueof Note

Annual Interest

Rate

Loan Periodin Terms of

One Year

InterestX X =

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

May 1 Notes Receivable Accounts Receivable — Brent Company To record acceptance of Brent Company note.

RECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLE

Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. (Brant bought merchandise on account on March 15. Brant did not pay in 30 days, but they will pay in the future. )

Wilma Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company to settle an open account. (Brant bought merchandise on account on March 15. Brant did not pay in 30 days, but they will pay in the future. )

1,000 1,000

HONOUR OF NOTES RECEIVABLEHONOUR OF NOTES RECEIVABLEHONOUR OF NOTES RECEIVABLEHONOUR OF NOTES RECEIVABLE

• A 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.

• A 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.

Date Account Title and Explanation Debit CreditSept. 30 Cash 10,150

Notes Receivable - Higly 10,000 Interest Revenue 150

To record collection of Higly note.

GENERAL JOURNAL

Adjusting Entry on July 31Adjusting Entry on July 31Adjusting Entry on July 31Adjusting Entry on July 31

• If the year end was July 31, and the note receivable from previous example was still outstanding, then they should make the following adjusting entry to honor matching principle.

• Two months have passed from the issue date, so we must recognize two months of accrued interest.

• 0.045 * 2/12 * 10,000 = 75

July 31 Interest Receivable 75Interest Revenue 75

Sep 30 Cash 10150Interest Receivable 75Notes Receivable 10000Interest Revenue 75

• Like accounts receivable, short-term notes receivable are reported at their net realizable value. (you must estimate how much of it will actually be collected)

• The notes receivable allowance account is Allowance for Doubtful Notes. (or ADN, which is same as ADA)

• Use bad debt expense and ADN to write off.

VALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLEVALUING NOTES RECEIVABLE

Classwork / HomeworkClasswork / HomeworkClasswork / HomeworkClasswork / Homework

• P438 E8.7, E8.8• P443 P8.8

DISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLEDISHONOUR OF NOTES RECEIVABLE

• A 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 or ADA

• A 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 or ADA

Date Account Title and Explanation Debit CreditSept. 30 Accounts Receivable - Higly 10,150

Notes Receivable - Higly 10,000 Interest Revenue 150

To record the dishonour of Higly note.

GENERAL JOURNAL

GENERAL JOURNALDate Account Titles and Explanation Debit Credit

May 1 Cash

Accounts Receivable — Brent Company

To record acceptance of Brent

Company note.

RECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLERECOGNIZING NOTES RECEIVABLE

•If a note is made to get cash, then the entry is a debit to Notes Receivable and credit to Cash. (For borrower)

•Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company.

•Interest will be recorded later when it is paid.

•If a note is made to get cash, then the entry is a debit to Notes Receivable and credit to Cash. (For borrower)

•Company receives a $1,000, 6% promissory note, due in two months (July 31) from Brent Company.

•Interest will be recorded later when it is paid.

1,000 1,000