Training, Teaching and Learning Materials

NEFAS SILK POLY TECHNIC COLLEGE

ACCOUNTS AND BUDGET SUPPORT LEVEL III

Unit of CompetenceMonitor and Control Accounts Receivable

Module TitleMonitoring and Controlling Accounts Receivable
LG Code: BUF ACB3 09 0921
TTLM Code: BUF ACB3M 09 0921

Learning Guide

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INTRODUCTION

Welcome to the module “Monitor and Control Accounts Receivable”. This learner’s
guide was prepared to help you achieve the required competence in “Accounts and Budget
Support Level III”. This will be the source of information for you to acquire knowledge
attitude and skills in this particular occupation with minimum supervision or help from your
trainer.

Summary of Learning Outcomes

After completing this learning guide, you should be able to:

Lo1:- Collect and record monies due
Lo2:- Review compliance with terms and conditions
Lo3:- Resolve disputed amounts within predetermined parameters

How to Use this TTLM

o Read through the Learning Guide carefully. It is divided into sections that cover
all the knowledge, skills and attitude that you need.
o Read Information Sheets and complete the Self-Check at the end of each section
to check your progress
o Read and make sure to Practice the activities in the Operation Sheets. Ask your
trainer to show you the correct way to do things or talk to more experienced
person for guidance.
o When you are ready, ask your trainer for institutional assessment and provide you
with feedback from your performance.

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Lo1:- Collect and record monies due

Information Sheet: 1Identify the Different Types of Receivables

 The term receivables refer to amounts due from individuals and companies.

 Receivables are claims that are expected to be collected in cash.

 Receivables represent one of a company’s most liquid assets.

 Receivables are frequently classified as:

 Accounts receivable:
 Are amounts owed by customers on account.
 Result from the sale of goods and services (often called trade receivables).
 Are expected to be collected within 30 to 60 days.
 Are usually the most significant type of claim held by a company.
 Notes receivable:
 Represent claims for which formal instruments of credit are issued as evidence of
debt.
 Are credit instruments that normally require payment of interest and extend for time
periods of 60-90 days or longer.
 May result from sale of goods and services (often called trade receivables).
 Other receivables:
 Nontrade receivables including interest receivable, loans to company officers,
advances to employees, and income taxes refundable.
 Generally classified and reported as separate items in the balance sheet.

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Information Sheet: 1Explain how Accounts Receivable are Recognized in the Accounts

Two accounting problems associated with accounts receivable are:

1. Recognizing accounts receivable
2. Valuing accounts receivable

Recognizing accounts receivable

 Service organizations -- A receivable is recorded when service is provided on account.
 Debit accounts receivable and credit service revenue

 Merchandisers – A receivable is recorded at the point of sale of merchandise on account.

 Debit accounts receivable and credit sales

 Receivable may be reduced by sales discount and/or sales return

Information Sheet: 3 - Describe the Methods Used to Account for Bad Debts

Valuing accounts receivable

 Determining the amount of accounts receivable to report is difficult because some
receivables will become uncollectible.
 This creates bad debt expense – a normal and necessary risk of doing business on
credit.

Two methods are used in accounting for uncollectible accounts:

1. Direct Write-off Method
2. Allowance Method

 Direct Write-Off Method

 When a specific account is determined to be uncollectible, the loss is charged to Bad
Debt Expense.
 For example, assume that Warden Co. writes off M. E. Doran’s $200 balance as
uncollectible on December 12. The entry is:

Dec. 12 Bad Debts Expense 200

Accounts Receivable--M. E. Doran200
(To record write-off of M. E. Doran account)

 Bad debts expense will show only actual losses from uncollectibles.
 Bad debts expense is often recorded in a period different from that in which the revenue
was recorded.

 Under this method, no attempt is made to:

(1) show accounts receivable in the balance sheet at the amount actually expected
to be received; and
(2) Match bad debts expenses to sales revenue in the income statement.

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 Use of the direct write-off method can reduce the usefulness of both the income statement
and balance sheet.
 Unless bad debt losses are insignificant, the direct write-off method is not acceptable for
financial reporting purposes.

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Lo2:- Review compliance with terms and conditions

Information SheetAllowance Method

 The allowance method of accounting for bad debts involves estimating uncollectible
accounts at the end of each period.
 It provides better matching of expenses and revenues on the income statement and
ensures that receivables are stated at their cash (net) realizable value on the balance
sheet.
 Cash (net) realizable value is the net amount of cash expected to be received. It
excludes amounts that the company estimates it will not collect.
 Receivables are therefore reduced by estimated uncollectible amounts on the balance
sheet through use of the allowance method.
 The allowance method is required for financial reporting purposes when bad debts are
material.
 Three essential features of the allowance method are:
1. Uncollectible accounts receivable are estimated and matched against revenues in
the same accounting period in which the revenues occurred.
2. Estimated uncollectibles are recorded as an increase to Bad Debts Expense and an
increase to Allowance for Doubtful Accounts (a contra asset account) through an
adjusting entry at the end of each period.
3. Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited
to Accounts Receivable at the time the specific account is written off as
uncollectible.

Recording Estimated Uncollectibles

 Allowance for Doubtful Accounts shows the estimated amount of claims on customers
that are expected to become uncollectible in the future.
 The credit balance in the allowance account will absorb the specific write-offs when they
occur.
 Allowance for Doubtful Accounts is not closed at the end of the fiscal year.
 Bad Debts Expense is reported in the income statement as an operating expense (usually
a selling expense).

Recording the Write-Off

 Each write-off should be approved in writing by authorized management personnel.

 Under the allowance method, every bad debt write-off is debited to the allowance account
(not to Bad Debt Expense) and credited to the appropriate Account Receivable.
 A write-off affects only balance sheet accounts. Cash realizable value in the balance
sheet, therefore, remains the same.

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Recovery of an Uncollectible

 When a customer pays after the account has been written off, two entries are required:
(1) The entry made in writing off the account is reversed to reinstate the customer’s
account.
(2) The collection is journalized in the usual manner.
 The recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet
account.

In “real life,” companies must estimate the amount of expected uncollectible accounts if they
use the allowance method.
 Frequently the allowance is estimated as a percentage of the receivables.
 Management establishes a percentage relationship between the amount of receivables
and expected losses from uncollectible accounts.
 A schedule is prepared in which customer balances are classified by the length of
time they have been unpaid.
 Because of its emphasis on time, this schedule is often called an aging schedule and
the analysis of it is often called aging the accounts receivable.
 After the accounts are arranged by age, the expected bad debt losses are determined
by applying percentages, based on past experience, to the totals of each category.
 The estimated bad debts represent the existing customer claims expected to become
uncollectible in the future.
 This amount represents the required balance in Allowance for Doubtful Accounts at
the balance sheet date.
 Accordingly, the amount of the bad debts adjusting entry is the difference between
the required balance and the existing balance in the allowance account.
 Occasionally the allowance account will have a debit balance prior to adjustment
because write-offs during the year have exceeded previous provisions for bad debts.
 In such a case, the debit balance is added to the required balance when the
adjusting entry is made.

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Information Sheet2 - Compute the Interest on Notes Receivable

 A promissory note is a written promise to pay a specified amount of money on demand or at

a definite time.
 In a promissory note, the party making the promise to pay is called the maker.
 The party to whom payment is to be made is called the payee. The payee may be
specifically identified by name or may be designated simply as the bearer of the note.
 Notes receivable
 give the holder a stronger legal claim to assets than accounts receivable.
 are frequently accepted from customers who need to extend the payment of an
outstanding account receivable, and they are often required from high-risk
customers.
 notes receivable, like accounts receivable, can be readily sold to another party.
Promissory notes are negotiable instruments.
 There are three basic issues in accounting for notes receivable:
1. Recognizing notes receivable.
2. Valuing notes receivable.
3. Disposing of notes receivable.

Computing Interest

 The formula for computing interest is:

Face Value of Note (principle) x Annual Interest Rate x Time (in terms of one year)

 The interest rate specified on the note is an annual rate of interest. The time factor in the
computation expresses the fraction of a year that the note is outstanding.

When the maturity date is stated in days, the time factor is frequently the number of days divided
by 360. For example, the maturity date of a 60-day note dated July 17 is determined as follows:

Term of note 60 days

Days in July 31
Date of note 17
Note’s days in July 14

Days in August 31
Plus note’s days in July 14
Notes days to the end of August 45 45
Maturity date, September 15

 When the due date is stated in terms of months, the time factor is the number of months
divided by 12.

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Lo3:- Resolve disputed amounts within predetermined parameters

Information Sheet:-Recognizing Notes Receivable

 To illustrate the basic entry for notes receivable, the text uses Brent Company’s $1,000, two-
month, 8% promissory note dated May 1. Assume that the note was written to settle an open
account. The entry for the receipt of the note by Wilma Company is as follows:

May 1 Notes Receivable 1,000

Accounts Receivable—Brent Company 1,000
(To record acceptance of Brent Company note)

 The note receivable is recorded at its face value, the value shown on the face of the note.

 No interest revenue is reported when the note is accepted because the revenue recognition
principle does not recognize revenue until earned. Interest is earned (accrued) as time passes.

 If a note is exchanged for cash, the entry is a debit to Notes Receivable and a credit to Cash
in the amount of the note.
Valuing Notes Receivable

 Like accounts receivable, short-term notes receivable are reported at their cash (net)
realizable value.
 The notes receivable allowance account is Allowance for Doubtful Accounts.
 The computations and estimations are similar to the ones related to accounts receivable.

Information Sheet5 - Describe the Entries to Record the Disposition of Notes Receivable

 Notes may be held to their maturity date, at which time the face value plus accrued interest is
due.

 In some situations, the maker of the note defaults, and appropriate adjustment must be made.

 A note is honored when it is paid in full at maturity.

 A dishonored note is a note that is not paid in full at maturity.

 If the lender expects that it will eventually be able to collect, the Notes Receivable account is
transferred to an Account Receivable for both the face value of the note and the interest due.

 If there is no hope of collection, the face value of the note should be written off.

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Information Sheet6 - Explain the Statement Presentation of Receivables

 Each of the major types of receivables should be identified in the balance sheet or in the
notes to the financial statements.

 Short-term receivables are reported in the current asset section of the balance sheet below
short-term investments. These assets are nearer to cash and are thus more liquid.

 Both the gross amount of receivables and the allowance for doubtful accounts should be
reported.

 Notes receivable are listed before accounts receivable because notes are more easily
converted to cash.

 Bad Debts Expense is reported under “Selling expenses” in the operating expense section
of the income statement.

 Interest Revenue is shown under “Other Revenues and Gains” in the nonoperating section
of the income statement.

 If a company has significant risk of uncollectible accounts or other problems with

receivables, it is required to discuss this possibility in the notes to the financial
statements.

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Information Sheet7 - Describe the Principles of Sound Accounts Receivable Management

 Managing accounts receivable involves five steps:

1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
4. Evaluate the receivables balance.
5. Accelerate cash receipts from receivables when necessary.

 Determine to whom to extend credit.

1. Risky customers might be required to provide letters of credit or bank guarantees.
2. Particularly risky customers might be required to pay cash on delivery.
3. Ask potential customers for references from banks and suppliers and check the
references.
4. Periodically check financial health of continuing customers.

 Establish a payment period.

1. Determine a required payment period and communicate that policy to customers.
2. Make sure company's payment period is consistent with that of competitors.

 Monitor collections.
1. Prepare accounts receivable aging schedule at least monthly.
2. Pursue problem accounts with phone calls, letters, and legal action if necessary.
3. Make special arrangements for problem accounts.

4. If a company has significant concentrations of credit risk, it is required to discuss this risk
in the notes to its financial statements.

5. A concentration of credit risk is a threat of nonpayment from a single customer or class

of customers that could adversely affect the financial health of the company.

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Information Sheet8 - Identify Ratios to Analyze a Company's Receivables

 Liquidity is measured by how quickly certain assets can be converted into cash. The ratio
used to assess the liquidity of the receivables is the receivables turnover ratio.

 The ratio measures the number of times, on average, receivables are collected during the
period.

 The receivables turnover ratio is computed by dividing net credit sales (net sales less cash
sales) by the average net accounts receivables during the year.

 A popular variant of the receivables turnover ratio is to convert it into an average collection
period in terms of days. This is computed by dividing the receivables turnover ratio into 365
days.
 The general rule is that the average collection period should not greatly exceed the
credit term period (i.e., the time allowed for payment).

In some cases, receivables turnover may be misleading. Therefore, it is important to know how a
company manages its receivables.

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Information Sheet9 - Describe Methods to Accelerate the Receipt of Cash from Receivables

 Two common expressions apply to the collection of receivables:

1. Time is money—that is, waiting for the normal collection process costs money.
2. A bird in the hand is worth two in the bush—that is, getting the cash now is better than
getting it later or not at all.

 There are three reasons for the sale of receivables.

1. The size of the receivables may cause a company to sell them because it may not want to
hold such a large amount of receivables . In recent years, for competitive reasons, sellers
(retailers, wholesalers, and manufacturers) often have provided financing to purchasers of
their goods. The purpose is to encourage the sale of the company’s product by assuring
financing to buyers.
2. Receivables may be sold because they may be the only reasonable source of cash.When
credit is tight, companies may not be able to borrow money in the usual credit markets or
the cost of borrowing may be prohibitive.
3. A final reason for selling receivables is that billing and collection are often time-
consuming and costly. As a result, it is often easier for a retailer to sell the receivables
to another party that has expertise in billing and collection matters.

National credit card sales:

 Approximately one billion credit cards are recently in use. A common type of credit card is a
national credit card such as Visa and MasterCard.

 Three parties are involved when national credit cards are used in making retail sales: (1) the
credit card issuer, who is independent of the retailer, (2) the retailer, and (3) the customer.

 A retailer’s acceptance of a national credit card is another form of selling—factoring—

the receivable by the retailer.

There are several advantages of credit cards for the retailer:

1. Issuer does credit investigation of customer.
2. Issuer maintains customer accounts.
3. Issuer undertakes collection process and absorbs any losses.
4. Retailer receives cash more quickly from credit card issuer.

 In exchange for these advantages, the retailer pays the credit card issuer a fee of 2%
to 4% of the invoice price for its services.

 Sales resulting from the use of national credit cards are considered cash sales by the retailer.
Upon receipt of credit card sales slips from a retailer, the bank that issued the card
immediately adds the amount to the seller’s bank balance.

 To illustrate, Morgan Marie purchases $1,000 of compact discs for her restaurant from
Sondgeroth Music Co., and she charges this amount on her Visa First Bank Card. The

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service fee that First Bank charges Sondgeroth Music is 3 percent. The entry by Sondgeroth
Music to record this transaction is:

Cash 970
Service Charge Expense 30
Sales 1,000
(To record Visa credit card sales)

Sale of receivables to a factor:

 A common way to accelerate receivables collection is a sale to a factor. A factor is a finance
company or a bank that buys receivables from businesses for a fee and then collects the
payments directly from the customers.

 Factoring arrangements vary widely, but typically the factor charges a commission of 1% to
3% of the amount of receivables purchased.

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Check List

 Define receivables. What are the different types of receivables? Why is it necessary to have
them in different categories?

 Explain how accounts receivable are recognized in the accounts. How are accounts
receivable valued on the balance sheet?

 What are the two methods used to account for bad debts? Which method is required by
GAAP if bad debts are material? How is bad debt estimated when using the allowance
method? Prepare journal entries for each method. How is an aging schedule prepared? How
is it used?

 What is a promissory note? What is the formula for computing interest on notes receivable?
Discuss the three issues involved in accounting for notes receivable. Prepare journal entries
for note transactions.

 Describe the entries to record the disposition of notes receivable. Prepare the journal entries
for a dishonored note.

 Explain the statement presentation of receivables.

 Describe the principles of sound accounts receivable management. What are the five steps in
managing accounts receivable?

 Identify and compute ratios to analyze a company's receivables. Explain what the ratios
measure and what they tell users of financial statements.

 What methods are used to accelerate the receipt of cash from receivables? Why do
companies pay fees for this service. Prepare journal entries for credit card sales.

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TTLM Development Manual Date: SEPTEMBER ,2021