Principles of Accounting

(MTL 1111)
Spring- 2025
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 Assistant Professor
Abid Hasan ACMA
Associate Cost and Management Accountant
The Institute of Cost and Management Accountants of Bangladesh

Contact Detail:
Email: [email protected]
Recognition of Accounts Receivable

Explain how companies recognize accounts receivable.

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Recognition of Accounts Receivable

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Recognizing Accounts Receivable

• Service organizations record a receivable when it

performs service on account.
• Merchandisers record accounts receivable at point
of sale of merchandise on account.
• Companies report receivables from employees
separately in financial statements.

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Recognizing Accounts Receivable

Illustration: Assume that Jordache Co. on July 1, 2020, sells

merchandise on account to Polo Company for $1,000, terms 2/10,
n/30. On July 5, Polo returns merchandise with a sales price of
$100 to Jordache Co. Prepare the journal entries to record these
transactions.

July 1 Accounts Receivable 1,000

Sales Revenue 1,000

July 5 Sales Returns and Allowances 100

Accounts Receivable 100

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Recognizing Accounts Receivable

Illustration: On July 11, Jordache receives payment from Polo

Company for the balance due. Prepare the journal entire to record
this transaction.

July 11 Cash ($900 − $18) 882

Sales Discounts ($900 × .02) 18
Accounts Receivable 900

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Recognizing Accounts Receivable

Some retailers issue their own credit cards. When you use a
retailer’s credit card (JCPenney, for example), the retailer charges
interest on the balance due if not paid within a specified period
(usually 25–30 days).
Illustration: Assume you use your JCPenney credit card to purchase
clothing with a sales price of $300 on June 1, 2020. The entry is
recorded as follows.

June 1 Accounts Receivable 300

Sales Revenue 300

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Recognizing Accounts Receivable

Illustration: Assuming that you owe $300 at the end of the month
and JCPenney charges 1.5% per month on the balance due, the
adjusting entry that JCPenney makes to record interest revenue of
$4.50 ($300 × 1.5%) on June 30 is as follows.

June 30 Accounts Receivable 4.50

Interest Revenue 4.50

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Valuing Accounts Receivable
How should they report receivables in the financial statements?
Companies report accounts receivable on the balance sheet as an asset.
But determining the amount to report is sometimes difficult because
some receivables will become uncollectible.
A customer may not be able to pay because of a decline in its sales
revenue due to a downturn in the economy. Companies record credit
losses as Bad Debt Expense (or Uncollectible Accounts Expense).

Two methods are used in accounting for uncollectible accounts: (1) the
direct
write-off method and (2) the allowance method.

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DIRECT WRITE-OFF METHOD FOR UNCOLLECTIBLE ACCOUNTS
Under the direct write-off method, when a company determines a particular
account to be uncollectible, it charges the loss to Bad Debt Expense. Assume,
for
example, that Warden Co. writes off as uncollectible M. E. Doran’s $200 balance
on December 12. Warden’s entry is as follows.
Bad Debt Expense 200
Accounts Receivable—M. E. Doran 200

Under this method, Bad Debt Expense will show only actual losses from
uncollectible.
Quick Buck Computer Company distributed one million computers with a selling
price of $800 each. This increased Quick Buck’s revenues and receivables by
$800 million. The promotion was a huge success! The 2017 balance sheet and
income statement looked great. Unfortunately, during 2018, nearly 40% of the
customers defaulted on their loans. This made the 2018 income statement and
balance sheet look terrible.
Under the direct write-off method, companies often record bad debt expense in
a period different from the period in which they record the revenue.
Consequently, unless bad debt losses are insignificant, the direct
write-off
method is not acceptable for financial reporting purposes.
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ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
The allowance method of accounting for bad debts involves
estimating uncollectible accounts at the end of each period. This
provides better matching on the income statement.
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 the revenues.
2. Companies debit estimated uncollectible to Bad Debt Expense and
credit them to Allowance for Doubtful Accounts through an adjusting
entry at the end of each period. Allowance for Doubtful Accounts is a
contra account to Accounts Receivable.
3. When companies write off a specific account, they debit actual
uncollectible to Allowance for Doubtful Accounts and credit that
amount to Accounts Receivable.

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ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
RECORDING ESTIMATED UNCOLLECTIBLES To illustrate the allowance
method,
assume that Hampson Furniture has credit sales of $1,200,000 in 2017. Of this
amount, $200,000 remains uncollected at December 31. The credit manager
estimates that $12,000 of these sales will be uncollectible. The adjusting entry to
record the estimated uncollectibles increases (debits) Bad Debt Expense and
increases (credits) Allowance for Doubtful Accounts, as follows.
Bad Debt Expense 12000
Allowance for Doubtful Accounts 12000
Hampson reports Bad Debt Expense in the income statement as an operating
expense (usually as a selling expense). Thus, the estimated uncollectible are
matched with sales in 2017. Hampson records the expense in the same year it
made the sales.
The net amount of $188,000 represents the expected cash realizable value of
the accounts receivable at the statement date. Companies do not close
Allowance for Doubtful Accounts at the end of the fiscal year.

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ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
RECORDING THE WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT
assume that the financial vice president of Hampson Furniture authorizes a write-
off of the $500 balance owed by R. A. Ware on March 1, 2018. The entry to record
the write-off is as follows:
Allowance for Doubtful Accounts 500
Accounts Receivable—R. A. Ware 500
Bad Debt Expense does not increase when the write-off occurs. Under the
allowance method, companies debit every bad debt write-off to the
allowance account rather than to Bad Debt Expense. A debit to Bad Debt
Expense would be incorrect because the company has already recognized the
expense when it made the adjusting entry for estimated bad debts.
A write-off affects only balance sheet accounts—not income statement
accounts. The write-off of the account reduces both Accounts Receivable and
Allowance for Doubtful Accounts. Cash realizable value in the balance sheet,
therefore, remains the same:
Before Write-Off After
Write-Off
Accounts receivable $ 200,000 $
199,500 Less: Allowance for doubtful accounts
12,000 11,500
RECOVERY OF AN UNCOLLECTIBLE ACCOUNT $188,000
$188,000
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ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
RECOVERY OF AN UNCOLLECTIBLE
Occasionally, a company collects from a customer after it has written off
the account as uncollectible.
To illustrate, assume that on July 1, R. A. Ware pays the $500 amount
that Hampson had written off on March 1. Hampson makes the following
entries:
Accounts Receivable—R. A. Ware 500
Allowance for Doubtful Accounts 500

Cash 500
Accounts Receivable—R. A. Ware 500

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Notes Receivables
A note is a written promise to pay a specified amount of money on
demand or at a definite time.
Notes may be used:
 When individuals and companies lend or borrow money,
 When the amount of the transaction and the credit period exceed
normal limits,
 In settlement of accounts receivable.
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.

Notes receivable give the holder a stronger legal claim to assets than do
accounts receivable.

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Notes Receivables
A note is a written promise to pay a specified amount of money on
demand or at a definite time.
Notes may be used:
 When individuals and companies lend or borrow money,
 When the amount of the transaction and the credit period exceed
normal limits,
 In settlement of accounts receivable.
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.

Notes receivable give the holder a stronger legal claim to assets than do
accounts receivable.

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Determining the Maturity Date
When the life of a note is expressed in terms of months, you find the
date when it
matures by counting the months from the date of issue.
For example, the maturity date of a three-month note dated May 1 is
August 1. A note drawn on the last day of a month matures on the last
day of a subsequent month. That is, a July 31 note due in two months
matures on September 30.

When the due date is stated in terms of days, you need to count the
exact
number of days to determine the maturity date. In counting, omit the
date the
note is issued but include the due date. For example, the maturity
date of a
60-day note dated July 17 is September 15.

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Computing Interest
The basic formula for computing interest on an interest-bearing note is:

Face Value of Note * Annual Interest rate * Time in terms of 1 year= Interest

The interest rate specified in a note is an annual rate of interest.

Terms of Note Interest Computation
Face 3 Rate 3 Time 5
Interest
$ 730, 12%, 120 days $ 730 * 12% * 120/360 = $
29.20
$1,000, 9%, 6 months $1,000 * 9% * 6/12 =$
45.00
$2,000, 6%, 1 year $2,000 * 6% * 1/1 =
$120.00

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Recognizing Notes Receivable
To illustrate the basic entry for notes receivable, we will use Calhoun
Company’s $1,000, two-month, 12% promissory note dated May 1.
Assuming that Calhoun Company wrote the note to settle an open
account, Wilma Company makes the following entry for the receipt of
the note.

Notes Receivable 1,000

Accounts Receivable—Calhoun Company 1,000

The company records the note receivable at its face value, the amount
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 the performance obligation is satisfied. Interest
is earned (accrued) as time passes.

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HONOR OF NOTES RECEIVABLE
A note is honored when its maker pays in full at its maturity date. For
each interest bearing note, the amount due at maturity is the face
value of the note plus interest for the length of time specified on the note.
To illustrate, assume that Wolder Co. lends Higley Co. $10,000 on June 1,
accepting a five-month, 9% interest note. In this situation, interest is $375
($10,000 * 9% * 5/12). The amount due, the maturity value, is $10,375
($10,000 +$375). To obtain payment, Wolder (the payee) must present the
note either to Higley Co. (the maker) or to the maker’s agent, such as a
bank. If Wolder presents the note to Higley Co. on November 1, the
maturity date, Wolder’s entry to record the collection is as follows.
Cash 10,375
Notes Receivable 10,000
Interest Revenue ($10,000 * 9% * 5/12) 375

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 ACCRUAL OF INTEREST RECEIVABLE
Suppose instead that Wolder Co. prepares financial statements as of
September 30.
To reflect interest earned but not yet received, Wolder must accrue interest
on September30. In this case, the adjusting entry by Wolder is for four
months of interest, or $300, as shown below:
Interest Receivable ($10,000 * 9% * 4/12) 300
Interest Revenue 300
At the note’s maturity on November 1, Wolder receives $10,375. This amount
represents repayment of the $10,000 note as well as five months of interest,
or $375, as shown below. The $375 is comprised of the $300 Interest
Receivable accrued on September 30 plus $75 earned during October.
Wolder’s entry to record the honoring of the Higley note on November 1 is as
follows:
Cash [$10,000 1 (10,000 * 9% * 5/12)] 10,375
Notes Receivable 10,000
Interest Receivable 300
Interest Revenue (10,000 * 9% * 1/12)] 75

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 Presentation of Receivables
Balance Sheet:
Current Assets:
Accounts Receivables XXXX
Less: Allowance for doubtful accounts XXX
XXXX
Notes Receivables XXXX

Income Statement:
Selling Expenses/Administrative expenses:
Bad debt expenses XXXX

Other revenue:
Interest revenue XXXX

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 Liabilities

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Accounting for Current Liabilities
Explain how to account for current liabilities.

What is a Current Liability?

A debt that a
• company expects to pay within one year or
• the operating cycle, whichever is longer.
Current liabilities include notes payable, accounts
payable, unearned revenues, and accrued liabilities such
as taxes payable, salaries and wages payable, and
interest payable.

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Accounting for Current Liabilities

Accounts payable
Notes Payable
• Written promissory note
• Frequently issued to meet short-term financing needs
• Requires borrower to pay interest
• Issued for varying periods

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Notes Payable

Illustration: First National Bank agrees to lend $100,000 on

September 1, 2020, if Cole Williams Co. signs a $100,000, 12%,
four-month note maturing on January 1. When a company issues
an interest-bearing note, the amount of assets it receives upon
issuance of the note generally equals the note’s face value. Cole
Williams therefore will receive $100,000 cash and will make the
following journal entry.
Sept. 1 Cash 100,000

Notes Payable 100,000

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Notes Payable

Illustration: If Cole Williams prepares financial statements annually,

it makes an adjusting entry at December 31 to recognize interest
expense and interest payable. Compute the interest for the four
months ended December 31, 2020.
4
$100,000 × 12% × = $4, 000
12
Cole Williams makes an adjusting entry as follows.
Dec. 31 Interest Expense 4,000

Interest Payable 4,000

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Notes Payable

Illustration: At maturity (January 1, 2021), Cole Williams must pay

the face value of the note plus interest. It records payment of the
note and accrued interest as follows.

Jan. 1 Notes Payable 100,000

Interest Payable 4,000
Cash 104,000

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VAT Payable

Many of the products we purchase at retail stores are subject to VAT.

Illustration: if on March 25 cash register reading for Cooley Grocery

shows sales of $10,000 and VAT of $600 ( rate 6%), the journal entry is
as follows.
Cash 10,600
Sales Revenue 10,000
VAT Payable 600
When the company remits the taxes to the taxing agency, it debits
Sales Taxes Payable and credits Cash.

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Unearned Revenues

An airline company, such as American Airlines, often receives cash when it

sells tickets for future flights.
Company does two things in such situation:
1. When a company receives the advance payment, it debits Cash and credits
a current liability account identifying the source of the unearned revenue.
2. When the company recognizes revenue, it debits an unearned revenue
account and credits a revenue account.
To illustrate, assume that Superior University sells 10,000 season football
tickets at $50 each for its five-game home schedule. The university makes the
following entry for the sale of season tickets.
Cash 500,000
Unearned Ticket Revenue 500,000

Unearned Ticket Revenue 100,000

Ticket Revenue 100,000

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Current Maturities of Long-Term Debt

Companies often have a portion of long-term debt that comes due in the
current year. That amount is considered a current liability. As an
example, assume that Wendy Construction issues a five-year, interest-
bearing $25,000 note on January 1, 2016. This note specifies that each
January 1, starting January 1, 2017, Wendy should pay $5,000 of the
note. When the company prepares financial statements on December
31, 2016, it should report $5,000 as a current liability and $20,000 as a
long-term liability. (The $5,000 amount is the portion of the note that is
due to be paid within the next 12 months.)

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Contingent liability

A contingent liability is a liability that may occur depending on the

outcome of an uncertain future event. A contingent liability is recorded
if the contingency is likely and the amount of the liability can be
reasonably estimated.
Guidelines for contingent liability:
1. If the contingency is probable (if it is likely to occur) and the
amount can be reasonably estimated, the liability should be
recorded in the accounts.
2. If the contingency is only reasonably possible (if it could happen),
then it needs to be disclosed only in the notes that accompany the
financial statements.
3. If the contingency is remote (if it is unlikely to occur), it need not be
recorded or disclosed.

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Contingent liability
Product warranties are an example of a contingent liability that companies
should record in the accounts.
The accounting for warranty costs is based on the expense recognition principle.
The estimated cost of honoring product warranty contracts should be
recognized as an expense in the period in which the sale occurs. To
illustrate, assume that in 2017 Denson Manufacturing Company sells 10,000
washers and dryers at an average price of $600 each. The selling price includes
a one-year warranty on parts. Denson expects that 500 units (5%) will be
defective and that warranty repair costs will average $80 per unit. In 2017, the
company honors warranty contracts on 300 units, at a total cost of $24,000.
At December 31, it is necessary to accrue the estimated warranty costs on the
2017 sales. Denson computes the estimated warranty liability as follows.
Number of units sold 10,000
Estimated rate of defective units 5%
Total estimated defective units 500
Average warranty repair cost $80
Estimated warranty liability $40,000

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Contingent liability

The company makes the following adjusting entry.

Warranty Expense 40,000
Warranty Liability 40,000

Denson records those repair costs incurred in 2017 to honor warranty

contracts on 2017 sales as shown below.
Warranty Liability 24,000
Repair Parts 24,000

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Business Documents

1. Invoice
2. Debit Note
3. Credit Note
4. Cheque
5. Counterfoil
6. Paying in Slip
7. Receipt
8. Books of primary entry.

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Business Documents
Invoice: An invoice is a document submitted to a customer, identifying a transaction for
which the customer owes payment to the issuer. This document represents an asset of the
issuer and a liability of the customer.
 The invoice number
 The name and address of the seller
 The name and address of the buyer
 The date of shipment or when services were delivered
 A description of the items purchased
 The quantities and total costs of the items purchased
 Any taxes owed
 Any shipping and handling charges
 The grand total owed
 Payment terms

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Business Documents
Debit Note: If a buyer returns goods to the seller which are bought on credit,
the seller’s account must be debited by the buyer and send this information to
the seller through a note. This note is known as “Debit Note.”
 A debit note, also known as a debit memo.
 generally used in business-to-business transactions
 A debit note is separate from an invoice and informs a buyer of current
debt obligations.
 In the case of returned items, the note will show the credit amount, the
inventory of the returned items, and the reason for the return.

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Business Documents
Credit Note: If a buyer returns goods to the seller bought on credit, the
buyer’s account will be credited by the seller and will be informed by the
seller through a note. This note is called “Credit Note.“
 A credit note, also known as a credit memo.

Cheque: A cheque is a bill of exchange in which one party orders the bank to
transfer the money to the bank account of another party. Other way a cheque is an
authorization to draw funds from a bank account.

Books of Primary Entry: where the transactions that are made by a business are
recorded for the first time, before they are entered into the separate ledger
accounts.

• Cash Receipts Book

• Cash Payments Book
• Sales daybook
• Purchase daybook
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Business Documents
Counter foil: A part of a bank check, money order, etc., that is kept by the issuer
and on which a record of the transaction is made.

Paying in Slip: Pay-in-slip is an outline presented in banks and is used to deposit

money into a bank account. Each pay-in-slip has a counterfoil which is returned
to the depositor accordingly sealed and signed by the bank officer. It is also
called deposit slip.

Receipts: A receipt is a written acknowledgment that something of value has

been transferred from one party to another. Receipts are an official record that
represents proof of a financial transaction or purchase.

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