Receivables

CHAPTER

8
Electronic Presentations in Microsoft®
PowerPoint® to accompany
Fundamental Accounting Principles, 16ce
Prepared by
Lise Wall, Red River College
 Learning Objectives
1. Describe accounts receivable and how they
1
occur and are recorded. (LO )
2. Apply the allowance method to account for
2
uncollectible accounts receivable. (LO )
3. Estimate uncollectible accounts receivable
using approaches based on sales and
3
accounts receivable. (LO )
© 2019 McGraw-Hill Education 8-2
 Learning Objectives
4. Describe and record a short-term note
receivable and calculate its maturity date
4
and interest. (LO )
5. Calculate accounts receivable turnover and
days’ sales uncollected to analyze liquidity
5
(LO )
6. Explain how receivables can be converted
to cash before maturity. (Appendix 8A) (LO6)
© 2019 McGraw-Hill Education 8-3
 Accounts Receivable

• Arise from credit (non-cash) sales to

customers.
• Often referred to as Trade Receivables.

• Other receivables include interest

receivable, rent receivable, tax refund
receivable.

© 2019 McGraw-Hill Education 8-4

 Accounts Receivable
Companies selling on account need to:

• Maintain a separate account for each

customer.

• Account for bad debts.

© 2019 McGraw-Hill Education 8-5

 Accounts Receivable
Example: TechCom has the following Accounts
Receivable balances at June 30:
EXHIBIT 8.2

General Ledger

Accounts Receivable
Bal. 3,000
Accounts Receivable - Subledger

RDA Electronics Comp Store

Bal. 1,000 Bal. 2,000
Balance of controlling
account in general ledger
agrees to total of accounts
Total $3,000
receivable subledger.

© 2019 McGraw-Hill Education 10-6

 Accounts Receivable

EXHIBIT 8.3

General Ledger Balance of Accounts Receivable - Subledger

controlling
Accounts Receivable RDA Electronics Comp Store
account in
Bal. 3,000 general ledger Bal. 1,000 Bal. 2,000
agrees to total
950 of accounts 720 950
receivable
720 Bal. 280 Bal. 2,950
subledger.
Bal. 3,230 Total $3,230

© 2019 McGraw-Hill Education 10-7

 Credit Risk Analysis Accounts
Receivable
1. Employing credit – scoring models.
2. Using the latest technology to make informed
credit granting decisions.
3. Adopting technology to improve the
collection process.
4. Monitoring the macroeconomics
environment such as: debt levels / interest
rates, employment and profit levels.

© 2019 McGraw-Hill Education 8-8

 Valuing Accounts Receivable

• Some customers who are granted credit

do not pay what they promised.

• The accounts of these customers are

called uncollectible accounts or bad
debts.

© 2019 McGraw-Hill Education 8-9

 Valuing Accounts Receivable
EXHIBIT 8.5 Methods for Writing Off Bad Debts

Allowance Direct Method

Method (does not
(satisfies GAAP) satisfy GAAP)

Percentage of Sales Accounts Receivable

(or Income Statement Approach) (or Balance Sheet Approach)
-calculates bad debt expense -calculates the required
for the period Balance in AFDA

Calculate as a percentage of
Calculate as a total Accounts Receivable
percentage of Sales OR
Calculate using an Aging
Analysis

© 2019 McGraw-Hill Education 10-10

 Allowance Method
• The matching principle requires that bad debts
expense be matched and reported in the same
period as the sale that generated the
receivable.
• The allowance method satisfies the matching
principle by recording any estimated bad debt
expense connected to the current period sales
in the same period the relative revenue is
earned.

© 2019 McGraw-Hill Education 8-11

 Recording Estimated Bad
Debt Expense
• Adjustments for bad debts are made at
the end of the accounting period by
recording an adjusting journal entry.

• Adjustments use a contra-asset account

called Allowance for Doubtful Accounts.

© 2019 McGraw-Hill Education 8-12

 Recording Estimated Bad Debt
Expense Allowance Method
Example: The estimated bad debts for TechCom is
$1,500.
The period end entry to record bad debts is:
Bad Debts Expense 1,500
Allowance for Doubtful Accounts 1,500

An allowance account is used since we do not know

which customer accounts will be uncollectible.

© 2019 McGraw-Hill Education 8-13

 Writing Off a Bad Debt -
Allowance Method
Example: A specific customer’s account (Jack Kent) is
considered uncollectible. The entry to record the
write-off is:

Allowance for Doubtful Accounts 520

Accounts Receivable - Jack Kent 520
*Note that there is no expense recorded when the
account is written off. The estimated bad debt expense
was previously recorded.
© 2019 McGraw-Hill Education 8-14
 General Ledger Balances
Bad Debts Expense 1,500
Allowance for Doubtful Accounts 1,500
(To record estimated bad debts)
Allowance for Doubtful Accounts 520
Accounts Receivable00- Jack Kent 520
(To write off an uncollectible account)

Accounts Receivable Allow. For Doubtful Accts.

bal. 20,000 1,500
520 520
bal. 19,480 bal. 980

© 2019 McGraw-Hill Education 8-15

 Realizable Value Before and
After Write-off
Accounts Receivable Allow. For Doubtful Accts.
bal. 20,000 1,500
520 520
bal. 19,480 bal. 980

EXHIBIT 8.10

Before
Write-Off (Dec. After Write-Off
31) (Jan. 23)
Accounts receivable……………………… $20,000 $19,480
Less: Allowance for doubtful accounts…. 1,500 980
Estimated realizable accounts receivable. $18,500 $18,500

© 2019 McGraw-Hill Education 8-16

 Recovery of a Bad
Debt-Allowance Method
Example: Jack Kent pays his account in full after the
account had been written off. Two entries are
needed to record the reinstatement of the account
and the subsequent collection.
The two entries are:
Accounts Receivable-Jack Kent 520
Allowance for Doubtful Accounts 520
(To reinstate customer’s account.)

Cash 520
Accounts Receivable-Jack Kent 520
(To record collection of account.)
© 2019 McGraw-Hill Education 8-17
 Estimating Bad Debts Expense

Acceptable Methods:
1. Percentage of Accounts Receivables

2. Aging of Receivables

3. The Percentage of Sales

© 2019 McGraw-Hill Education 8-18

 Percentage of Accounts Receivables
This method assumes that a percentage of Accounts
Receivable is uncollectible. Bad Debts Expense is
computed with two steps:

[Link] dollar amount of all outstanding accounts

receivables is multiplied by an estimated % for
uncollectible accounts.
[Link] amount is the new balance required in the
Allowance for Doubtful Accounts. Prepare the entry to
adjust the existing balance to equal the new balance
required.

© 2019 McGraw-Hill Education 8-19

Percentage of Accounts Receivables

Example: Modern Office has $50,000 of outstanding

accounts receivable on December 31. It estimates 5%
of outstanding receivables will not be collectible.
Therefore they want the AFDA account to have a
$2,500 credit balance ($50,000 x 5%).

Before they can do the entry, they need to know the

unadjusted balance in the AFDA account.

© 2019 McGraw-Hill Education 8-20

 Percentage of Accounts
Receivables
Modern Office has a $500 credit balance already in the
AFDA account. Adjustment required to make
AFDA equal $2,500 ($50,000
Allowance for Doubtful Accounts
Accounts receivable x 5%
500 Unadjusted estimated bad debt)
balance Dec 31
Entry required for $2,000
?
($2,500 required balance –
2,500 Desired 500 existing credit balance)
adjusted
balance

Bad Debts Expense 2,000

Allowance for Doubtful Accounts 2,000
(To record estimated bad debts)

© 2019 McGraw-Hill Education 8-21

 Aging of Accounts
Receivable Approach
Assumes that the older the Account Receivable the
more likely is will become uncollectible.
Steps:
1. Group accounts based on how much time has
passed since they were created.
2. Estimate rates of uncollectibility for each group.
3. Apply rate to each group to get the required
balance for the Allowance account.

© 2019 McGraw-Hill Education 8-22

 Aging of Accounts Receivable
Example: At December 31, the receivables for DeCor
were classified as follows:

© 2019 McGraw-Hill Education 8-23

 Aging of Accounts Receivable
Using estimated bad debt percentages, DeCor would calculate
the estimated uncollectible amount as follows:

1 2 3

© 2019 McGraw-Hill Education

8-24
 Aging of Accounts Receivable
DeCor’s unadjusted balance in the
allowance account is a debit of Allowance for Doubtful Accounts
Unadj. bal. 200
$200. The previous computation
shows the desired balance is Adj. bal. 2,290
$2,290.

© 2019 McGraw-Hill Education 8-25

 Aging of Accounts Receivable
DeCor’s unadjusted balance in the
allowance account is a debit of Allowance for Doubtful Accounts
Unadj. bal. 200
$200. The previous computation
Adj. 2,490
shows the desired balance is Adj. bal. 2,290
$2,290. Therefore, the adjusting
entry is for:
$2,290 + 200 = $2,490.

© 2019 McGraw-Hill Education 8-26

 Aging of Accounts Receivable
DeCor’s unadjusted balance in the
allowance account is a debit of Allowance for Doubtful Accounts
$200. The previous computation Unadj. bal. 200
2,490
shows the desired balance is Adj. bal. 2,290
$2,290. Therefore, the adjusting
entry is for:
$2,290 + 200 = $2,490.

Bad Debts Expense 2,490

Allowance for Doubtful Accounts 2,490
(To record estimated bad debts)

© 2019 McGraw-Hill Education 8-27

 Percent of Sales Approach
• Also referred to as the Income Statement
Approach.
• Based on idea that a percentage of a
company’s credit sales are uncollectible.
• The primary focus is on matching bad debts
expense with credit sales.

© 2019 McGraw-Hill Education 8-28

 Percent of Sales Approach

Under this approach, bad debts expense is

computed as follows:

Current Period Sales

x Estimated Bad Debt %
= Estimated Bad Debts Expense

© 2019 McGraw-Hill Education 8-29

 Percent of Sales Approach

Example: Music Land has credit sales of $400,000 and

estimates 0.6% of those sales will not be collectible.
Estimated Bad Debts Expense is calculated as $2,400
($400,000 x .6%).
The period end adjusting entry would be:
Bad Debts Expense 2,400
Allowance for Doubtful Accounts 2,400
(To record estimated bad debts)

© 2019 McGraw-Hill Education 8-30

 Approaches to Estimate Bad Debts
EXHIBIT 8.15

Income Statement Approach Balance Sheet Approach

Income Statement Focus Balance Sheet Focus Balance Sheet Focus

Percentage of Sales Percentage of Receivables Aging of Receivables

Emphasis on Matching Emphasis on Realizable Value Emphasis on Realizable Value
Sales Bad Debt Accounts Allowance Accounts Allowance
Expenses Receivables for Receivables for
Doubtful Doubtful
(total) Accounts (by aged Accounts
category)

© 2019 McGraw-Hill Education 8-31

 Direct Write-off Method
• Sometimes used as an alternative to the
Allowance method when uncollectible
accounts are not material.
• The loss from an uncollectible account is
recorded when it is determined to be
uncollectible.
• This method does not satisfy the principles of
faithful representation and matching.

© 2019 McGraw-Hill Education 8-32

 Writing Off a Bad Debt -
Direct Write-off Method
Example: A specific customer’s account (Jack
Kent) is considered uncollectible. The one
entry to record the write-off is:
Bad Debts Expense 520
Accounts Receivable—Jack Kent 520

© 2019 McGraw-Hill Education 8-33

 Mini-Quiz
On October 29, 2020, TC Co. concluded that a customer's $4,400
account receivable was uncollectible and that the account should
be written off. What effect will this write-off have on TC Co.’s 2020
profit and balance sheet totals assuming the allowance method is
used to account for bad debts?

A) Decrease in profit; no effect on total assets.

B) No effect on profit or on total assets.
C) Decrease in profit; decrease in total assets.
D) Increase in profit; no effect on total assets.
E) No effect on profit; decrease in total assets.

© 2019 McGraw-Hill Education 8-34

 Mini-Quiz
On October 29, 2020, TC Co. concluded that a customer's $4,400
account receivable was uncollectible and that the account should
be written off. What effect will this write-off have on TC Co.’s
2020 profit and balance sheet totals assuming the allowance
method is used to account for bad debts?
A) Decrease in profit; no effect on total assets.
B) No effect on profit or on total assets.
C) Decrease in profit; decrease in total assets.
D) Increase in profit; no effect on total assets.
E) No effect on profit; decrease in total assets.
ADA 4,400
A/R 4,400

© 2019 McGraw-Hill Education 8-35

 Short-Term Notes Receivable
Promissory Note
A written promise to pay a specified amount of
money either on demand or at a definite future
date.
Short-Term Note Receivable (or Note Receivable)
A promissory note that becomes due within the
next 12 months or within the business’s
operating cycle if greater than 12 months.

© 2019 McGraw-Hill Education 8-36

 Short-Term Notes Receivable
• Usually interest bearing.
• Interest rates are stated on an annual basis.
Interest is calculated as follows:
EXHIBIT 8.18
Time
Principal of Annual expressed in
Interest = the note x interest rate x years or i= Prt
Interest on a $1,000, 6%, six-month note is calculated as:

$1,000 x 6% x 6 = $30
12

© 2019 McGraw-Hill Education 8-37

 Short-Term Notes Receivable
Example: On July 10 TechCom receives a $1,000,
90-day, 6% promissory note at the time of a
sale (cost of sales $630).
The entry to record the transaction would be:

Notes Receivable 1,000

Sales 1,000
Cost of Goods Sold 630
Merchandise Inventory 630
© 2019 McGraw-Hill Education 8-38
 Short-Term Notes Receivable
Example: On October 8 TechCom receives payment
in full of $1,000, 90-day, 6% promissory note
signed on July 10. TechCom’s year end is
December 31.
The entry to record the transaction would be:
Cash 1,015
Note Receivable 1,000
Interest Income 15 ($1,000 x 6% x
90/365 = $15)

© 2019 McGraw-Hill Education 8-39

 Short-Term Notes Receivable
Example: On December 16, TechCom receives a
$3,000, 60-day, 6% promissory note and $1,000
cash to settle a $4,000 past due account.
The entry to record the transaction would be:
Cash 1,000
Notes Receivable 3,000
Accounts Receivable 4,000

© 2019 McGraw-Hill Education 8-40

 Short-Term Notes Receivable
On December 31, 15 days after the note is issued, an accrual for
interest earned on the note is made.
The entry to record the accrual would be:
Interest Receivable 7.40
Interest Revenue 7.40
(3,000 x 6% x 15/365)

On February 14, the 60-day note matures.

The entry to record the honouring of the note would be:
Cash 3,029.59
Interest Revenue 22.19
Interest Receivable 7.40
Notes Receivable 3,000.00
(3,000 x 6% x 60/365)= 29.59

© 2019 McGraw-Hill Education 8-41

 Short-Term Notes Receivable
• Sometimes the maker of a note does not pay
the note at maturity. This is known as
dishonouring the note.

• The payee should use every legitimate means

to collect.
• The note receivable and uncollected interest
income is charged to an accounts receivable in
the name of the maker of the note.

© 2019 McGraw-Hill Education 8-42

 Review
Explain why the allowance method satisfies the
generally accepted principles of faithful
representation and matching.
• The allowance method ensures that the asset, accounts
receivable, and the reported profit are not overstated. In
this way it accomplishes the requirements of the faithful
representation principle.

• The allowance method recognizes the bad debts expense

in the same period in which the related credit sales were
recognized. In this way it accomplishes the required
matching of expenses with the period in which the
revenue was recognized.
© 2019 McGraw-Hill Education 8-43
 Review
Explain how to record the receipt of a
note receivable.
• A note is recorded by entering the total
amount borrowed (principal) as a debit
to Notes Receivable and as a credit to
the account representing the asset or
service exchanged for the note.

© 2019 McGraw-Hill Education 8-44

 Financial Statement Analysis
The quality (likelihood of collection) and liquidity
(speed of collection) of a company’s receivables
may be assessed by calculating:

1. Accounts Receivable Turnover ratio

2. Days’ Sales Uncollected

© 2019 McGraw-Hill Education 8-45

 Financial Statement Analysis

EXHIBIT 8.19

Accounts receivable
turnover
₌ Net Sales
Average accounts receivable

EXHIBIT 8.20

Days’ sales
uncollected
₌ Accounts Receivable
x 365
Net Sales

© 2019 McGraw-Hill Education 8-46

 Converting Receivable to Cash Before
Maturity Appendix 8A
Receivables are sometimes converted into
cash before maturity because:
1. Companies may need the cash.
2. Companies do not want to be involved in
the collection activities.

© 2019 McGraw-Hill Education 8-47

Converting Receivables to Cash Before
Maturity Appendix 8A
Conversion of receivables into cash is
accomplished by either:
1. Selling them to a factor.*
2. Pledging them as loan security.

* Finance company or bank

© 2019 McGraw-Hill Education 8-48

 Summary
1. Describe accounts receivable and how they
occur and are recorded.
2. Apply the allowance method to account for
uncollectible accounts receivable.

3. Estimate uncollectible accounts receivable

using approaches based on sales and
accounts receivable.

© 2019 McGraw-Hill Education 8-49

 Summary
4. Describe and record a short-term note
receivable and calculate its maturity date
and interest.
5. Calculate accounts receivable turnover and
days’ sales uncollected to analyze liquidity.
6. Explain how receivables can be converted to
cash before maturity. (Appendix 8A)

© 2019 McGraw-Hill Education 8-50

End of Chapter

© 2019 McGraw-Hill Education 8-51