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REPORTING AND ACCOUNTS RECEIVABLE
LO 1: Explain how companies recognize accounts receivable.
RECEIVABLES
• “Amounts due from individuals and companies that are expected to be collected in cash.”
1. Accounts Receivable: Amounts customers owe on account that result from the sale of
goods and services. Companies generally expect to collect accounts receivable within 30
to 60 days.
2. Notes Receivable: Written promise (formal instrument) for amount to be received. Also
called trade receivables. They include interest and extend for time periods of 60 to 90
days or longer.
3. Other Receivables: Nontrade receivables such as interest, loans to officers, advances to
employees, and income taxes refundable.
• Service organization records a receivable when it performs service ON ACCOUNT.
• Merchandiser records accounts receivable at the point of sale of merchandise ON ACCOUNT.
***Below are examples of journal entries that would be made with accounts receivables.
Many of these journal entries were explained in Chapter 5.
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Example: Prepare journal entries to record the following transactions entered into by the Castagno
Company:
Nov. 1 Sold merchandise on account to Mercer, Inc., for $18,000, terms 2/10, n/30.
Nov. 5 Mercer, Inc., returned merchandise worth $1,000.
Nov. 9 Received payment in full from Mercer, Inc.
Date
Debit
Credit
Accounts Receivable- Mercer, Inc.
Nov. 1
18,000
Sales Revenue
18,000
Sales Returns and Allowances
Nov. 5
1,000
Accounts Receivable- Mercer, Inc.
1,000
Cash
Nov. 9
16,660
Sales Discounts ($17,000 x 0.02)
340
Accounts Receivable- Mercer, Inc.
17,000
***Remember: 2/10, n/30 means that the buyer (Mercer) will get a 2% discount
on the selling price if they pay Castagno within 10 days, otherwise the full
amount is due in 30 days with no discount.
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LO 2: Describe how companies value accounts receivable and record their
disposition.
VALUING ACCOUNTS RECEIVABLE
• Current asset on the balance sheet.
• Valuation (net realizable value). (The amount of accounts receivable that the company actually
expects to collect.)
• Bad Debt Expense: Losses that the seller records as a result from extending credit and not being
able to collect the money.
• Two methods used in accounting for uncollectible accounts are:
1. Direct Write-Off Method
• Records bad debt expense only when an account is determined to be worthless.
• Used by SMALL companies and companies with a FEW receivables.
• No matching.
• Receivable is not stated at net realizable value.
• Not acceptable for financial reporting.
• If an accounts receivable that has been written off is later collected, then 2 journal
entries have to be made. One to reinstate the accounts receivable and the other one
to collect the cash.
2. Allowance Method
• Records bad debt expense by estimating uncollectible accounts at the end of the
accounting period.
• Generally accepted accounting principles (GAAP) require companies with a large
amount of receivables to use the allowance method.
• When an estimation of bad debts is made the account “ALLOWANCE FOR
DOUBTFUL ACCOUNTS” gets credited (Has a normal CREDIT balance after the end
of period adjusting journal entry). It is a contra-asset.
o Allowance for Doubtful accounts has a DEBIT balance when:
the write-offs during the period EXCEED than the beginning balance.
o Allowance for Doubtful accounts has a CREDIT balance when:
write-offs during the period are LESS than the beginning balance.
Cash (Net) Realizable Value of Receivables= Accounts Receivable Balance – Allowance for Doubtful Accounts
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Example: On November 15, it was determined that Mr. Sanders account of $3,000 would be
uncollectible. On December 20, after Mr. Sanders account was written off he paid Company M $3,000 in
full. On December 31, Company M estimated that $10,000 of their remaining credit sales will prove
uncollectible.
a) Prepare the journal entries for November 15, December 20, and December 31 under the direct write-
off method.
Date
Debit
Credit
Bad Debt Expense
Nov. 15
3,000
Accounts Receivable- Mr. Sanders
3,000
Accounts Receivable- Mr. Sanders
Dec. 20
3,000
Bad Debt Expense
1,000
Cash
Dec. 20
3,000
Accounts Receivable- Mr. Sanders
3,000
NO JOURNAL ENTRY
Dec. 31
b) Prepare the journal entries for November 15, December 20, and December 31 under the allowance
method.
Date
Debit
Credit
Allowance for Doubtful Accounts
Nov. 15
3,000
Accounts Receivable- Mr. Sanders
3,000
Accounts Receivable- Mr. Sanders
Dec. 20
3,000
Allowance for Doubtful Accounts
1,000
Cash
Dec. 20
3,000
Accounts Receivable- Mr. Sanders
3,000
Bad Debt Expense
Dec. 31
10,000
Allowance for Doubtful Accounts
10,000
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PRESENTATION OF ACCOUNTS RECIEVABLE ON THE BALANCE SHEET UNDER THE
ALLOWANCE METHOD
• Cash (Net) Realizable Value = Accounts Receivable – Allowance for Doubtful Accounts
• For Hampson Furniture, of the $200,000 in Accounts Receivable, they only expect to collect
$188,000. They do not expect to collect $12,000.
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2 Methods for Estimating Uncollectible Accounts under the Allowance Method
1. Balance Sheet Approach (Percent of Ending Accounts Receivable Method)
Allowance for Doubtful Accounts
RULES
1. IF BEGINNING ALLOWANCE FOR DOUBTFUL ACCOUNTS IS A CREDIT THEN
END BALANCE – BEGINNING BALANCE = X
2. IF BEGINNING ALLOWANCE FOR DOUBTFUL ACCOUNTS IS A DEBIT THEN
END BALANCE + BEGINNING BALANCE = X
Ex: 1 Smith Inc. estimates that 1% of their $100,000 accounts receivable balance as of December
31 will be uncollectible. What Journal entry would be made on December 31 if the beginning
balance for the Allowance for Doubtful Accounts was a $600 CREDIT balance?
Bad Debt Expense 400 $1,000 (END) - $600 (BEG)
Allowance for Doubtful Accounts 400 $1,000 (END) - $600 (BEG)
Allowance for Doubtful Accounts
BEG Balance
*X--- WE NEED TO
FIGURE THE
ADJUSTMENT FROM
THE BEG TO END
BALANCE
Y- END BALANCE
% of End Accounts Receivable as Uncollectible as a decimal x End A/R = Y
JOURNAL ENTRY
Bad Debt Expense X
Allowance for Doubtful Accounts X
$600 Beginning Balance
$1,000
0.01 X $100,000 = $1,000
$400
$1,000 (END) - $600 (BEG) = $400
Ending Balance
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Ex: 2 Smith Inc. estimates that 1% of their $100,000 accounts receivable balance as of December
31 will be uncollectible. What Journal entry would be made on December 31 if the beginning
balance for the Allowance for Doubtful Accounts was a $600 DEBIT balance?
Bad Debt Expense 1,600 $1,000 (END) + $600 (BEG)
Allowance for Doubtful Accounts 1,600 $1,000 (END) + $600 (BEG)
Allowance for Doubtful Accounts
2. Balance Sheet Approach (Aging the Accounts Receivables Method)
Ending Balance of Allowance for Doubtful Accounts
*If Allowance for Doubtful Accounts had an unadjusted $500 credit balance then…..
Ending Balance – Beginning Balance = Adjustment
$1,820 - $500 = $1,320
Bad Debt Expense 1,320
Allowance for Doubtful Accounts 1,320
*The amount of the adjusting entry is the amount that will yield an adjusted balance for
Allowance for Doubtful Accounts equal to that estimated by the aging schedule. In this case the
adjusted entry which CREDITS Allowance for Doubtful Accounts by $1,320 leads to the ending
adjusted balance of the Allowance for Doubtful Accounts to have a CREDIT balance of $1,820.
BEG: $600
End: $1,000
0.01 X $100,000 = $1,000
$1,600
$1,000 (END) + $600 (BEG) = $1,600
Totals Not Yet Due 1-30 days Past Due 31-60 days Past Due 61-90 days Past Due 90 + Days Past Due
John Smith $2,000 $1,000 $1,000
Sue $3,000 $1,000 $1,000 $1,000
Jim $10,000 $5,000 $2,000 $1,000 $2,000
Total Recievables $15,000 $6,000 $2,000 $3,000 $2,000 $2,000
Percent Uncollectible 2% 5% 10% 25% 40%
ESTIMATED UNCOLLECTIBLE $1,820.00 $120 $100 $300 $500 $800
Aging of
Recievables
Method
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DISPOSING OF ACCOUNTS RECEIVABLE
Sale of Receivables to a Factor
• A factor is a finance company or bank.
o Buys receivables from businesses and then collects the payments directly from the
customers.
o Typically charges a commission to the company that is selling the receivables.
o Fee ranges from 1% to 3% of the receivables purchased.
Ex: Assume that Hendredon Furniture factors $600,000 of receivables to Federal Factors on Nov. 15.
Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry to
record the sale by Hendredon Furniture is as follows:
Date
Debit
Credit
Cash
Nov. 15
588,000
Service Charge Expense ($600,000 x 2%)
12,000
Accounts Receivable
600,000
National Credit Card Sales (Customers that use Visa, Mastercard, or other credit card)
• A retailer’s acceptance of a national credit card is another form of selling (factoring) the receivables
by the retailer.
o Retailer pays card issuer a fee of 2 to 4% of the invoice price for its services.
o Recorded the same as cash sales.
o Advantages to retailer:
▪ Issuer does credit investigation of customer.
▪ Issuer maintains customer accounts.
▪ Issuer undertakes collection and absorbs losses.
▪ Receives cash more quickly.
Ex: Chef Louie purchases $2,000 worth of food and ingredients for his restaurant from Frank’s Fresh
Market store, and he charges this amount on his MasterCard. The service fee that MasterCard charges
Frank’s Fresh Market is 4%. Frank’s Fresh Market would record this transaction on March 28 as follows:
Date
Debit
Credit
Cash
Mar. 28
1,920
Service Charge Expense ($2,000 x 4%)
80
Sales Revenue
2,000
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LO 3: Explain how companies recognize, value, and dispose of Notes Receivable.
Promissory Note: “written promise to pay a specified amount of money on demand or at a definite
time.”
• Promissory notes may be used when
1. Individuals and companies lend or borrow money.
2. Amount of transaction and credit period exceed normal limits.
3. In settlement of accounts receivable.
• Used for a credit period of more than 60 days. If it is going to be collected WITHIN ONE YEAR, it is
classified as a current asset on the balance sheet. If it is going to be collected AFTER MORE THAN A
YEAR, then it is classified as a noncurrent asset as an investment on the balance sheet.
• Report short-term notes receivable at their cash (net) realizable value.
• Estimation of cash realizable value and recording bad debt expense and related allowance are
similar to accounts receivable.
EXAMPLE used for terms below: A NOTE DATED JUNE 20, 20XX FOR RON TO PAY CAM $1,000 ON
OCTOBER 20, 20XX WITH AN INTEREST RATE OF 10%.
1. Face Value of a Note (Principal): specified amount of money at a definite future date.
(Ex: $1,000)
2. Maker of the Note: the person who signed the note and promised to pay it at maturity. (Ex: RON)
• The maker of the note recognizes a note payable.
3. Payee of the Note: the person to whom the note is payable. (Ex: CAM)
• The payee of the note recognizes a note receivable.
4. Issuance Date: the date the note is issued. (Ex: JUNE 20, 20XX)
5. Maturity date of the Note: the date the note must be repaid. (Ex: OCTOBER 20, 20XX)
• May be stated on demand, on a stated date, or at the end of a stated period of time.
• Note terms are expressed in months and days.
*When months or years are used, the note matures and is payable in the month of its maturity on the
same day of the month as its original date. For example, a 9-month note dated September 28 would be
payable on June 28.
*If days, then have to count days in the month. DON’T INCLUDE DATE OF NOTE AS PART OF NUMBER OF
DAYS. For example, if note issued March 16 the amount of days note is outstanding in
March is 31 days – 16 = 15 days.
Term of Note 90 days
March (31-16) 15 days
April 30 days
May 31 days 76
June 14
(Maturity Date)
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6. Term of Note: amount of time between the issuance and due dates. (About 122 days—Time
between June 20, 20XX and October 20, 20XX)
7. Interest Computation:
Time in Terms of One Year
Days: # of days ÷ 360
Months: # of months ÷ 12
Years: # of years ÷ 1
Ex: The total interest for a $1,000, 90-day, and 10% note would be computed as follows:
$1,000 X 10% X (90/360) = $25
Current Example: 122 day note between Ron and Cam.
$1,000 x 10% x (122/360) = $33.89 Interest
8. Maturity Value: Amount that must be paid at the due date of the note. It is the sum of the
face amount and interest. In our example Ron has to pay Cam $1,033.89 ($1,000 Face Amount
+ $33.89 Interest) when note is due on October 20, 2017.
Another Note Example
with Terms
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Journal Entries for Notes Receivable
1. Recognizing Notes Receivable (Tropical Breeze-Payee point of view)
Tropical Breeze Inc. received a $2,000, 90-day, 10% promissory note from Paradise Sand to settle their
overdue open account.
2. Recording an Honored Note (Tropical Breeze-Payee point of view)
After 90 days, Tropical Breeze Inc. receives $2,050 from Paradise Sand ($2,000 to repay the note and
$50 in interest.) Interest = (2,000 x 10% x (90/360))= $50
3. Recording a Dishonored Note (Tropical Breeze-Payee point of view)
After 90 days, Paradise Sand is unable and refuses to pay Tropical Breeze Inc. $2,050 ($2,000 to repay
the note and $50 in interest.)
4. Recording End-of-Period Interest Adjustment (Tropical Breeze-Payee point of view)
If Tropical Breeze Inc. receives a $2,000, 90-day, 10% promissory note from Paradise Sand on
December 1, then on December 31 Tropical Breeze Inc. would need to recognize 30 days of interest.
$2,000 X 10% X (30/360) = $16.67
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LO 4: Describe the statement presentation of receivables and the principles of
receivables management.
• Companies need to identify in the balance sheet or in notes to the financial statements each of the
major types of receivables.
• Companies report both the gross amount of receivables and the allowance for doubtful accounts.
MANAGING RECEIVABLES
Managing accounts receivable involves five steps:
1. Determine to whom to extend credit.
2. Establish a payment period.
3. Monitor collections.
• Companies should prepare an accounts receivable aging schedule at least monthly.
• Helps managers estimate the timing of future cash inflows.
• Provides information about the collection experience of the company and
identifies problem accounts.
4. Evaluate the liquidity of receivables.
• Accounts Receivable Turnover: Measure the number of times, on average, a
company collects receivables during the period.
• Average Collection Period: Used to assess the effectiveness of credit and collection
polices. This period SHOULD NOT EXCEED credit term period.
5. Accelerate cash receipts from receivables when necessary.
