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Chapter 8
• Receivables - amounts owed to company
by others.
• Accounts Receivable
– Company just bills its customers/clients
– Result from rendering services or selling
products to the public.
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• Notes Receivable
– Evidenced with promissory notes
• Formal written debt instruments
• Usually bear interest
• Usually has fixed maturity date
• Company should write off A/R where no
hope of collecting the A/R
– Conservatism – Don't show worthless A/R as
an asset
• This is misleading
– Doesn’t have to – Demand Note
• When customers pay A/R slowly
– Make customers sign promissory note & pay interest
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• Two methods to write off bad A/R
– Direct method
• Not GAAP
– Allowance method
• GAAP
• Another GAAP principle is materiality
– If amount is not material, you don’t need to
follow GAAP.
– Something is material if person's actions
would be different if he or she knew the item
in question.
– If bad A/R not a material amount
• You can use direct method
– Otherwise must use allowance method.
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• Direct Write-Off Method
– Charge uncollectible accounts to an expense
in the period of default
• A selling expense
• May not coincide with the period of the related sale
– Violates Matching Principle
D.
Uncollectible Accounts Expense
Cr.
– First, reinstate A/R.
• Reverse the prior journal entry.
D. Accounts Receivable
Cr.
$100
Accounts Receivable
$100
Uncollectible Accounts Expense
$100
$100
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• Allowance Method
• Second, you record that the A/R has been
paid:
D.
• If you write off A/R & customer eventually
pays
Cash
– Matching Principle
• Expense should be recorded in the same period as
the related sale
• Need to estimate bad debts each year
• Company does not know which customer won’t
pay.
$100
Cr. Accounts Receivable
$100
– So, you don’t write off any particular A/R
– Instead you reduce A/R with a contra account
» Allowance For Bad Debts
D. Uncollectible Accounts Expense
$12,000
Cr. Allowance for Uncollectible
Accounts
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• Allowance for Uncollectible Accounts is
contra account to A/R
– Reduces A/R to amount estimated to be
collectible.
– Net number is the net realizable value of the
A/R.
Accounts Receivable
Less: Allowance for Uncollectible Accounts
$12,000
$200,000
12,000
-------------
• Write off A/R when clear that it won’t be
paid:
– Note that there is no expense involved in the
entry.
• No Bad Debt Expense
• Expense happened in year of sale
D. Allowance for Uncollectible Accounts
Cr.
Accounts Receivable
$100
$100
$188,000
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• After write-off
• When customer pays after A/R written off
– A/R net value does not change
• Specific A/R was written off
• Allowance for Uncollectible Accounts decrease by
the same amount
– First, reinstate customer's A/R
D. Accounts Receivable
Cr.
$100
Allowance for Uncollectible
Accounts
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• Second, record collection
• Most common methods for estimating
uncollectible A/R
D.
Cash
Cr.
$100
Accounts Receivable
$100
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• Aging of accounts receivable method
(Percentage of receivables basis)
– Separate A/R by age categories
– The total amounts in each category are
multiplied by a different percentage (a
different probability of default for each age
category)
– Add up products for estimate of total bad
debts.
$100
– Accounts receivable aging method and
– Percentage of net sales method
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• Adjusting entry is for amount that brings
Allowance for Uncollectible Accounts to
the computed figure.
– If you estimate a total of $3,000 of you’re A/R
will not be paid, and
– Your allowance has a credit balance of
$1,000,
– Credit the allowance (and debit bad debt
expense) for $2,000.
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• Percentage of sales method
– Estimated percentage for uncollectible
accounts is multiplied by net sales (or net
credit sales) for the period.
– The resulting figure is then used in adjusting
entry.
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• Previous balance in Allowance for Uncollectible
Accounts
– amounts from previous years - not yet been written off
– irrelevant in making adjusting entry.
• If:
– You have net sales of $300,000
– You believe that 1% of your sales will not be collected
– Place $3,000 into the allowance.
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• A promissory note has two parties
– Maker (debtor) and
– Payee (lender)
• Promissory note
– Formal debt instrument
– Usually bears interest
• Interest on notes with terms of a year or less
– Interest usually paid at maturity.
– Usually has maturity date
• Can be demand note.
• Maturity value is the amount owed by maker at
maturity.
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• Promissory notes:
– Loan to someone
– Received in the sale of expensive
merchandise or other assets
• Extended payments
• E.g., sales of automobiles
• When promissory note replaces A/R
– Maker is customer who can’t pay A/R on time.
– Company gives more time, but wants interest.
– Company converts A/R into interest bearing
promissory note.
– In exchange for delinquent A/R
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• Assume a $6,000, 10%, six-month
promissory note is issued in place of A/R:
D.
Notes Receivable
Cr.
D.
$6,000
Accounts Receivable
$6,000
Interest Revenue
300
• Supposed to accrue interest revenue in the
period earned even though not yet paid
– Company just has A/R again.
– No more interest will accrue thereafter
Account Receivable
Cr. Notes Receivable
Interest Revenue
– You need to do an Adjusting Entry.
$6,300
$6,000
300
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• Assume 3-month promissory note is issued
in December:
• A promissory note is honored when it is
paid in full at its maturity date.
March 1
Dec.31
$6,300
Notes Receivable
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• If the note is dishonored:
Dec. 1
Cash
Cr.
$6,000
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D.
• When the note matures, the maker pays
the principle and the accrued interest:
D. Notes Receivable
Cr. Accounts Receivable
D.
Interest Receivable
Cr.
Interest Revenue
$6,000
$6,000
D.
Cash
Cr.
Notes Receivable
Interest Receivable
Interest Revenue
$6,150
$6,000
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100
$50
$50
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• Managing Accounts Receivable
– Company with A/R needs to watch the
following steps carefully:
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• Extending Credit
– Who should get credit?
• E.g., look at credit reports, ask for guarantees or
letters of credit
– Your credit policies have to be competitive
• But, you still want to make sure you will get paid.
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• Monitoring Collections
• Establishing a Payment Period
– You have to be competitive.
– Consider offering incentives for customers to
pay early (e.g., sales discounts).
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• Evaluating the Receivable Balance
– When evaluating company’s credit policies
management looks at two measures:
– (i) Receivables Turnover Ratio, and
– (ii) Average Collection Period.
– Make sure customers are paying you.
– Prepare an A/R aging schedule
• Helps to identify problem accounts
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• Receivables Turnover Ratio
– tells you how many times you give and collect
credit (A/R) during the year, on average:
Net Credit Sales
----------------------------------------------------Average Net Accounts Receivable
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• Average Collection Period
• Reflects the number of days it takes to
collect a firm’s A/R:
• I calculate the Average Collection Period
differently
– Same Ratio
• First calculate credit sales per day:
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--------------------------------------------Receivables Turnover Ratio
Net Credit Sales
--------------------------------------------365
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• Then divide one day’s worth of credit sales
into your average A/Rs:
• Accelerating Cash Receipts
Average Net Accounts Receivable
--------------------------------------------One Day’s Credit Sales
– Company needs cash faster than customers
are paying A/R
– A company can sell it’s A/R to a factor.
– Factor charges a fee to purchase the A/R.
• Treated as an expense
– operating expense or
– other expense
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D.
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Cash
Service Charge Expense
Cr. Accounts Receivable
$588,000
12,000
$600,000
• Similar to treatment of VISA or
MasterCard credit card sale
• Credit card company is agreeing to issue
credit to your customers
– so that you don’t have to
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D.
Cash
Service Charge Expense
Cr. Sales
$970
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$1,000
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