Classification of Receivables

• Accounts Receivable
Such accounts receivable are normally collected within a short period, such as 30 or 60 days.
They are classified on the balance sheet as a current asset.
• Notes Receivable
Notes receivable are amounts that customers owe for which a formal, written instrument of
credit has been issued. Notes are often used for credit periods of more than 60 days.
• Other Receivables
Other receivables include interest receivable, taxes receivable, and receivables from officers or
employees. If collection is expected beyond one year, they are classified as noncurrent assets
and reported under the caption Investments.
Uncollectible Receivables
• A major issue that has not yet been discussed is that some customers will not pay their
accounts. That is, some accounts receivable will be uncollectible. The operating expense
recorded from uncollectible receivables is called bad debt expense, uncollectible accounts
expense, or doubtful accounts expense.
• The two methods of accounting for uncollectible receivables are as follows:
• The direct write-off method records bad debt expense only when an account is determined to
be worthless.
• The allowance method records bad debt expense by estimating uncollectible accounts at the
end of the accounting period.
Direct Write-Off Method for Uncollectible Accounts
Under the direct write-off method, Bad Debt Expense is not recorded until the customer’s account is
determined to be worthless. To illustrate, assume that on May 10, a $4,200 account receivable from D.
L. Ross has been determined to be uncollectible.

An account receivable that has been written off may be collected later. In such cases, the account is
reinstated by an entry that reverses the write-off entry. The cash received in payment is then recorded
as a receipt on account.

Allowance Method for Uncollectible Accounts

The allowance method estimates the uncollectible accounts receivable at the end of the accounting
period. Based on this estimate, Bad Debt Expense is recorded by an adjusting entry.
To illustrate, assume that ExTone Company began operations on August 1. As of the end of its
accounting period on December 31, 20Y7, ExTone has outstanding accounts receivable of $200,000. This
balance includes some past due accounts. Based on industry averages, ExTone estimates that $30,000 of
the December 31 accounts receivable will be uncollectible. However, on December 31, ExTone doesn’t
know which customer accounts will be uncollectible. Thus, specific customer accounts cannot be
decreased or credited. Instead, a contra asset account, Allowance for Doubtful Accounts, is credited
for the estimated bad debts.

The preceding adjusting entry affects the income statement and balance sheet. This amount, $170,000
($200,000 – $30,000), is called the net realizable value of the receivables.
After the preceding adjusting entry is recorded, Accounts Receivable still has a debit balance of
$200,000. This balance is the total amount owed by customers on account on December 31 as
supported by the accounts receivable subsidiary ledger.

Write-Offs to the Allowance Account

When a customer’s account is identified as uncollectible, it is written off against the allowance account.
This requires the company to remove the specific accounts receivable and an equal amount from the
allowance account.

To illustrate, assume that during 20Y8 ExTone Company writes off $26,750 of uncollectible accounts,
including the $6,000 account of John Parker recorded on January 21. Allowance for Doubtful Accounts
will have a credit balance of $3,250 ($30,000 – $26,750), computed as follows:

If ExTone had written off $32,100 in accounts receivable during 20Y8, Allowance for Doubtful Accounts
would have had a debit balance of $2,100, computed as follows:

After the end-of-period adjusting entry is recorded, Allowance for Doubtful Accounts should always
have a credit balance.
An account receivable that has been written off against the allowance account may be collected later.
Estimating Uncollectibles
• Percent of Sales Method
To illustrate, assume the following data for ExTone Company on December 31, 20Y8, before any
adjustments:

Bad Debt Expense of $22,500 is estimated as follows

The adjusting entry for uncollectible accounts:

After the adjusting entry is posted to the ledger, Bad Debt Expense will have an adjusted
balance of $22,500. Allowance for Doubtful Accounts will have an adjusted balance of $25,750
($3,250 + $22,500). Both T accounts follow:

Under the percent of sales method, the amount of the adjusting entry is the amount estimated
for Bad Debt Expense.
• Analysis of Receivables Method
is based on the assumption that the longer an account receivable is outstanding, the less likely it
will be collected. The analysis of receivables method is applied as follows:
To illustrate, assume that ExTone Company uses the analysis of receivables method instead of the
percent of sales method. ExTone prepared an aging schedule for its accounts receivable of $240,000 as
of December 31, 20Y8:

Comparing the estimate of $26,490 with the unadjusted balance of the allowance account determines
the amount of the adjustment for Bad Debt Expense. For ExTone, the unadjusted balance of the
allowance account is a credit balance of $3,250. The amount to be added to this balance is therefore
$23,240 ($26,490 – $3,250). The adjusting entry is as follows:

After the preceding adjusting entry is posted to the ledger, Bad Debt Expense will have an adjusted
balance of $23,240. Allowance for Doubtful Accounts will have an adjusted balance of $26,490, and the
net realizable value of the receivables is $213,510 ($240,000 – $26,490). Both T accounts follow:

The T accounts appear as follows:

Comparing Estimation Methods
Under the percent of sales method, Bad Debt Expense is the focus of the estimation process. Allowance
for Doubtful Accounts is then credited for this amount.
Under the analysis of receivables method, Allowance for Doubtful Accounts is the focus of the
estimation process. Bad Debt Expense is then debited for this amount.
Comparing Direct Write-Off and Allowance Methods
Using the direct write-off method, there is no adjusting entry on December 31 for uncollectible
accounts. In contrast, the allowance method records an adjusting entry for estimated uncollectible
accounts of $42,500.

Notes Receivable
Characteristics of a promissory note are as follows:
1. The maker is the party making the promise to pay.
2. The payee is the party to whom the note is payable.
3. The face amount is the amount for which the note is written on its face.
4. The issuance date is the date a note is issued.
5. The due date or maturity date is the date the note is to be paid.
6. The term of a note is the amount of time between the issuance and due dates.
7. The interest rate is that rate of interest that must be paid on the face amount for the term of the
note.
Accounting for Notes Receivable
A promissory note may be received by a company from a customer to replace an account receivable.
To illustrate, assume that a company accepts a 30-day, 12% note dated November 21, 20Y1, in
settlement of the account of W. A. Bunn Co., which is past due and has a balance of $6,000. The
company records the receipt of the note as follows:

At the due date, the company records the receipt of $6,060 ($6,000 face amount plus $60 interest) as
follows:

If the maker of a note fails to pay the note on the due date, the note is a dishonored note receivable. A
company that holds a dishonored note transfers the face amount of the note plus any interest due back
to an accounts receivable account.

The company has earned the interest of $60, even though the note is dishonored. If the account
receivable is uncollectible, the company will write off $6,060 against Allowance for Doubtful Accounts.

A company receiving a note should record an adjusting entry for any accrued interest at the end of the
period.
Reporting Receivables on the Balance Sheet
All receivables that are expected to be realized in cash within a year are reported in the Current assets
section of the balance sheet.