Chapter 10 – Receivables
Receivables

  • amount that another party owes, amount that can be received
  • 2 most common types of receivables are accounts receivables and note receivables
  • Accounts Receivable (aka trade receivables) – amount that another party owes a company from credit sales
  • can arise when:
    • credit is directly given to the customer by the business or
    • when customers use credit cards that are issued by third parties
    • when companies directly give credits, they must:
      • maintain seperate accounts receivables for each customer
      • account for bad debts from credit sales

Valuing Accounts Receivable

  • when credits are granted to customers, some customers may not pay the promised amount, and the accounts of these customers are called uncollectible accounts or bad debts
  • the total amount of uncollectable accounts is an expense of selling on credit
  • there are two methods of accounting for uncollectable accounts:
    • allowance method
    • direct write-off method

 Allowance Method

  • the matching principle states that any bad debt expense should be matched and recorded in the same period as the sales it help produce
  • allowence method matches the expected loss from the uncollectible accounts receivable of each period
  • expected loss is an estimated amount

Accounting for Bad Debt

  • an allowance is recorded for the expected loss by using the Allowance for Doubtful Accounts, which is a contra-asset account (contra-asset account is used because at the time of adjusting, the customers that will not pay are unknown
  • Allowance for Doubtful Accounts – can be either debit or credit balance
  • done at the end of the period
  • realizable value – amount that can be collected from credit customers

Journal Entry for Adjusting for Bad Debt
Bad Debt Expense                                                                           xx

Allowance for doubtful accounts                                                                xx

Writing Off Bad Debt

  • when accounts are identified as uncollectable, they have to be written off
  •  the uncollectable accounts are removed from accounts receivable
  • when writing off bad debt, the expense account is not debited because it has already been estimated and recorded

Journal Entry for Writing Off Bad Debt:

Allowance for Doubtful Accounts                                               XX

Accounts Receivable – NAME                                                                      XX

Recovery of a Bad Debt

  • when a customer’s account is written off and the customer pays part or all of the amount owed after the account is written off, a bad debt has to be recovered

Journal Entry for Recovering Bad Debt:
Accounts Receivable – NAME                                                                      X

Allowance for Doubtful Accounts                                                                               X

Cash                                                                                                                      X

Accounts Receivable – NAME                                                                                      X
Percent of sales method

This method is also known as the “income statement method”. This method uses the Net Sales and experiences from previous cycles to estimate the amount of uncollectable accounts.

A company has credit sales of $200 000 in 2010. and based on experiences they assume that 0.5% of all sales are uncollectable.

Calculations: $200,000 x 0.005 = $1000

Dec 31 Bad Debt Expense ……………………………………… 1000
Allowance for doubtful accounts ………… 1000

Account Receivable Method
This method is also known as the “balance sheet method”. This method uses Accounts receivable and allowance for doubtful accounts to estimate bad debts. This method can be done in two different ways.

Method 1: using a percentage to estimate the total uncollectable account receivables

Method 2: Determine by using “aging” account receivable

Percent of Accounts Receivable Method
This method assumes that there will be a percentage of all outstanding accounts receivable that is uncollectable. Estimates are based on past experience (Ms. Cuttle will give this amount)

A company has $50,000 of outstanding accounts receivable on December 31. From past experience it suggests that 5% of the account receivable is uncollectable. Assume that the unadjusted balance in AFDA on December 31 is currently 500.

Calculation: $50,000 x 0.005 = 2,500

AFDA

500   Unadjusted balance (Dec 31)?       Bad Debt expense
2500 Desired adjusted balance

2500 = 500 + ?
2000 = Bad debt expense

The adjusting entry
Dec 31 Bad debt expense …………………………………….. 2000
Allowance for doubtful accounts ………. 2000

After determining the adjusted balance in the AFDA the accounts receivable can now be adjusted with 2 different way.

The more common and easier to understand method:
Current Assets:
Accounts receivable ……………………………………………… X
Less: Allowance for doubtful accounts …………………….        Y Z

or

Current assets:
accounts receivable (net of Y estimated uncollectable accounts) … Z

Aging of Accounts Receivable Method
The aging of accounts receivable method looks at each accounts receivable and basically classify them depending on if its current (not due yet) or if its due which are usually in 30 days intervals. The longer it takes get the money from the customer the less likely the company will be paid.

Direct Write-Off Method
It records the debits lost from an accounts receivable that has been deemed uncollectable
Violates Matching Principle – because many times expenses are not matched with revenues (different periods)
Materiality principle allows this method when bad debts are much smaller in relation to other items

For example: Giggle Corp. specializes in the sale of giggles. Their client Mr. Fraser has been unhappy for some time so he purchased a giggle for $1000. He was so happy, he fled the country. As a result, Giggle Corp has deemed that his debt will not be collected. Journalize:
April 1           Bad Debt Expense                                                                     1000-
Accounts Receivable – Fraser                                    1000-
To write off bad debt

In summary, the journal entry to write off directly is
–      Debit: Bad Debt Expense
–      Credit: Accounts Receivable – (Name)

Notes Receivable
A note is a written promise to give an extension to the consumer with an interest for the time period. Creditors generally prefer it over accounts receivable. Promissory note is a written promise to pay a specific amount of money either on demand or at a definite future date.

The period of a note is sometimes expressed in months or years. When months are used, the note matures and is payable in the month of its maturity on the same day of the month as the original date.
Example: A three-month note dated July 10th, is payable on October 10th.

Interest Calculation
Interest = principal   x   annual interest rate   x   exact days/365 ( i = Prt )
Example: Calculate interest on a $1000, 12%, 90 days note
$1000 x 0.12 x 90/365 = $29.59

Receipt of Note
Date   Cash………….…………………………..……       xx
Notes Receivable……………………………..……              xx
Interest Revenue……………………………..……              xx

To record payment of the note.

End-of-period Interest Adjustment
Accrued interest is computed and recorded when notes receivables are outstanding at the end of an accounting period. This recognizes both the interest revenue when it is earned and the interest receivable owned by the note’s holder.

Date   Interest Receivables………….…………………………..……       xx
Interest Revenue…………………………………..……              xx
To record the issues of a note for extensions of a past due account.

Honoring a Note
Example: Note dated December 16th for $3000, interest rate: 12%, 60 days

Feb. 14 Cash………………………………………………….3059.18
Interest Revenue………………………………………..44.39
Interest Receivable……………………………………..14.79
Notes Receivable………………………………………..3000
Received payment of a note and its interest.

Dishonouring a Note
A note is dishonored when the customer does not pay the note at maturity.
Date Accounts Receivable…………………………………………….xx
Interest Revenue……………………………………………….xx
Notes Receivable……………………………………………….xx
To charge the account for John Smith for a dishonored note including interest.

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