RECEIVABLES

LEARNING OBJECTIVES
1. In this lesson you will be able to account for receivables and short term investments
and you will be able to:
2. Distinguish between trade and non-trade receivables.
3. Distinguish between the direct write off and allowance methods.
4. Prepare entries for uncollectible accounts using the direct write off and allowance
methods.
5. Differentiate between the income statement and balance sheet approaches to
estimating bad debts.
6. Prepare entries used by a retailer to account for credit card sales.
7. Accounts for notes receivable with interest and non-interest bearing notes.
The term trade receivables refers to any receivable generated by selling a product
or providing a service to a customer.

Trade receivables can be accounts or notes receivable. A non-trade receivable

would be when someone owes the company money not related to providing a
service or selling a product.
Examples of receivables

 Account receivable –
 Notes receivable
 Loans receivable
 Advances
 Accrued income
 Deposits
 Claims receivables
 The term trade receivables refers to any receivable generated by
selling a product or providing a service to a customer. Trade receivables
can be accounts or notes receivable.
 A non-trade receivable would be when someone owes the company
money not related to providing a service or selling a product. For
example, the company loans an employee money for a travel advance or
a company borrows money from another company.
 When a company sells goods on account, customers do not sign formal,
written promises to pay, but they agree to abide by the company’s
customary credit terms. However, customers may sign a sales invoice to
acknowledge purchase of goods.
 Payment terms for sales on account typically run from 30 to 60 days.
Companies usually do not charge interest on amounts owed, except on
some past-due amounts.
 Companies will establish a subsidiary (think of as secondary or detail)
ledger for accounts receivable to keep up with what is owed by each
customer.
 The total amount owed according to the subsidiary ledger should always
match the balance in the accounts receivable account.
Notes receivable
 A note (also called a promissory note) is an unconditional written
promise by a borrower to pay a definite sum of money to the
lender (payee) on demand or on a specific date and usually include a
required interest amount. A customer may give a note to a business for
an amount due on an account receivable or for the sale of a large item
such as a refrigerator. Companies also have non-trade note receivables
if they loan money to non-customers.

 Companies usually do not establish a subsidiary ledger for notes.

Instead, they maintain a file of the actual notes receivable and copies of
notes payable.
Receivables –
 Why they are important At this point, we begin to study financial accounting
topics not covered in Accounting 100. This chapter will be challenging because all
material is new. Therefore, make certain to devote the proper amount of time to
the course material.

 A receivable is an amount due from another party. Receivables are usually one of
the largest current assets on a company’s books. The control and analysis of this
asset is very important, because receivables are usually the biggest source of a
company’s cash flow. What happens when your cash flow at home is reduced? You
have trouble paying your bills, leading to financial hardship. Companies face this
same issue. The proper control over accounts receivables is very important.
Common types of receivables
Accounts Receivable. Accounts Receivable are the most common kind of receivable.
Accounts Receivable are amounts due from customers from the sale of services or
merchandise on credit. They are usually due in 30 – 60 days. They are classified on
the Balance Sheet as current assets. Notes Receivable.
Notes Receivable can arise when the seller asks for a promissory note to replace an
Accounts Receivable when the customer requests additional time to pay a past-due
account.
A promissory note is a written promise to pay a specific amount of money, usually
including interest, at a future date. If the note is due within a year it is classified as
a current asset. If the note is due after one year, it is classified as a long-term asset.
Other Receivables. Examples of other receivables are income tax refunds, interest
receivable, or receivables from employees. These are not covered in this chapter.
Uncollectible Accounts Receivable

 In order to help minimize credit losses, a company needs to be very careful

and prudent in extending credit. References and credit scores should be
checked and credit worthiness needs to be established before credit is
granted.

 Once a receivable becomes past due, companies need to put forth great
efforts to collect it. The older a receivable gets, the less likely the chance of
collection.
A business will usually have some customers that will not pay their debts. GAAP
requires that a company estimate the amount of uncollectable receivables at the
end of the accounting period and record that amount as Bad Debt Expense.

The Bad Debt Expense is recorded in the same year as the sale, complying with the
matching principle.
As previously mentioned, there will always be customers that don’t pay. This could
be due to a dispute over the amount owed, or due to cash flow problems
experienced by the customer.
The amount estimated as uncollectible will be debited to a new operating expense
called Bad Debts Expense.

The Bad Debts Expense will be recorded in an adjusting entry that debits Bad Debts
Expense and credits Allowance for Doubtful Accounts.
The Allowance Method

 The Allowance for Doubtful Accounts is a contra asset account with a normal
credit balance. It will offset the Accounts Receivable balance. The
presentation of Accounts Receivable and the Allowance for Doubtful Accounts
on the balance sheet is often reported as follows.

The 99,000 shown above is called the “realizable value” and estimates what the
company can realistically expect to collect from their account receivables.
 GAAP mandates that we use the Allowance Method of estimating uncollectible
accounts receivable. (The Direct Write Off method is used by some smaller
companies, because it is needed for tax purposes; it is not acceptable under
GAAP.) Most companies estimate their uncollectible accounts receivable using one
of three approaches:
 1. The percent of sales method
 2. The percent of receivables method
 3. The aging of receivables method
1. The percent of sales method.

The method chosen will determine the calculation. We will practice these methods of
determining the adjustment for bad debts expense extensively in class. These
methods are summarized below.

Under this method, the amount of the adjustment is calculated by multiplying a

historical percent of bad debts by the current year’s net credit sales. Although
acceptable, this method is not as accurate as the either the percentage of
receivables method or the aging of receivables method.
2. The percent of receivables method.

 The percent of receivables method assumes a given percent of a company’s

receivables is uncollectible.
 The desired amount of the Allowance for Doubtful Accounts is calculated by
multiplying Accounts Receivable by this percent. The Allowance for Doubtful
Accounts is this adjusted so that it equals this desired amount
Example:

 The balance of Accounts Receivable is 100,000, and it is estimated that 5% of

accounts are uncollectible. The balance of the Allowance for Doubtful
Accounts, before adjustment, is 2,000 (credit). The desired balance of the
Allowance for Doubtful Accounts would be 5,000 (100,000 * 5%). Since the
balance of the Allowance for Doubtful Accounts is now only 2,000, a 3,000
adjustment is required, as follows.

Bad Debts Expense 3,000

Allowance for Doubtful Accounts 3,000
3. The aging of receivables method.

Most companies have an aging of customers’ accounts receivable. In this aging

report, each customer balance is classified by how long it is past due. Based on this
aging, experience is used to estimate the percent of each aging total. Older past
due receivables will be more likely uncollectible.
Once the total uncollectible amount is estimated, an adjusting entry is made to
increase the Allowance for Doubtful Accounts so that its balance equals the
uncollectible estimate calculated by using the aging report.
 Example: A company had net sales of 1,000,000. It is estimated that
one percent of net sales are uncollectible.
 The amount of the adjusting entry is 10,000 (1% * 1,000,000). The
adjusting entry recorded at the end of the accounting period is

Bad Debts Expense 10,000

Allowance for Doubtful Accounts 10,000
Writing off a Bad Debt
Strict internal control procedures should be used when writing off an account
that is no longer deemed collectible. We will discuss these in class.
For example, the entry to write off the 500 balance owed by Mahoney
Company is

Allowance for Doubtful Accounts 500

Accounts Receivable-Mahoney Company 500

Note that Bad Debts Expense is not used to record the write off. This is because Bad
Debts Expense was debited in the adjusting entry to estimate bad debts. If Bad Debts
Expense was debited in the entry to write off a bad debt, Bad Debts Expense would be
counted twice.
Collection of a bad debt previously written off

 If a company collects an accounts receivable balance previously written off, two

entries are required. The first entry reverses the write off. The second entry
records the cash receipt on account.
 For example, assume Lee Company pays its 350 account previously written off,
the following entries would be recorded.

Accounts Receivable-Lee Company 350

Allowance for Doubtful Accounts 350

Cash 350
Accounts Receivable-Lee Company 350
Notes Receivable
 Notes Receivable can arise when the seller asks for a promissory note to
replace an Accounts Receivable when the customer requests additional time to
pay a past-due account. A promissory note is a written promise to pay a
specific amount of money, usually including interest, at a future date. The
journal entries required are:

Converting an accounts receivable to a note receivable

Recording an adjusting entry for interest receivable at the end of the
accounting period
Recording receipt of note payment and interest when due
Recording a dishonored note
Computing Maturity Date and Interest

 The maturity date is the date repayment of the note is due. The interest
charged to the issuer of the note is a cost of borrowing money for the borrower.
We should learn to calculate both.
For example, assume a 1,000, 6%, 90-day note was issued on
July 15. The maturity date would be October 13, as follows:

July (31 days in July minus 15, the date of the note) 16
August 31
September 30
October 13
Period of the note, in days 90

To compute interest, multiply the principal of the note by its interest rate and the time factor.

For example, the interest due on the note receivable above is 15, calculated as follows:
1,000 * 6% * 90/360 = 15
Recognizing Notes Receivable and Settling Notes
Receivable
 A seller can accept a note from a customer to grant a time extension on a
past-due receivable.

As an example, assume Globulomer accepted 100 in cash along with a 900, 30-
day, 12% note from Chef Enterprises on July 5 to settle their 1,000 past-due
account. Globulomer would make the following entry.
July 5 Cash 100
Notes Receivable 900
Accounts Receivable-Chef Enterprises 1,000
 Assume Chef Enterprises paid the amount due with interest on the due date.
Globulomer would record the payment as

Aug. 4 Cash 909

Notes Receivable 900
Interest Revenue (900 * 12% * 30/360) 9