ACCOUNTS RECEIVABLE
Complete Study Guide — Gulf Corporation Demo Problem
All concepts explained from scratch · Every journal entry · Exam tricks
Table of Contents
Section Topic
1 What is Accounts Receivable? (Key Concepts & Terms)
2 Notes Receivable — Formal Promises to Pay
3 Bad Debts — When Customers Don't Pay
4 All June Journal Entries (Parts a & b)
5 Month-End Adjusting Entries Explained
6 Quick Exam Tricks & Cheat Sheet
SECTION 1 — What is Accounts Receivable?
The Big Idea
When a company sells goods or services and the customer pays LATER (not immediately), the amount
owed is called Accounts Receivable (AR). It is recorded as an ASSET because the company has a legal
right to collect that cash in the future.
Simple example: You sell $500 of goods to a customer on credit (they will pay next month). You record: Debit
Accounts Receivable $500 | Credit Sales Revenue $500. When they pay: Debit Cash $500 | Credit Accounts
Receivable $500.
Key Terms — Defined Simply
Money customers OWE the company. Short-term asset. No formal
Accounts Receivable (AR)
document needed.
A SIGNED written promise (promissory note) to pay. More formal than AR.
Notes Receivable (NR)
Can be long-term.
A contra-asset — estimated amount of AR expected to go uncollected.
Allowance for Doubtful Accounts
Reduces AR on balance sheet.
The actual bad debt expense recorded at period end via an adjusting
Uncollectible Accounts Expense
entry.
Removing a specific customer's AR because it's hopeless. Does NOT
Write-Off
affect expenses.
When a previously written-off customer actually pays. Requires TWO
Recovery
journal entries.
Contra-asset account for notes where interest is built into the face amount.
Discount on Notes Receivable
Amortised over time.
Interest earned on notes but not yet collected in cash. An asset — accrued
Interest Receivable
revenue.
Income earned from lending money. Recorded as it is earned (accrual
Interest Revenue
basis).
A schedule listing AR by how old (overdue) the amounts are, used to
Aging of AR
estimate bad debts.
A legal document signed by the borrower promising to pay a specific
Promissory Note
amount by a specific date.
The amount written on the note. May include hidden interest
Face Amount
(non-interest-bearing) or not.
★ MEMORY TRICK — Debit/Credit for AR
AR is an ASSET. Assets increase with DEBITS and decrease with CREDITS. So: Customer owes you
money? DEBIT AR. Customer pays you? CREDIT AR (it goes away). Golden rule: Debits = Credits in
every journal entry. Always balance!
SECTION 2 — Notes Receivable
What is a Note Receivable?
A Note Receivable is a FORMAL written promise (signed document) from a customer or borrower
agreeing to pay a specific amount by a specific date. It may or may not carry explicit interest.
Two Types of Notes:
Type Description Example in Problem
Non-interest-bearing Face amount > cash exchanged. The June 1 — Target Co. note Face
(Interest is HIDDEN) difference is unearned interest (discount) to be $32,700 | AR $30,000 Discount =
earned over time. $2,700
Interest-bearing (Interest Face amount = cash given. Interest is June 15 — Casa Blanca note $120,000
is STATED) calculated separately using the stated rate. at 8% per year Interest paid at maturity
June 1 — Target Company Note (Non-Interest-Bearing)
Target Co. owed Gulf $30,000 as a regular account receivable. Instead of paying cash, they signed a
ONE-YEAR promissory note for $32,700 (face amount). The extra $2,700 ($32,700 − $30,000) represents
the interest for one year, built into the face amount. Since there is 'no mention of interest,' the note is
non-interest-bearing on its face — but interest exists as a discount.
Why use a 'Discount on Notes Receivable' account? The note shows $32,700 on paper, but today it is only worth
$30,000 (what Gulf gave up). The $2,700 is FUTURE interest — you cannot call it income today. The Discount
account is a contra-asset that reduces the note to its present value ($30,000). Each month, $225 of the discount is
amortised (moved to Interest Revenue).
Journal Entry — June 1 (Target Co.)
Date Account Debit ($) Credit ($)
June 1 Notes Receivable 32,700
Discount on Notes Receivable 2,700
Accounts Receivable (Target Co.) 30,000
Received a 1-year note with interest included in the face amount
★ TRICK — How to identify hidden interest
If the problem says 'no mention of interest' BUT face amount > cash given → hidden interest! Discount =
Face Amount − Cash (or AR) Given Monthly amortisation = Discount ÷ Life of note in months Here:
$2,700 ÷ 12 months = $225 per month
June 15 — Casa Blanca Note (Interest-Bearing)
Gulf Corporation gave $120,000 cash to Casa Blanca, a supplier, in exchange for a 3-year, 8%
promissory note for $120,000. Since the note states an interest rate separately, there is no hidden
interest — no discount account needed. Interest will be calculated as: $120,000 × 8% = $9,600 per year,
paid at maturity.
Journal Entry — June 15 (Casa Blanca)
Date Account Debit ($) Credit ($)
June 15 Notes Receivable 120,000
Cash 120,000
Made a 3-year loan to Casa Blanca, Inc. in exchange for an 8% note receivable
SECTION 3 — Bad Debts & Uncollectible Accounts
Why Do We Estimate Bad Debts?
In the real world, not every customer pays. Accounting's matching principle requires that we estimate bad
debts in the SAME period as the related sales — not wait until a debt actually goes bad. The Allowance
Method is used for this purpose.
The Allowance Method — How It Works
Step What Happens Journal Entry Accounts
1 — Estimate At period end, estimate total bad debts using Dr: Uncollectible Accounts Expense Cr:
aging or % of sales. Record an adjusting entry. Allowance for Doubtful Accounts
2 — Write-Off When a specific account is deemed hopeless, Dr: Allowance for Doubtful Accounts Cr:
write it off. No effect on net AR or expense! Accounts Receivable (customer)
3 — Recovery If a written-off customer pays later, FIRST reverse Step 1: Dr AR / Cr Allowance Step 2: Dr Cash /
the write-off, THEN record collection. Cr AR
June 10 — Writing Off S. Willis's Account ($700)
Gulf determined that the $700 owed by S. Willis will never be collected. This is written off against the
Allowance for Doubtful Accounts — NOT as a new expense, because the expense was already estimated
and recorded in a previous period.
Journal Entry — June 10 (Write-Off)
Date Account Debit ($) Credit ($)
June 10 Allowance for Doubtful Accounts 700
Accounts Receivable (S. Willis) 700
To write off the account of S. Willis as uncollectible
★ CRITICAL RULE — Write-Off Does NOT Affect Expense!
Both the Allowance AND the AR decrease by the same amount ($700). Net AR on the balance sheet
stays exactly the same! Think: Allowance was already set aside for this — it just absorbs the loss now.
Wrong entry: Dr Bad Debt Expense / Cr AR ← INCORRECT for allowance method!
June 22 — Recovery of F. Hill's Account ($200)
F. Hill's $200 AR had been written off previously as uncollectible. Unexpectedly, she paid in full. A
recovery ALWAYS requires TWO journal entries:
Journal Entry — June 22, Step 1 (Reinstate)
Date Account Debit ($) Credit ($)
June 22 Accounts Receivable (F. Hill) 200
Allowance for Doubtful Accounts 200
Date Account Debit ($) Credit ($)
To reinstate the account receivable previously written off as uncollectible
Journal Entry — June 22, Step 2 (Collect Cash)
Date Account Debit ($) Credit ($)
June 22 Cash 200
Accounts Receivable (F. Hill) 200
To record collection of account receivable from F. Hill
★ WHY TWO STEPS FOR RECOVERY?
Step 1 puts the AR back on the books, showing Hill DID eventually pay (good for credit history). Step 2
records the actual cash collected. Skipping Step 1 and just recording Cash / Allowance is WRONG —
always use both steps!
SECTION 4 — All June Journal Entries (Complete)
PART A — Regular June Transactions
Date Account Debit ($) Credit ($)
June 1 Notes Receivable 32,700
Discount on Notes Receivable 2,700
Accounts Receivable (Target Co.) 30,000
Received a 1-year note with interest included in face amount
June 10 Allowance for Doubtful Accounts 700
Accounts Receivable (S. Willis) 700
To write off S. Willis account as uncollectible
June 15 Notes Receivable 120,000
Cash 120,000
Made a 3-year 8% loan to Casa Blanca, Inc.
June 22 Accounts Receivable (F. Hill) 200
Allowance for Doubtful Accounts 200
To reinstate account receivable previously written off
June 22 Cash 200
Accounts Receivable (F. Hill) 200
To record collection of F. Hill account
SECTION 5 — Month-End Adjusting Entries (June 30)
What Are Adjusting Entries?
At the end of every accounting period (here: June 30), we make adjusting entries to record items that have
occurred but were not yet formally recorded — such as interest earned, depreciation, or updating the bad
debt allowance. These ensure financial statements are accurate under the accrual basis of accounting.
Adjustment 1 — Update Allowance for Doubtful Accounts
An aging analysis shows we need a total of $9,000 in the Allowance. We must calculate the current
balance first:
Step Description Amount
Opening balance (end of May) Credit balance given in problem $5,710
Less: June 10 write-off (Willis) Reduced the allowance − $700
Add: June 22 recovery (Hill) Restored the allowance + $200
Current balance before
= $5,710 − $700 + $200 $5,210
adjustment
Required balance (from aging) Per the aging of accounts receivable $9,000
ADJUSTING ENTRY NEEDED $9,000 − $5,210 = amount to record $3,790
Adjusting Entry — June 30 (Bad Debt Expense)
Date Account Debit ($) Credit ($)
June 30 Uncollectible Accounts Expense 3,790
Allowance for Doubtful Accounts 3,790
To increase Allowance to $9,000 [ $9,000 − ($5,710 − $700 + $200) = $3,790 ]
Adjustment 2 — Amortise Discount on Target Co. Note
The $2,700 discount on the Target Co. note represents interest earned over 12 months. Since the note
was dated June 1, we earn 1/2 month of interest in June (from June 1 to June 30 = half month in the
textbook's convention):
$2,700 discount x 1/12 = $225 Interest Revenue for June
Adjusting Entry — June 30 (Discount Amortisation)
Date Account Debit ($) Credit ($)
June 30 Discount on Notes Receivable 225
Interest Revenue 225
To record interest revenue earned on the 1-year Target Co. note ($2,700 x 1/12)
Why DEBIT the Discount? The Discount on NR is a contra-asset (has a credit balance). Debiting it reduces the
discount, which increases the carrying value of the note toward its face amount ($32,700). This process is called
'amortising the discount.' After 12 months the discount = $0 and the note shows $32,700 on the books.
Adjustment 3 — Accrue Interest on All Other Notes
Interest earned on notes receivable must be accrued (recorded) even if not yet received in cash.
Note Calculation Amount
Casa Blanca ($120,000 $120,000 x 8% x 1/24 (half month — note started June 15) $400
@ 8%)
Other notes ($33,000 @ $33,000 x 10% x 1/12 (full month — held all of June) $275
10%)
TOTAL INTEREST $400 + $275 $675
ACCRUED
Adjusting Entry — June 30 (Interest Accrual)
Date Account Debit ($) Credit ($)
June 30 Interest Receivable 675
Interest Revenue 675
Accrued interest: Casa Blanca $120,000 x 8% x 1/24 = $400; Other notes $33,000 x 10% x 1/12 = $275
SECTION 6 — Exam Tricks & Quick Reference
The Master Interest Formula
Interest = Principal x Rate x Time (in years)
TIME is always expressed in YEARS. Use 360 days (not 365) unless told otherwise. Examples: 1 month = 1/12 |
Half month = 1/24 | 90 days = 90/360 = 1/4 Casa Blanca: $120,000 x 8% x 1/24 = $400 | Other notes: $33,000 x
10% x 1/12 = $275
Allowance Adjustment Formula
Adjusting Entry Amount = Required Balance − Current Balance
★ STEP-BY-STEP: Always recalculate the current balance first!
Current Balance = Opening Balance − Write-offs + Recoveries Here: $5,710 − $700 + $200 = $5,210
(current) Required: $9,000 | Shortfall: $9,000 − $5,210 = $3,790 → record as expense
Complete Cheat Sheet — What to Debit & Credit
Transaction Debit Credit Affects Expense?
Credit sale (AR created) Accounts Receivable Sales Revenue No (income)
Customer pays AR Cash Accounts Receivable No
Note received Notes Receivable Cash or AR No
(interest-bearing)
Note received Notes Receivable Discount on NR + AR No
(non-interest-bearing)
Write off bad debt Allowance for Doubtful Accts Accounts Receivable NO — already done
Bad debt recovery — Step 1 Accounts Receivable Allowance for Doubtful Accts No
Bad debt recovery — Step 2 Cash Accounts Receivable No
Period-end bad debt Uncollectible Accounts Allowance for Doubtful Accts YES
estimate Expense
Amortise discount on note Discount on Notes Interest Revenue No (income)
Receivable
Accrue interest (not yet Interest Receivable Interest Revenue No (income)
received)
Collect accrued interest Cash Interest Receivable No
5 Golden Rules to Remember
Rule 1 — Balance Every journal entry must have Total Debits = Total Credits. If they don't balance, you've
Always made an error. Always check!
Rule 2 — Write-Off ≠ Writing off a specific bad debt does NOT record an expense. It only reduces both AR and
Expense the Allowance by the same amount. Net AR is unchanged.
Rule 3 — Recovery = 2 Always reverse the write-off first (reinstate AR), then record the cash collection. Never
Steps combine into one entry.
Rule 4 — Discount Non-interest-bearing notes have a Discount that is amortised to Interest Revenue
Amortisation monthly. Debit Discount (reduces it) / Credit Interest Revenue.
Rule 5 — Accrual for Interest earned but not yet received in cash must be accrued: Debit Interest Receivable /
Interest Credit Interest Revenue. This applies to all interest-bearing notes.
Summary of All Amounts — Gulf Corporation June
Item Amount Account Type
Target Co. note face $32,700 Notes Receivable (asset)
Discount on Target note $2,700 Contra-asset (reduces NR)
AR cancelled for Target $30,000 Accounts Receivable removed
Willis write-off $700 AR removed / Allowance reduced
Casa Blanca loan $120,000 Notes Receivable (asset)
Hill recovery $200 AR reinstated / Cash collected
Allowance before adjustment $5,210 Contra-asset balance
Required allowance (aging) $9,000 Target balance
Bad debt expense (adjusting) $3,790 Expense this period
Discount amortised — June $225 Interest Revenue
Interest accrued — Casa Blanca $400 Interest Receivable / Revenue
Interest accrued — Other notes $275 Interest Receivable / Revenue
Total interest revenue — June $700 $225 + $400 + $275