Accounting for ReceivablesA receivable is a companys claims for money, goods, or services.

An account receivable is classified as a current asset representing money due for services performed or merchandise sold on credit.

When an account becomes uncollectible, a bad debt expense is incurred.

Example: Accounts ReceivableAssume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows:

Example: Accounts ReceivableCredit Sale: Accounts Receivable 1,000 Sales Revenue 1,000

Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows:

Example: Accounts ReceivableCredit Sale: Accounts Receivable..... 1,000 Sales Revenue......... 1,000

Collection--2/10,n/30: Cash.............................. 980 Sales Discounts............. 20 Accounts Receivable 1,000Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows:

Uncollectible AccountsSome receivables will never be collected and must be written off as uncollectible.

Uncollectible AccountsOccurs when customers do not pay for items or services purchased on credit.Bad Debts are uncollectible accounts receivables.The uncollectible expense is placed on the income statement as a selling expense.

Two Methods of Accounting for Uncollectible AccountsDirect MethodOr:Allowance Method

EXAMPLE:

If We Have $100,000 in A/R All invoices are presumed to be good . . . (Valued at $100,000)They would be represented by a stack of invoices

until we discover someone cant pay the amount owed.

Direct Method When an invoice is discovered to be uncollectible it must be removed from A/R. That is it must be expensed or written off.

Direct Method Journal Entry to record Bad Debt:Bad Debt Expense 500Accounts Receivable 500

Direct Method Problem:Accounts Receivable is reported at the full $100,000 until bad debts are specifically identified.But, we know some customers in the stack will not pay.So, what is the real value of A/R?

Direct Method Like all assets, the value of A/R is only what you expect to collect.Accounts Receivable is overstated.Bad debt expense is understated! It is not recorded in the same period the sale was made.

Requires expenses be recorded in the same period the corresponding revenue is recognized.Direct Method is in conflict with the Matching PrincipleNot accepted under GAAP The Matching Principle

Under theAllowance Method We presume some invoices will not be good . . . We just dont know which ones.If We Have $100,000 in A/R

Allowance MethodESTIMATE the amount, but dont remove any invoices from A/RHow do we write off an unknown amount of Accounts Receivable?

An estimate can be based on:Size of the receivablesAge of the receivablesPast loss experienceAll of the above

Allowance Method

An estimate can be based on:Size of the receivablesAge of the receivablesPast loss experienceAll of the above

Allowance Method

Assume you made an estimate that $2000 will not be collectable. What journal entry would you make? Hint: Accounts Receivable is NOT reduced because which invoices will become uncollectable is unknown!

Allowance Method

Bad Debt Expense 2000Allowance for Doubtful Accounts 2000To record estimated bad debts

Allowance Method

Balance Sheet PresentationAssets: Cash20,000 Accounts Receivable100,000 Supplies2,500 PP&E3,000,000 Total Assets3,120,500

Balance Sheet PresentationAssets: Cash 20,000 Accounts Receivable 100,000 Less Allowance for DA 2,000 Net Accounts Receivable98,000 Supplies2,500 PP&E3,000,000 Total Assets3,120,500Note: Accounts Receivable is NOT reduced but the net receivable is!

Journal Entry needed when an account is identified as uncollectible:Allowance for Doubtful Accounts 500Accounts Receivable 500To write off Smith Co. (in bankruptcy)

Allowance Method

Bad Debt Expense 2000Accounts Receivable 500Allowance MethodAllowance for DA 2000Allowance for DA 500May 5Dec 31Direct vs. Allowance MethodsBad Debt Expense 500Accounts Receivable 500Direct MethodMay 5

(1)The Allowance for Doubtful Accounts is a contra-asset account which is subtracted from accounts receivable on the balance sheet.(2)The actual write-off entry does not reduce net receivables, as shown below:

Acct Receivable$100,000 Acct Receivable $99,500Less Allowance for Less Allowance for Doubtful Accounts 2,000 Doubtful Accounts 1,500Net Receivables$ 98,000 Net Receivables $98,000

Allowance Method

(1)The Allowance for Doubtful Accounts is a contra-asset account which is subtracted from accounts receivable on the balance sheet.(2)The actual write-off entry does not reduce net receivables.(3)The estimation error inherent in this approach is more acceptable than the violation of matching with the direct write-off method.

Allowance Method

Reversing Written-Off ReceivablesReverse Write Off: Accounts Receivable 500 Allowance for Doubtful Accounts 500 To reinstate a written-off receivable.

Reverse Write Off: Accounts Receivable 500 Allowance for Doubtful Accounts 500 To reinstate a written-off receivable.

Eliminate Receivable: Cash 500 Accounts Receivable 500 Payment for written-off receivable.Reversing Written-Off Receivables

Estimating the Allowance for Uncollectible AccountsPercentage of Total Receivables-- Determines the desired balance for Allowance for Doubtful Accounts. The difference between the actual and the desired balance is the expense entry.Aging Method--The process of categorizing each account receivable by the number of days it has been outstanding.

Example: Bad Debt ExpenseThe ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected.

The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected. Example: Bad Debt Expense

Bad Debt Expense 2,701 Allowance for Doubtful Accounts 2,701To adjust the Allowance account to desired balance.The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected. Example: Bad Debt Expense

The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Example 2: Bad Debt Expense Percentage Estimated to beAgeBalance Uncollectible AmountCurrent..............$10,000 1.5 $ 1501-30 days.......... 4,000 4.0 16031-90 days........ 2,100 20.0 420Over 90 days..... 1,000 40.0 400$17,000 $1,130

The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Uncollectible AccountExpenseAllowance for Doubtful Accounts 150 Balance Expense 980 980 Expense End. Bal. 1,130 End. Bal.Example 2: Bad Debt Expense980

The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150. Uncollectible AccountExpenseAllowance for Doubtful Accounts 150 Balance Expense 980 980 Expense End. Bal. 980 1,130 End. Bal.Uncollectible Account Expense 980 Allowance for Doubtful Accounts 980To adjust the Allowance account to desired balance.Example 2: Bad Debt Expense

The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary?Accounting for Uncollectible Receivables (Percentage of Credit Sales)

The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary?Uncollectible Accounts Expense 4,000 Allowance for Uncollectible Accounts 4,000

To record estimated uncollectible accounts for the year.Accounting for Uncollectible Receivables (Percentage of Credit Sales)

Assessing Management of ReceivablesAccounts Receivable Turnover--A measure used to determine a companys average collection period for receivables. Computed by dividing net sales (credit sales) by average accounts receivables.

Accounts Receivable TurnoverNumber of Days in Receivables--A measure of the average number of days it takes to collect a credit sale. It is computed by dividing 365 days by the accounts receivable turnover.Assessing Management of Receivables

ExampleThe Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.

The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.

Accounts Receivable Turnover:

Net Sales $150,000 = 4.0Average Accounts Receivable $ 37,500Example

Number of Days in Receivables:

Number of Days 365 = 91.25Accounts Receivable Turnover 4.0The Wheeler Company had Net Credit Sales of $150,000 during 2009. The accounts receivables increased $5,000 to $40,000 during the same time. Calculate the Accounts Receivable Turnover and Number of Days in Receivables.Example

Notes ReceivableA written promise that allows someone to pay a certain amount of money on or before a specific future date.

Notes are classified as current or long-term assets, depending on the due date.

Maker--The individual who signs the note and assumes responsibility.Payee--The person to whom payment is made.Principal--The face amount of the note.Maturity Date--The date the note becomes due.Interest Rate--Annualized percentage of the principal the maker is charged to borrow money.Interest--The cost of borrowing money.Notes Receivable -- Components

Computing InterestPrincipal (amount)

Principal (amount)Interest Rate (%)XComputing Interest

Principal (amount)Interest Rate (%)Time (years)XXComputing Interest

Principal (amount)Interest Rate (%)Time (years)Interest OwedXXEqualsComputing Interest

Example: InterestThe Ohio Company signed a 90-day, $5,000 note payable to the Florida Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost.

The Ohio Company signed a 90-day, $5,000 note payable to the Florida Company in settlement of existing accounts payable. The interest rate of the agreement is 14 percent. Calculate the interest cost.Principal x Interest Rate x Time = Interest $5,000 x 0.14 x 90/365 = $172.60Example: Interest

Accept Note: Accounts Payable............ 5,000.00 Note Payable............. 5,000.00

Pay Note Plus Interest: Note Payable................... 5,000.00 Interest Expense.............. 172.60 Cash.......................... 5,172.60

The Ohio Company--MakerJournalizing Notes Receivable

Accept Note: Note Receivable............... 5,000.00 Accounts Receivable.. 5,000.00

Collect Note Plus Interest: Cash................................. 5,172.60 Note Receivable......... 5,000.00 Interest Revenue........ 172.60

The Virginia Company--PayeeJournalizing Notes Receivable

Selling or Factoring ReceivablesReceivables are sold to factoring companies for cash.The factoring companies charge a percentage of the receivable as a service cost.Factoring allows companies to receive cash now, instead of waiting to collect on the receivable.

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