Hope Enterprise University College

Department of Accounting & Finance

Principles of Accounting II

Chapter One: Receivables

CLASSIFICATIONS OF RECEVABLES: The term receivables refer to money claims against people,
organizations or other debtors. Receivables are classified in to two with respect to time:
I- Short-term receivables: are those receivables that will be collected or received within a
year or less. Such receivables are reported in the current asset section of the balance
sheet.
II- Long-term receivables: are those receivables that will be collected or received after a
year. Such receivables are reported in the investment section of the balance sheet.
According to the agreement between debtors and creditors, Receivables are also classified in
to:
A) Receivables created by open agreement:
B) Receivables crated by a written promise
Advantage of Notes
 the debtor acknowledges the debt and agrees to pay according to the terms given
 it is a stronger legal claim than open accounts
 it is more liquid than open accounts

CHARACTERISTICS OF NOTES RECEVABLES

1) Due date: is the date on which the note is to be paid. It is also called as maturity
date and can be stated in terms of days or months.
2) Interest: is the cost of capital or the value of money. From the above example it is
possible to calculate interest.
3) Maturity Value: is the amount due at the maturity date.
 Maturity value of a non- interest-bearing note is the face of the note
 Maturity of value of an interest-bearing note is the sum of the face amount
and interest. There are two kinds of notes
i) Interest Bearing Note: is a note that provides the payment of interest for period between
the issuance date and he due date.
ii) Non- interest-bearing Note: is a note that does not provide the payment of interest.
 4) Payee: is the one to whose order the note is payable. From the example in #1 above
the payee is ABC Company.
5) Maker: is the person or organization that makes the promise or the one who signs
the note. From the example in #1 above the maker is Sam Enterprise.
6) Discount: is the amount that the bank deducts when a note is discounted or
transferred to a third party for borrowing money.
7) Proceed: is the excess of the maturity value over the discount

ACCOUNTING FOR NOTES RECEIVABLES

Journal Entry:
 Notes that a business accepts for which it will receive cash in the future are called notes
receivable.
Note Receivable XXX
Account Receivable XXX
 Due date and the necessary journal Entry:
Cash XXX
Note Receivable XXX
 If the note received from a customer is interest should be computed and recorded as
appropriate.
Note Receivable XXX
Interest Receivables XXX
Account Receivable XXX
 End of the accounting period – Adjustment for interest)
Interest Receivable XXX
Interest Income XXX
 Due date and cash collection
Cash XXX
Note Receivables XXX
Interest Receivables XXX
Interest Income XXX

DISCOUNTING NOTES RECEIVABLES

A company that needs cash may transfer its one receivable to a bank by endorsement. This
transfer of the note to a bank is called discounting notes receivable The amount charge by the
bank or deducted by the bank (which is the interest) is called discount The excess of the on the
maturity value over the discount is called proceeds. The discount (Interest charged by the
maturity value over of time the bank must hold the note until the due date.
 A- Maturity Value = Note+ interest and determine discount period
A- Discount = Maturity Value X Discount Rate X discount period
D- Proceeds = Maturity Value – Discount
E- Journalize entries respectively:
I ) Notes Receivable XXX
Account Receivable XXX
II) Endorser: Cash XXX
Note Receivables XXX
Interest income XXX
Bank: Note Receivable XXX
Cash XXX
Interest income XXX
If the maker of the note fails to pay the note to the bank; the endorser of the note is committed
to paying the note. Such potential obligations that will become actual committed only if certain
events occur in the future are called contingent liabilities.
Contingent liabilities include discounted receivable, litigation, guarantees, events subsequent to
date of financial stamens etc. thus the endorser of a note that has been discounted has
contingent liability that is in effect until the due date.
If the maker as the promise amount on the due date (at maturity), the contingent liability is
removed without any action on the part of the endorser.

DISHONORED NOTES RECEIVABLES

If the maker of note fails to pay the debt (the maturity amount) on the due date, the note is
said to be dishonored. A dishonored notes receivable is no longer negotiable. The amount of
the claim again the maker is transferred an Account Receivable account. The Account
Receivable account of the maker (customer) is debited for the amount of the note, interest due
(if any) and any protest fee. If the note in the above example is refused by Y- Company at
maturity and the note is not discounted, the entry is record as:
Due Date: Account Receivable XXX
Notes Receivable XXX
Interest Income XXX
When a discounted notes receivable is dishonored, the holder usually notifies the endorser of
such facts and asks for payment. The entire amount paid to the holder by the endorser,
including the interest should be debited to the account receivable account of the make. The
entry to record the payment of cash to the bank by the endorsers:
Account Receivable XXX
Cash XXX
If the maker pays, no need of journal entry in the record of the endorser

UNCOLLECTIBLE RECEIVABLES
When merchandise or services are sold without the immediate receipt of cash, part of the claim
against customers usually proves to be uncollectible. The operating expense incurred because
of the failure to collect receivables is called an expense, specifically loss from uncollectible
accounts or doubtful accounts or bad debts. There is no single general rule for determining
when an account or note becomes uncollectible.
Reasons for Uncollectibilty:
 Bankruptcy of the debtor
 Death of the debtor
 Failure of repeated attempt to collect
 Disappearance of the debtor
 The barring of collection by statue limitation
 Closing of the debtor’s business
There are two methods of accounting for uncollectible:
1) ALLOWANCE METHOD (RESERVE METHOD):
The advance provision for uncollectiblility is made by an adjusting entry at the end of the fiscal
period. This entry serves two purposes:
I) The reduction of the value of the receivables to an amount of cash expected to be
realized from them in the future.
II) The allocation to current period of the expected expense resulting from such reduction.
GAAP requires the allowance method for financial reporting purpose when bad debts are
material in amount. This method has three essential features:
1. Companies estimate uncollectible accounts receivable. They match this estimated
expense against revenues in the same accounting period in which they record revenues.
2. Company’s debt estimated uncollectible to Bad Debts Expense and credit them to
Allowance for doubtful Accounts (a contra asset account) through an adjusting entry at
the end of each period.
3. When companies write off a specific account, they debit actual uncollectible to
Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.

WRITE-OFFS TO THE ALLOWANCE ACCOUNT

Companies use various methods of collecting past due accounts, such as letters, calls, and legal
action. When they have exhausted all means of collecting a past due account and collection
appears impossible, the company should write off the account. To prevent premature or
unauthorized write offs, management should formally approve, in writing, each write off. When
an account is believed to be uncollectible it is written off against the allowance account.
 1) Under the allowance method of accounting the receivables is believed to be
uncollectible the journal entry is:
Allowance for doubtful accounts XXX
Account Receivables XXX
2) If the amount of the written off is collected at a later time in the future, it can be
recorder in two different ways.
Recovery of an Uncollectible Account
A) Assume that the amount that is written off is collected on the same year:
i) Reinstate the entry, which is the direct reverse of the write off:
ii) Recording the collection of cash
If the amount that has been written of is collected income other years Other than the
current accounting period.
i) Reinstate:
ii) Cash Collection: The same as the entry shown above
 Recovery of uncollectible accounts written off appears in the income stamens as a
deduction from the uncollectible accounts expense.
 The estimation of uncollectible at the end of the fiscal period is based on past
experience and forecasts of future business activity. This estimation is base on:

Bases Used for Allowance Methods

To simplify the preceding explanation, we assumed we knew the amount of the expected
uncollectible. In ‘real life,’ companies must estimate that amount when they use the allowance
methods. Two bases are used to determine this amount: (1) Percentage of Sales, and (2)
Percentages of Receivables. Both bases generally accepted.
A) Percentage of Sales: Account Receivables are acquired as a result of sales on account. The
amount estimate based on sales is added to whatever balance exists in the allowance for
doubtful accounts. It follows the matching principle. The percentage can be developed
based on credits sales or cash sales or total sales.
B) Percentage of Receivables: The process of analyzing receivables based on the length of
time pasts due is termed as aging of the receivables. The base point for determining age is
the due date of an account. The amount determine by the analysis of receivables is the
amount of the desired balance of the allowance account after adjustment. The excess of
this figure over the balance of the allowance account before adjustment is the amount of
the current provision to be made for uncollectible expense.
Adjusting Entry: Uncollectible Accounts expense XXX
Allowance for doubtful accounts XXX
 2) DIRECT WRITE-OFF METHOD: is a method of accounting for uncollectible receivables,
where by an expense is recognized only whe4n specific accounts are judged to be
uncollectible. In this method:
If an account that has been written of collected at a later time the necessary entries are
recorded as follows:
1) If the amount written off is collected I the same a accounting period in which the written off

Note Receivables Exercise

1. Discuss the similarities and differences between accounts receivables, notes receivables and
other receivables.
2. What is the due date of a 60-day note?
3. What is the maturity value of a 12%, 60-day note for Br. 5,000?
4. After the accounts are adjusted and closed at the end of the fiscal year, Accounts Receivable
has a balance of Br. 340,000 and Allowance for Doubtful Accounts has a balance of Br.
51,000. What is the net realizable value of the accounts receivable?
5. At the end of a period (before adjustment), Allowance for Doubtful Accounts has a balance
of Br. 5,000. The Accounts Receivable balance is analyzed by aging the accounts and the
amount estimated to be uncollectible is Br. 50,000. What is the amount to be recorded in
the adjusting entry for the Bad Debt Expense?
6. ABC Company analyzes its receivables to estimate bad debt expense. The accounts
receivable balance is Br. 390,000 and credit sales are Br. 1,300,000. An aging of accounts
receivable shows that approximately 5% of the outstanding receivables will be uncollectible.
What adjusting entry will ABC Company make if the Allowance for Doubtful Accounts has a
balance of Br. 2,500 before adjustment?
7. Allowance for Doubtful Accounts has a debit balance of Br. 600 at the end of the year
(before adjustment), and an analysis of accounts in the customers ledger indicates
uncollectible receivables of Br. 13,000. Which of the following entries records the proper
adjusting entry for bad debt expense?
8. ABC Company receives a Br. 6,000, 3-month, 6% promissory note from XYZ Company in
settlement of an open accounts receivable. What entry will ABC Company make upon
receiving the note?
9. Happy Company lends Stone Company Br. 40,000 on March 1, accepting a four-month, 6%
interest note. Happy Company prepares financial statements on March 31. What adjusting
entry should be made before the financial statements can be prepared?
10. At the end of the current year, Accounts Receivable has a balance of Br. 90,000; Allowance
for Doubtful Accounts has a credit balance of Br. 850; and net sales for the year total Br.
300,000. Bad debt expense is estimated at 2.5% of net sales.
Required: Determine
(a) the amount of the adjusting entry for uncollectible accounts;
(b) the adjusted balances of Accounts Receivable, Allowance of Doubtful Accounts; and Bad
Debt Expense; and
(c) the net realizable value of accounts receivable.
11.