recivables.doc

7/30/2019 Recivables.doc

1/20

UNIT 8. ACCOUNTING FOR RECEIVABLESUNIT 8. ACCOUNTING FOR RECEIVABLES

ContentsContents

8.08.0 Aims & ObjectivesAims & Objectives

8.1 Introduction8.1 Introduction8.2 Classification of Receivables8.2 Classification of Receivables

8.3 Internal Control Over Receivables8.3 Internal Control Over Receivables

8.4 Characteristics of Notes Receivables8.4 Characteristics of Notes Receivables

8.5 Accounting for Notes Receivable8.5 Accounting for Notes Receivable

8.6 Converting Receivables to Cash Before Maturity8.6 Converting Receivables to Cash Before Maturity

8.7 Accounting for Uncollectibles8.7 Accounting for Uncollectibles

8.7.1 Allowance Method8.7.1 Allowance Method

8.7.2 Estimating Uncollectibles8.7.2 Estimating Uncollectibles

8.7.2.1 Estimate Based on Sale8.7.2.1 Estimate Based on Sale

8.7.2.2 Estimate Based on Analysis of Receivables8.7.2.2 Estimate Based on Analysis of Receivables

8.7.3 Direct-write-off method8.7.3 Direct-write-off method

8.8 Summary8.8 Summary

8.9 Answer to Check your Progress Exercises8.9 Answer to Check your Progress Exercises

8.10 Model Examination Questions8.10 Model Examination Questions

8.11 Glossary of Terms8.11 Glossary of Terms

8.0 AIMS & OBJECTIVES8.0 AIMS & OBJECTIVES

After you have studied this unit, you will be able to:After you have studied this unit, you will be able to:

-- list the common classification of Receivableslist the common classification of Receivables

-- explain internal Control procedures that apply to receivablesexplain internal Control procedures that apply to receivables

-- describe the nature of and the accounting for uncollectibles and,describe the nature of and the accounting for uncollectibles and,

-- explain how receivables can be converted to cash before maturity.explain how receivables can be converted to cash before maturity.

8.1 INTRODUCTION8.1 INTRODUCTION

In this unit, we emphasize on how companies account for and report receivables. We haveIn this unit, we emphasize on how companies account for and report receivables. We have

discussed the importance of estimating uncollectibles in order to determine the reasonablediscussed the importance of estimating uncollectibles in order to determine the reasonable

balance of receivables on the balance sheet.balance of receivables on the balance sheet.

154


2/20

Most of the companies sell goods and services on credit in order to earn more profits.Most of the companies sell goods and services on credit in order to earn more profits.

Receivables represent claims for money, goods, services, and non-cash assets from otherReceivables represent claims for money, goods, services, and non-cash assets from other

firms. Receivables may be current or non-current depending on the expected collection date.firms. Receivables may be current or non-current depending on the expected collection date.

8.2 CLASSIFICATION OF RECEIVABLES8.2 CLASSIFICATION OF RECEIVABLES

Receivables can be broadly classified into Trade Receivables and Non-trade Receivables.Receivables can be broadly classified into Trade Receivables and Non-trade Receivables.

Trade ReceivablesTrade Receivablesdescribe amounts owed to the company for goods and services sold in thedescribe amounts owed to the company for goods and services sold in the

normal course of business. Non-trade Receivable arise from many other sources, such asnormal course of business. Non-trade Receivable arise from many other sources, such as

advance to employees, interest receivables, rent receivables and loan to affiliated companies.advance to employees, interest receivables, rent receivables and loan to affiliated companies.

Unless we indicate otherwise, we will assume that all receivables in this unit are tradeUnless we indicate otherwise, we will assume that all receivables in this unit are trade

receivables.receivables.

Based on the above broad classification, receivables can be further classified into AccountBased on the above broad classification, receivables can be further classified into Account

Receivable and Notes Receivables. Account Receivable refers to amounts due from customersReceivable and Notes Receivables. Account Receivable refers to amounts due from customers

for credit sales. These receivables are supported by sales invoices or other documents ratherfor credit sales. These receivables are supported by sales invoices or other documents rather

than any formal written promises. Such Account Receivables are normally expected to bethan any formal written promises. Such Account Receivables are normally expected to be

collected within relatively short period, such as 30 or 60 days. They are classified on thecollected within relatively short period, such as 30 or 60 days. They are classified on the

balance sheet as a current asset. On the other hand, Notes Receivable refers to amounts thatbalance sheet as a current asset. On the other hand, Notes Receivable refers to amounts that

customers owe, for which a formal, written instrument of credit has been issued. Notes arecustomers owe, for which a formal, written instrument of credit has been issued. Notes are

usually used for credit periods of more than sixty days and for transactions of relatively largeusually used for credit periods of more than sixty days and for transactions of relatively large

value. Notes may also be used in settlement of an open account and in borrowing or lendingvalue. Notes may also be used in settlement of an open account and in borrowing or lending

money.money.

8.3 INTERNAL CONTROL OVER RECEIVABLES8.3 INTERNAL CONTROL OVER RECEIVABLES

The principles of internal control that we saw in chapter 5 are required by organizations toThe principles of internal control that we saw in chapter 5 are required by organizations to

safeguard their assets from any kind of error and misconduct. These control proceduressafeguard their assets from any kind of error and misconduct. These control procedures

should apply on receivables because they are one of the asset elements for the organization.should apply on receivables because they are one of the asset elements for the organization. For example, the individual responsible for sales should be separate from the individualFor example, the individual responsible for sales should be separate from the individual

accounting for the receivables and approving credit. By doing so, the accounting and creditaccounting for the receivables and approving credit. By doing so, the accounting and credit

approval functions serve as independent checks on sales. Separation of responsibility forapproval functions serve as independent checks on sales. Separation of responsibility for

related functions reduces the possibility of errors and misuse of funds.related functions reduces the possibility of errors and misuse of funds.

155


3/20

Adequate control over Accounts Receivable begins with the approval of the sales by aAdequate control over Accounts Receivable begins with the approval of the sales by a

responsible company official or the credit department, after the customers credit rating hasresponsible company official or the credit department, after the customers credit rating has

been reviewed. Likewise, adjustments of Account Receivable, such as for sales return andbeen reviewed. Likewise, adjustments of Account Receivable, such as for sales return and

allowance, and sales discount, should be authorized or reviewed by a responsible party.allowance, and sales discount, should be authorized or reviewed by a responsible party.

Effective collection procedure should also be established to ensure timely collection ofEffective collection procedure should also be established to ensure timely collection of

receivables and to minimize losses from uncollectible accounts.receivables and to minimize losses from uncollectible accounts.

Check Your Progress Exercise -1Check Your Progress Exercise -1

1.1. Why is Account Receivable classified as a current asset?Why is Account Receivable classified as a current asset?

2.2. Why is segregation of duties required for related activities related to receivables?Why is segregation of duties required for related activities related to receivables?

8.4 CHARACTERISTICS OF NOTES RECEIVABLE8.4 CHARACTERISTICS OF NOTES RECEIVABLE

A claim supported by a note has some advantages over a claim in the form of an AccountA claim supported by a note has some advantages over a claim in the form of an Account

Receivable. By signing a note, the debtor recognizes the debt and agrees to pay according toReceivable. By signing a note, the debtor recognizes the debt and agrees to pay according to

the terms listed. A note is therefore a strong legal claim if there is a court action.the terms listed. A note is therefore a strong legal claim if there is a court action.

A promissory note is a written promise to pay a sum of money on demand or at a definiteA promissory note is a written promise to pay a sum of money on demand or at a definite

time. It is payable to the order of a person or firm or to the bearer or holder of the note. Thetime. It is payable to the order of a person or firm or to the bearer or holder of the note. The

person or firm that makes the promise signs it. The one to whose order the note is payable isperson or firm that makes the promise signs it. The one to whose order the note is payable is

called thecalled thepayeepayee, and the one making the promise is called the, and the one making the promise is called the makermaker..

Notes have several characteristics that affect how they are recorded and reported in theNotes have several characteristics that affect how they are recorded and reported in the

financial statements. The characteristics are described in the following paragraphs: -financial statements. The characteristics are described in the following paragraphs: -

Due DateDue Date

The date a note is to be paid is called theThe date a note is to be paid is called the Due Date or Maturity dateDue Date or Maturity date. The period of time. The period of time

between the issuance date and the due date of a short-term note may be stated in either days orbetween the issuance date and the due date of a short-term note may be stated in either days or

156


4/20

months. When the term on a note is expressed in days, the maturity date is the specifiedmonths. When the term on a note is expressed in days, the maturity date is the specified

number of days after the notes date. As an example, a five-day note dated January-1 maturesnumber of days after the notes date. As an example, a five-day note dated January-1 matures

and is due on Jannuary-6. A 90-day notes dated March-10, matures on Jun-8. This due date,and is due on Jannuary-6. A 90-day notes dated March-10, matures on Jun-8. This due date,

June-8, is computed as below: -June-8, is computed as below: -

Term of the Note--------------------------------------------90Term of the Note--------------------------------------------90

Days in March---------------------------31Days in March---------------------------31

Minus the date of the note-------------10Minus the date of the note-------------10

Days remaining in March------------------------21Days remaining in March------------------------21

Add days in April---------------------------------30Add days in April---------------------------------30

Add days in May----------------------------------Add days in May----------------------------------3131

8282

Number of days remaining to equal 90-daysNumber of days remaining to equal 90-days

(90 82 = 8)------------------------------------------------8(90 82 = 8)------------------------------------------------8

Therefore, Due date isTherefore, Due date is June-8.June-8.

The period of a note is sometimes expressed in months. When months are used, the noteThe period of a note is sometimes expressed in months. When months are used, the note

matures and is payable in the month of its maturity on the same date of the month as itsmatures and is payable in the month of its maturity on the same date of the month as its

original dateoriginal date

A three-month note dated March-10, for instance, is payable on June-10.A three-month note dated March-10, for instance, is payable on June-10.

Interest ComputationInterest Computation

Interest is the cost of borrowing money for the borrower. It is the profit from lending moneyInterest is the cost of borrowing money for the borrower. It is the profit from lending money

for the lender. The interest rate on notes is normally stated in terms of per year, regardless offor the lender. The interest rate on notes is normally stated in terms of per year, regardless of

the actual period of time involved.the actual period of time involved.

The formula for computing interest is as follows: -The formula for computing interest is as follows: -

Interest = Principal X Annual X TimeInterest = Principal X Annual X Time

(Face Amount interest Rate(Face Amount interest Rate

of the Note)of the Note)

To illustrate the formula, the interest on a Br. 10,000, 12%, 60 day note is computed as:-To illustrate the formula, the interest on a Br. 10,000, 12%, 60 day note is computed as:-

157


5/20

Br. 10,000 X 12% X 60/360 = 200Br. 10,000 X 12% X 60/360 = 200

N.B.N.B.To simplify interest computations for notes with periods expressed in days, it is commonTo simplify interest computations for notes with periods expressed in days, it is common

to treat a year as having 360 days.to treat a year as having 360 days.

Maturity ValueMaturity Value

The amount that is due at the maturity or due date is called the maturity value. The maturityThe amount that is due at the maturity or due date is called the maturity value. The maturity

value of a note is the sum of the face amount and the interest. In the above example, thevalue of a note is the sum of the face amount and the interest. In the above example, the

maturity value is Br. 10,200 (which is Br. 10,000 face amount plus Br. 200 interest)maturity value is Br. 10,200 (which is Br. 10,000 face amount plus Br. 200 interest)

I.e. MV = FV + I where MV= Maturity valueI.e. MV = FV + I where MV= Maturity value

FV = Face valueFV = Face value

I = InterestI = Interest

8.5 ACCOUNTING FOR NOTES RECEIVABLE8.5 ACCOUNTING FOR NOTES RECEIVABLE

Notes Receivable are usually recorded in a single note Receivable account to simplify recordNotes Receivable are usually recorded in a single note Receivable account to simplify record

keeping. We need only one account because the original notes are kept on file. This means thekeeping. We need only one account because the original notes are kept on file. This means the

maker; rate of interest, due date, and other information can be learned by examining the actualmaker; rate of interest, due date, and other information can be learned by examining the actual

note.note.

To illustrate the recording of the receipt of a note, assume that on Jannuary-10, Nile Co. salesTo illustrate the recording of the receipt of a note, assume that on Jannuary-10, Nile Co. sales

merchandise on account to Tana Co. and receive a Br. 5,000, 90-day, 12% promissory note.merchandise on account to Tana Co. and receive a Br. 5,000, 90-day, 12% promissory note.

This transaction is recorded as: -This transaction is recorded as: -

Jan. 10. Notes Receivable ------------------------5000Jan. 10. Notes Receivable ------------------------5000

Sales--------------------------------------5000Sales--------------------------------------5000

The maker of the note usually honors the note and pays it in full. The entry required to recordThe maker of the note usually honors the note and pays it in full. The entry required to record

the receipt of cash by Nile Co. from Tana Co. is as follows:the receipt of cash by Nile Co. from Tana Co. is as follows:

April-10 Cash------------------------------5150April-10 Cash------------------------------5150

Notes Receivable-----------------------5000Notes Receivable-----------------------5000

Interest RevenueInterest Revenue (500 X 12/100 X 90/360)(500 X 12/100 X 90/360)----150----150

Companies can sometimes accept a note for an overdue customer as a way of granting a timeCompanies can sometimes accept a note for an overdue customer as a way of granting a time

extension on a past-due account Receivable. To illustrate, assume that a 60-day, 10% noteextension on a past-due account Receivable. To illustrate, assume that a 60-day, 10% note

dated September 5, 20x1 is accepted by Awash Co. in settlement of the account of Happy co,dated September 5, 20x1 is accepted by Awash Co. in settlement of the account of Happy co,

158


6/20

which is past due and has a balance of 10,000. The entry to record the transaction is aswhich is past due and has a balance of 10,000. The entry to record the transaction is as

follows:follows:

September 5 N/R---------------------------------------------10, 000September 5 N/R---------------------------------------------10, 000

A/R ----------------------------------------------10,000A/R ----------------------------------------------10,000

Received a note to settle accountReceived a note to settle account

Recording a dishonored noteRecording a dishonored note

When a notes maker is unable or refuses to pay at maturity, the note is dishonored. The act ofWhen a notes maker is unable or refuses to pay at maturity, the note is dishonored. The act of

dishonoring a note doesnt relieve the maker of the obligation to pay. The payee should usedishonoring a note doesnt relieve the maker of the obligation to pay. The payee should use

every legitimate means to collect. But how do companies report this event? The balance of theevery legitimate means to collect. But how do companies report this event? The balance of the

Notes Receivable account normally includes only those notes that have not matured. When aNotes Receivable account normally includes only those notes that have not matured. When a

note is dishonored, we therefore remove the amount of this note from the Notes Receivablenote is dishonored, we therefore remove the amount of this note from the Notes Receivable

account and charge it back to an Accounts Receivable from its maker. Assume for instanceaccount and charge it back to an Accounts Receivable from its maker. Assume for instance

Nile Co., holds a Br. 1000, 12%, 30-day note of Ato Alemu. At maturity, Alemu dishonoredNile Co., holds a Br. 1000, 12%, 30-day note of Ato Alemu. At maturity, Alemu dishonored

the note. Nile Co. records this dishonoring of its N/R, on Oct. 25, as follows:the note. Nile Co. records this dishonoring of its N/R, on Oct. 25, as follows:

Oct.25, A/R---------------Ato Alemu 1010Oct.25, A/R---------------Ato Alemu 1010

N/R---------------------------1000N/R---------------------------1000

Int. Rev.-------------------------10Int. Rev.-------------------------10

To record dishonored note & interest of 1000 X 12% XTo record dishonored note & interest of 1000 X 12% X30/360 =1030/360 =10

The above entry records interest of Br. 10, which has been earned, even though the note hasThe above entry records interest of Br. 10, which has been earned, even though the note has

been dishonored.been dishonored.

End-Of-Period interest AdjustmentEnd-Of-Period interest Adjustment

When notes receivable are outstanding at the end of an accounting period, accrued interest isWhen notes receivable are outstanding at the end of an accounting period, accrued interest is

computed and recorded. For example, on December 20, 20x1, Nile Co. accepted a Br. 2000,computed and recorded. For example, on December 20, 20x1, Nile Co. accepted a Br. 2000,

60-day, 12% notes from a customer in granting an extension of a past-due account. Assuming60-day, 12% notes from a customer in granting an extension of a past-due account. Assuming

that the accounting period ends on Dec. 31, the entries to record the receipt of the note,that the accounting period ends on Dec. 31, the entries to record the receipt of the note,

accrued interest, and payment of the note at maturity are shown below: -accrued interest, and payment of the note at maturity are shown below: -

Dec. 19. N/R -------------------------------------2000Dec. 19. N/R -------------------------------------2000

A/R- customer-X --------------------------------2000A/R- customer-X --------------------------------2000

159


7/20

Received note in settlement of A\RReceived note in settlement of A\R

Dec. 31. Interest Receivable-------------------------8Dec. 31. Interest Receivable-------------------------8

Int. Revenue------------------------------------8Int. Revenue------------------------------------8

Adjusting entry for ace needAdjusting entry for ace need

Interest, Br. 2000 X 12% X 12/360 = 8Interest, Br. 2000 X 12% X 12/360 = 8

Feb. 17. Cash----------------------------------2040Feb. 17. Cash----------------------------------2040

N/R---------------------------------------------2000N/R---------------------------------------------2000

Int. Rec.--------------------------------------------8Int. Rec.--------------------------------------------8

Int. Revenue-------------------------------------32Int. Revenue-------------------------------------32

Received pyt of note & interest at maturityReceived pyt of note & interest at maturity

The adjusting entry above on Dec. 31, 20X1,was required to show the interest earned for theThe adjusting entry above on Dec. 31, 20X1,was required to show the interest earned for the

period on the Income Statement.period on the Income Statement.

8.6 CONVERTING RECEIVABLES TO CASH BEFORE MATURITY8.6 CONVERTING RECEIVABLES TO CASH BEFORE MATURITY

Sometimes, companies convert receivables to cash before they are due. Reasons for thisSometimes, companies convert receivables to cash before they are due. Reasons for this

include the need for cash or a desire not to be involved in collection activities. Convertinginclude the need for cash or a desire not to be involved in collection activities. Converting

receivable is usually done either (1) by selling them, or (2) by using them as security for areceivable is usually done either (1) by selling them, or (2) by using them as security for a

loan. The topic of using notes as security for a loan will be discussed in future courses. Notesloan. The topic of using notes as security for a loan will be discussed in future courses. Notes

Receivable can be converted to cash by discounting them at a financial institution such as aReceivable can be converted to cash by discounting them at a financial institution such as a Bank. The process has three steps as indicated in the following diagram. In the first step, theBank. The process has three steps as indicated in the following diagram. In the first step, the

maker receives goods, service or cash from the payee in exchange for the note. In the secondmaker receives goods, service or cash from the payee in exchange for the note. In the second

step, the payee discounts the note with a bank and receives the maturity value of the note lessstep, the payee discounts the note with a bank and receives the maturity value of the note less

a discount (a fee) charged by the bank. In the third step, the maker pays the bank at thea discount (a fee) charged by the bank. In the third step, the maker pays the bank at the

maturity of the note.maturity of the note.

MakerMaker Goods (1)Goods (1) PayeePayee

Note (2)Note (2)

Cash (3)Cash (3) cash less discountcash less discount

BankBank

Note (2)Note (2)

160


8/20

Notes ReceivableNotes Receivable are discounted with or withoutare discounted with or without recourserecourse. When a note is discounted without. When a note is discounted without

recourse, the bank assumes the risk of a bad debt loss and the original payee doesnt have arecourse, the bank assumes the risk of a bad debt loss and the original payee doesnt have a

contingent liability. A contingent liability is an obligation to make a future payment if andcontingent liability. A contingent liability is an obligation to make a future payment if and

only if an uncertain future event occurs. A note discounted without recourse is like an outrightonly if an uncertain future event occurs. A note discounted without recourse is like an outright

sale of an asset. If a note is discounted with recourse and the original maker of the note failssale of an asset. If a note is discounted with recourse and the original maker of the note fails

to pay the bank when it matures, the payee of the note must pay for it. This means a companyto pay the bank when it matures, the payee of the note must pay for it. This means a company

discounting a note (an endorser) with recourse has a contingent liability until the bank is paid.discounting a note (an endorser) with recourse has a contingent liability until the bank is paid.

A Co. should disclose contingent liabilities in the accompanying notes to its financialA Co. should disclose contingent liabilities in the accompanying notes to its financial

statements.statements.

To illustrate, assume that a 90-day, 12%, Br. 20,000 N/R from Hiwot Co. dated Jan.1, 20x2 isTo illustrate, assume that a 90-day, 12%, Br. 20,000 N/R from Hiwot Co. dated Jan.1, 20x2 is

discounted at the payees bank on February 12, 20x2 at thediscount rate of 15%. The steps todiscounted at the payees bank on February 12, 20x2 at thediscount rate of 15%. The steps to

determine thedetermine the proceedsproceeds (-the amount to be received by the payee from the bank upon(-the amount to be received by the payee from the bank upon

discounting) are as follows:discounting) are as follows:

Step 1Step 1 Determine the maturity date & maturity value. Determine the maturity date & maturity value.

MD = April 1 & MV = FV + I = 20,000 + [20,000 X 12% X 90/360]MD = April 1 & MV = FV + I = 20,000 + [20,000 X 12% X 90/360]

= 20,600= 20,600

Step 2Step 2 Determine the Bank Discount ( Determine the Bank Discount (Bank discountBank discountis an interest that is charged byis an interest that is charged by

the bank and is computed based on the maturity value of the note for the discountthe bank and is computed based on the maturity value of the note for the discount

period.period. Discount PeriodDiscount Periodis the time the bank must hold the note) before it becomesis the time the bank must hold the note) before it becomes

due.due.

Bank Discount = MV X DR X DP where MV = Maturity value ( 20,600)Bank Discount = MV X DR X DP where MV = Maturity value ( 20,600)

DR = Discount Rate (15%)DR = Discount Rate (15%)

Discount = 20,600 X 15% X 48/360 DP = Discount period ( fromDiscount = 20,600 X 15% X 48/360 DP = Discount period ( from

February12 to April 1)February12 to April 1)

== 412412

Step 3Step 3- Determine proceed (proceed is the amount of cash paid to the endorser after- Determine proceed (proceed is the amount of cash paid to the endorser after

deducting discount)deducting discount)

i.e. proceed = MV Di.e. proceed = MV D

161


9/20

= 20,600 412 = 20188= 20,600 412 = 20188

Step 4Step 4 Record the necessary journal entry at the date of discount. (Here, record interest Record the necessary journal entry at the date of discount. (Here, record interest

revenue which is the excess of proceeds from the face value or record interestrevenue which is the excess of proceeds from the face value or record interest

expense when the proceed is less than the face value of the note)expense when the proceed is less than the face value of the note)

Feb 12. Cash---------------------------------20,188Feb 12. Cash---------------------------------20,188

N/R -----------------------------------------20,000N/R -----------------------------------------20,000

I. Rev. --------------------------------------188.00I. Rev. --------------------------------------188.00

Discounted Br. 20,000, 90-day, 12% note at 15%Discounted Br. 20,000, 90-day, 12% note at 15%

The length of the discount period and the difference between the interest rate and the discountThe length of the discount period and the difference between the interest rate and the discount

rate determine whether interest expense or interest revenue will result from discounting.rate determine whether interest expense or interest revenue will result from discounting.

When a discounted Notes Receivable is dishonored, the bank notifies the endorser and asksWhen a discounted Notes Receivable is dishonored, the bank notifies the endorser and asks

for payment if there is no statement that limits the responsibility of the endorser. In somefor payment if there is no statement that limits the responsibility of the endorser. In some

cases, the bank may charge a protest fee of notifying the endorser that a note has beencases, the bank may charge a protest fee of notifying the endorser that a note has been

dishonored. The entire amount paid to the bank by the endorser, including the interest anddishonored. The entire amount paid to the bank by the endorser, including the interest and

protest fee, should be debited to the A/R of the maker. For example, assume that the maker,protest fee, should be debited to the A/R of the maker. For example, assume that the maker,

Hiwot Co, dishonored the above discounted note at maturity. The bank charges a protest feeHiwot Co, dishonored the above discounted note at maturity. The bank charges a protest fee

of Br. 25. The endorsers entry to record the payment to the bank is as follows:of Br. 25. The endorsers entry to record the payment to the bank is as follows:

April 2. A/R Hiwot Co----------------- 20,625April 2. A/R Hiwot Co----------------- 20,625

Cash-----------------------------------20, 625Cash-----------------------------------20, 625

Paid dishonored, discounted notePaid dishonored, discounted note


1.Chilallo Co. issued a 60-day, 12% note for Br. 40,000, dated February-12, to Garra Muleta1.Chilallo Co. issued a 60-day, 12% note for Br. 40,000, dated February-12, to Garra Muleta

Co. an account.Co. an account.

a)a) Determine the due date of the noteDetermine the due date of the note

b)b) Determine the maturity value of the noteDetermine the maturity value of the note

c)c) Present entries required to record the followingPresent entries required to record the following

Receipt of the note by the payee.Receipt of the note by the payee.

Receipt by payee of payment of the note at maturity.Receipt by payee of payment of the note at maturity.

162


10/20

2. Record the following transaction in the account of Axumite Co.2. Record the following transaction in the account of Axumite Co.

May-1. Received a Br. 15,000, 60-day, 12% note from Adama Co. on account.May-1. Received a Br. 15,000, 60-day, 12% note from Adama Co. on account.

May-21. Discounted the note at Mekele Bank at 14%May-21. Discounted the note at Mekele Bank at 14%

June-30. The note is dishonored, paid the bank the amount due on the note plus aJune-30. The note is dishonored, paid the bank the amount due on the note plus a

protest fee of Br. 30.protest fee of Br. 30.

July-20. Received the amount due on the dishonored note plus interest for 20-days, atJuly-20. Received the amount due on the dishonored note plus interest for 20-days, at

12% on the amount charged to Adama Co. on April-30.12% on the amount charged to Adama Co. on April-30.

8.7 ACCOUNTING FOR UNCOLLECTIBLE ACCOUNTS RECEIVABLE8.7 ACCOUNTING FOR UNCOLLECTIBLE ACCOUNTS RECEIVABLE

When credit is extended, some amount of uncollectible receivables is generally inevitableWhen credit is extended, some amount of uncollectible receivables is generally inevitable

regardless of the care taken in granting credit and the control procedures used. The operatingregardless of the care taken in granting credit and the control procedures used. The operating

expense incurred because of the failure to collect receivables is called Uncollectible Accountsexpense incurred because of the failure to collect receivables is called Uncollectible Accounts

Expense or Bad Debts Expense or Doubtful Accounts Expense.Expense or Bad Debts Expense or Doubtful Accounts Expense.

When does an account as a note become uncollectibles? There is no general rule forWhen does an account as a note become uncollectibles? There is no general rule for

determining when an account receivable becomes uncollectible. The fact that a debtor fails todetermining when an account receivable becomes uncollectible. The fact that a debtor fails to

pay an account receivable according to a sales contract or fails to pay a note on the due datepay an account receivable according to a sales contract or fails to pay a note on the due date

does not necessarily mean that the account receivable will be uncollectible. The debtorsdoes not necessarily mean that the account receivable will be uncollectible. The debtors

bankruptcy is one of the most significant indications of partial or complete uncollectibility.bankruptcy is one of the most significant indications of partial or complete uncollectibility.

Other indications include the closing of the customers business and the failure of repeatedOther indications include the closing of the customers business and the failure of repeated

attempts to collect.attempts to collect.

There are two methods of accounting for uncollectible receivables. The allowance method,There are two methods of accounting for uncollectible receivables. The allowance method,

which provides an expense for uncollectible receivables in advance of their write-off (removalwhich provides an expense for uncollectible receivables in advance of their write-off (removal

from the ledger) and the direct write-off method, which recognizes the expense only whenfrom the ledger) and the direct write-off method, which recognizes the expense only when

accounts receivable are judged to be worthless. We will discuss each of these methods next.accounts receivable are judged to be worthless. We will discuss each of these methods next.

8.7.1 Allowance Method8.7.1 Allowance Method

The allowance method of accounting for bad debts matches the expected loss fromThe allowance method of accounting for bad debts matches the expected loss from

uncollectibles A/R against the sales they helped produce. We must useuncollectibles A/R against the sales they helped produce. We must use expectedexpected losses sincelosses since

management cant exactly identify the customers who wont pay their bills at the time of sale.management cant exactly identify the customers who wont pay their bills at the time of sale.

This means at the end of each period the allowance method requires us to estimate the totalThis means at the end of each period the allowance method requires us to estimate the total

163


11/20

bad debts expected to result from that periods sales. An allowance is then recorded for thisbad debts expected to result from that periods sales. An allowance is then recorded for this

expected loss. This method has two advantages over the direct write-off method:expected loss. This method has two advantages over the direct write-off method:

(1) Bad debt expense is charged to the period in which the related sales are recognized, and(1) Bad debt expense is charged to the period in which the related sales are recognized, and

(2) A/R is reported on the Balance Sheet at the estimated amount of cash to be collected.(2) A/R is reported on the Balance Sheet at the estimated amount of cash to be collected.

The allowance method estimates bad debt expense at the end of each accountig period andThe allowance method estimates bad debt expense at the end of each accountig period and

records it through an adjusting entry. To illustrate this method, assume the A/R account has arecords it through an adjusting entry. To illustrate this method, assume the A/R account has a

balance of Br. 50,000 and based on careful study of the experience of other companies, Nilebalance of Br. 50,000 and based on careful study of the experience of other companies, Nile

Co. estimates that a total of Br. 2000 will be uncollectibles.Co. estimates that a total of Br. 2000 will be uncollectibles.

This estimated expense is recorded through the following adjusting entry.This estimated expense is recorded through the following adjusting entry.

Dec. 31 Uncollectibles Accounts Expense 2000Dec. 31 Uncollectibles Accounts Expense 2000

Allowance for Doubtful Accounts 2000Allowance for Doubtful Accounts 2000

To record estimated bad debtsTo record estimated bad debts

The amount Br. 2000 is an estimated reduction in A/R;but it cannot be credited to specificThe amount Br. 2000 is an estimated reduction in A/R;but it cannot be credited to specific

customer accounts or to the A/R controlling account. Instead, a contra asset account entitledcustomer accounts or to the A/R controlling account. Instead, a contra asset account entitled

Allowance for Doubtful Accounts is credited.Allowance for Doubtful Accounts is credited.

As with all periodic adjustments the above entry serves two purposes. First, it reduces theAs with all periodic adjustments the above entry serves two purposes. First, it reduces the

value of the receivable to the amount of cash expected to be realized in the future. Thisvalue of the receivable to the amount of cash expected to be realized in the future. This

amount, which is Br. 48,000 (Br. 50,000 Br. 2,000), is called the Net Realizable value of theamount, which is Br. 48,000 (Br. 50,000 Br. 2,000), is called the Net Realizable value of the

receivables. Second, the adjusting entry matches the Br. 2000 expense of uncollectiblesreceivables. Second, the adjusting entry matches the Br. 2000 expense of uncollectibles

account with the related revenues of the period.account with the related revenues of the period.

Write-off to the Allowance AccountWrite-off to the Allowance Account

When specific accounts are identified as uncollectibles, they are written-off against theWhen specific accounts are identified as uncollectibles, they are written-off against the

Allowance for Doubtful Accounts. Assume after spending some time trying to collect fromAllowance for Doubtful Accounts. Assume after spending some time trying to collect from

Shalla Co., Nile Co. decides that Shallas Br. 200 accounts receivable is uncollectible andShalla Co., Nile Co. decides that Shallas Br. 200 accounts receivable is uncollectible and

makes the following entry to writ-it off.makes the following entry to writ-it off.

164


12/20

Jan. 25 Allowance for Doubtful Accounts 200Jan. 25 Allowance for Doubtful Accounts 200

A/R-Shalla Co. 200A/R-Shalla Co. 200

To write-off uncollectible accounts.To write-off uncollectible accounts.

Note two aspects of this entry and its related accountsNote two aspects of this entry and its related accounts

Before Write-off After Write-offBefore Write-off After Write-off

A/RA/R 50,00050,000 49,80049,800

Less Allowance for D. a/csLess Allowance for D. a/cs 2,0002,000 1,8001,800

NRVNRV 48,00048,000 48,00048,000

Neither total assets nor net income are affected by the Write-off of a specific account. ButNeither total assets nor net income are affected by the Write-off of a specific account. But

both total assets and net income are affected by the recognized bad debts expense for the yearboth total assets and net income are affected by the recognized bad debts expense for the year

in the adjusting entry.in the adjusting entry.

Recovery of Uncollectibles AccountsRecovery of Uncollectibles Accounts

When a customer fails to pay and the account is written-off as uncollectibles, his or her creditWhen a customer fails to pay and the account is written-off as uncollectibles, his or her credit

standing is jeopardized. To help restore credit standing, a customer may later choose tostanding is jeopardized. To help restore credit standing, a customer may later choose to

voluntarily pay all or part of the amount owed. A company makes two entries when collectingvoluntarily pay all or part of the amount owed. A company makes two entries when collecting

an account previously written-off. The first is to reverse the original write-off and reinstate thean account previously written-off. The first is to reverse the original write-off and reinstate the

customers account. For example, assume the amount written-of in the preceding entry is latercustomers account. For example, assume the amount written-of in the preceding entry is later

collected on February 15.collected on February 15.

On Feb. 15- The entries to record this recovery are:On Feb. 15- The entries to record this recovery are:

Feb. 15- A/R Shalla Co. 200Feb. 15- A/R Shalla Co. 200


To reinstate accounts previously written-offTo reinstate accounts previously written-off

Feb. 15- Cash 200Feb. 15- Cash 200

A/R-Shalla Co. 200A/R-Shalla Co. 200

To record full payment of accountTo record full payment of account

8.7.2 Estimating Uncollectibles8.7.2 Estimating Uncollectibles

The allowance method of accounting for bad debts requires an estimate of bad debts expenseThe allowance method of accounting for bad debts requires an estimate of bad debts expense

to prepare the adjusting entry at the end of each accounting period. How does a companyto prepare the adjusting entry at the end of each accounting period. How does a company

estimate bad debts expense? There are two common methods. One is based on the Incomeestimate bad debts expense? There are two common methods. One is based on the Income

165


13/20

Statement relationship between bad debts expense and sales. The second is based on theStatement relationship between bad debts expense and sales. The second is based on the

Balance Sheet relationship between A/R and the Allowance for Doubtful Accounts. BothBalance Sheet relationship between A/R and the Allowance for Doubtful Accounts. Both

methods require an analysis of past experience.methods require an analysis of past experience.

8.7.2.1 Estimating Based on Sales8.7.2.1 Estimating Based on Sales

Accounts receivable are created by credit sales. The amount of credits sales during the periodAccounts receivable are created by credit sales. The amount of credits sales during the period

may therefore be used to estimate the amount of uncollectible accounts expense. The amountmay therefore be used to estimate the amount of uncollectible accounts expense. The amount

of this estimate is added to whatever balance exists in Allowance for Doubtful Accounts. Toof this estimate is added to whatever balance exists in Allowance for Doubtful Accounts. To

illustrate, assume Wonji Co. has credit sales of Br. 500,000 in 20X2. Based on pastillustrate, assume Wonji Co. has credit sales of Br. 500,000 in 20X2. Based on past

experience and the experience of other Cos, Wonji Co. estimated 0.007% of credit sales areexperience and the experience of other Cos, Wonji Co. estimated 0.007% of credit sales are

uncollectible. Using this prediction, the adjusting entry for uncollectible accounts at the end ofuncollectible. Using this prediction, the adjusting entry for uncollectible accounts at the end of

the period, 20X2 is as follows.the period, 20X2 is as follows.

Dec. 31 Uncollectibles Accounts Exp. (500,000 X 0.007%) 3500Dec. 31 Uncollectibles Accounts Exp. (500,000 X 0.007%) 3500


To record estimated Uncoll. Exp.To record estimated Uncoll. Exp.

This entry doesnt mean that the Dec. 31, 20X2, balance of Allowance for Doubtful AccountsThis entry doesnt mean that the Dec. 31, 20X2, balance of Allowance for Doubtful Accounts

will be Br. 3500. A Br. 3500 balance results only if the account had a zero balance prior towill be Br. 3500. A Br. 3500 balance results only if the account had a zero balance prior to

posting the adjusting entry. For example, assume that Allowance for Doubtful Accounts has aposting the adjusting entry. For example, assume that Allowance for Doubtful Accounts has a

credit balance of Br. 1000 before adjustment. Now, what will be the balance of Allowance forcredit balance of Br. 1000 before adjustment. Now, what will be the balance of Allowance for

Doubtful Accounts be at the end of 20X2 ? It will be Br. 4500. If there had been a debitDoubtful Accounts be at the end of 20X2 ? It will be Br. 4500. If there had been a debit

balance of Br. 500 in the Allowance for Doubtful Accounts before the year-end adjustment,balance of Br. 500 in the Allowance for Doubtful Accounts before the year-end adjustment,

and the amount of adjustment. would still have been Br. 3500. What will have been the endand the amount of adjustment. would still have been Br. 3500. What will have been the end

balance of Allowance for Doubtful Accounts at the end of 20X2? (Find by your own!)balance of Allowance for Doubtful Accounts at the end of 20X2? (Find by your own!)

8.7.2.2 Estimate Based on Analysis of Receivables8.7.2.2 Estimate Based on Analysis of Receivables

The longer an A/R remains outstanding, the less likely that it will be collected. Thus, we canThe longer an A/R remains outstanding, the less likely that it will be collected. Thus, we can

base the estimate of uncollectibles accounts on how long the accounts have been outstanding.base the estimate of uncollectibles accounts on how long the accounts have been outstanding.

For this purpose, we can use a process called Ageing receivables which examines each A/R toFor this purpose, we can use a process called Ageing receivables which examines each A/R to

estimate the amount of uncollectibles. Receivables are classified by how long they are pastestimate the amount of uncollectibles. Receivables are classified by how long they are past

their due date. Then, estimates of uncollectibles are made assuming the longer an amount istheir due date. Then, estimates of uncollectibles are made assuming the longer an amount is

past due the more likely it is to be uncollectible. After the outstanding amounts are classifiedpast due the more likely it is to be uncollectible. After the outstanding amounts are classified

166


14/20

and analyzed in the Aging schedule the expected balance for the Allowance for Doubtfuland analyzed in the Aging schedule the expected balance for the Allowance for Doubtful

Accounts will be estimated. Lets assume the amount estimated is Br. 5000. So, do you thinkAccounts will be estimated. Lets assume the amount estimated is Br. 5000. So, do you think

this is the adjustment amount required for the current period? NO!this is the adjustment amount required for the current period? NO!

Because, this estimated amount is the expected balance of the Allowance for DoubtfulBecause, this estimated amount is the expected balance of the Allowance for Doubtful

Accounts after adjustment rather than the current year provision for Uncollectible AccountsAccounts after adjustment rather than the current year provision for Uncollectible Accounts

Expense. Therefore, to determine the current year provision we must take in to account theExpense. Therefore, to determine the current year provision we must take in to account the

balance before adjustment in the Allowance for Doubtful Accounts. To illustrate, assumebalance before adjustment in the Allowance for Doubtful Accounts. To illustrate, assume

there is as credit Balance of Br. 1300 in the allowance account before adjustment. The amountthere is as credit Balance of Br. 1300 in the allowance account before adjustment. The amount

to be added to this balance is therefore Br. 3800 (B.r 5000 Br. 1200) and the adjustmentto be added to this balance is therefore Br. 3800 (B.r 5000 Br. 1200) and the adjustment

entry is as follows:entry is as follows:

Dec. 31 Uncollectible Accounts Expense 3800Dec. 31 Uncollectible Accounts Expense 3800


To record Uncollectible expense.To record Uncollectible expense.

Alternatively, if the Allowance for Doubtful Accounts had an unadjusted debit balance of Br.Alternatively, if the Allowance for Doubtful Accounts had an unadjusted debit balance of Br.

700, then the required adjustment is Br. 5700. (Br. 5000 + 700) and the adjustment entry is as700, then the required adjustment is Br. 5700. (Br. 5000 + 700) and the adjustment entry is as

follows:follows:

Dec. 31 . Uncollectible Accounts Expense 5700Dec. 31 . Uncollectible Accounts Expense 5700


To record Uncollectible expense .To record Uncollectible expense .

8.7.3 The Direct- Write-Off Method8.7.3 The Direct- Write-Off Method

The Direct Write-off method of accounting for bad debts records the loss from anThe Direct Write-off method of accounting for bad debts records the loss from an

uncollectible A/R at the time it is determined to be uncollectible. No attempt is made touncollectible A/R at the time it is determined to be uncollectible. No attempt is made to

predict uncollectible accounts expense. Bad debt expense is recorded when specific accountspredict uncollectible accounts expense. Bad debt expense is recorded when specific accounts

are determined to be worthless. If Wonji Co. uses a direct write-off method and determines onare determined to be worthless. If Wonji Co. uses a direct write-off method and determines on

Feb. 20, it cant collect from a customer- Home Co.- Br. 500. The entry to write-off theFeb. 20, it cant collect from a customer- Home Co.- Br. 500. The entry to write-off the

customers account is as followscustomers account is as follows

Feb. 20 Uncollectible Accounts Expense 500Feb. 20 Uncollectible Accounts Expense 500

167


15/20

A/R- Home Co. 500A/R- Home Co. 500

To write-off Uncollectible accountsTo write-off Uncollectible accounts

Some times an amount previously written off is later collected. This can be due to factors suchSome times an amount previously written off is later collected. This can be due to factors such

as continual collection efforts or the good fortune of a customer. If the account of Home Co.as continual collection efforts or the good fortune of a customer. If the account of Home Co.

that was written-off directly to Bad Debit Expense is later collected in full, the following twothat was written-off directly to Bad Debit Expense is later collected in full, the following two

entries record this recovery.entries record this recovery.

Mar. 5 - A/R- Home Co. 500Mar. 5 - A/R- Home Co. 500

Uncollectible Accounts Expense 500Uncollectible Accounts Expense 500

To reinstate accountTo reinstate account

Mar. 5 - Cash 500Mar. 5 - Cash 500

A/R- Home Co. 500A/R- Home Co. 500

To record full payment of accountTo record full payment of account

If the recovery is in the year following the writ- off, there is no balance in the UncollectibleIf the recovery is in the year following the writ- off, there is no balance in the Uncollectible

Accounts Expense account related to the previous years write-off and no other write-offs areAccounts Expense account related to the previous years write-off and no other write-offs are

expected. So the credit portion of the entry recording the recovery can be made to a Badexpected. So the credit portion of the entry recording the recovery can be made to a Bad

Debts Recoveries revenue account.Debts Recoveries revenue account.

To conclude this part companies must weigh at least two principles when considering use ofTo conclude this part companies must weigh at least two principles when considering use of

the direct write-off method:the direct write-off method:

(1) Matching principle, & (2) Materiality principle(1) Matching principle, & (2) Materiality principle

Check Your Progress Exercise - 4Check Your Progress Exercise - 4

1.1. Record the following transactions in the accounts of Dashen P/c.,Record the following transactions in the accounts of Dashen P/c.,

which uses the allowance method of accounting for uncollectibles receivables.which uses the allowance method of accounting for uncollectibles receivables.

Sep. 5- Sold merchandise on account to Hirut Co. Br. 5000Sep. 5- Sold merchandise on account to Hirut Co. Br. 5000

Oct. 20- Received Br. 3000 from, Hirut Co. and Writes-off the remainder owed on the sale ofOct. 20- Received Br. 3000 from, Hirut Co. and Writes-off the remainder owed on the sale of

September 5 as uncollectibles.September 5 as uncollectibles.

Dec. 10- reinstated the account of Hirut Co. that had been written-off on October-20 andDec. 10- reinstated the account of Hirut Co. that had been written-off on October-20 and

received Br. 2000 cash in full payment.received Br. 2000 cash in full payment.

168


16/20

8.8 SUMMARY8.8 SUMMARY

Receivables are money claims against other entities, including people, business firms andReceivables are money claims against other entities, including people, business firms and other organizations. These receivables as other assets of the business organization need to beother organizations. These receivables as other assets of the business organization need to be

properly handled otherwise they might be exposed for different type of error and fraud.properly handled otherwise they might be exposed for different type of error and fraud.

Based on the nature of the account, there are different accounting treatments required forBased on the nature of the account, there are different accounting treatments required for

recording transactions made on credit and for the related risk of uncollectibles that arise whenrecording transactions made on credit and for the related risk of uncollectibles that arise when

customers default to make payment according to their agreement. The common methods usedcustomers default to make payment according to their agreement. The common methods used

to treat uncollectibles accounts in the book of the payee are the allowance method and theto treat uncollectibles accounts in the book of the payee are the allowance method and the

direct-write-off method.direct-write-off method.

If a company selects the allowance method to treat uncollectibles, estimation is required eitherIf a company selects the allowance method to treat uncollectibles, estimation is required either

based on sales or analysis of receivables.based on sales or analysis of receivables.

8.9 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS8.9 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS


a.a. Account Receivable is classified as current asset because it is normally expected to beAccount Receivable is classified as current asset because it is normally expected to be

collected within a relatively short period or time.collected within a relatively short period or time.b.b. Segregation of duties for related activities is required in order to decrease theSegregation of duties for related activities is required in order to decrease the

possibility of inefficiency, error and fraud.possibility of inefficiency, error and fraud.


1.

a.a. April-13April-13

b.b. Br. 40,800 MV = FV + I = [40,000 + (40,000 X 12/100 X 60/360 )]Br. 40,800 MV = FV + I = [40,000 + (40,000 X 12/100 X 60/360 )]

c.c. 1- Notes Receivables----------------40,0001- Notes Receivables----------------40,000

A/R- Garra Muleta Co.----------------40,000A/R- Garra Muleta Co.----------------40,000

2- Cash-----------------------40,8002- Cash-----------------------40,800

N/R------------------------------40,000N/R------------------------------40,000

Interest Revenue-------------------800Interest Revenue-------------------800

169


17/20

2.2.

May-1. Note Receivable 15,000May-1. Note Receivable 15,000

A/R-Adama Co. 15, 000A/R-Adama Co. 15, 000

May-21. Cash (15300 238) 15062May-21. Cash (15300 238) 15062

N/R 15,000N/R 15,000

Interest Revenue 62Interest Revenue 62

June-30. A/R-Adama Co. (15300 + 30) 15330June-30. A/R-Adama Co. (15300 + 30) 15330

Cash 15330Cash 15330

July-20. Cash 15432.20July-20. Cash 15432.20

A/R-Adama Co. 15,330A/R-Adama Co. 15,330

Interest Revenue (15330 x 12/100 x 20/360) 102.20Interest Revenue (15330 x 12/100 x 20/360) 102.20


Sep. 5 A/R-Hirut Co. 5000Sep. 5 A/R-Hirut Co. 5000

Sale 5000Sale 5000

Oct.20 Cash 3000Oct.20 Cash 3000

A/R-Hiruit Co. 3000A/R-Hiruit Co. 3000

Allowance for Doubtful account 2000Allowance for Doubtful account 2000

A/R-Hirut Co. 2000A/R-Hirut Co. 2000

Dec. 10 A/R-Hiruit Co. 2000Dec. 10 A/R-Hiruit Co. 2000

Allowance for D.a/c 2000Allowance for D.a/c 2000

Cash 2000Cash 2000

A/R Hiruit Co. 2000A/R Hiruit Co. 2000

8.10 MODEL EXAMINATION QUESTIONS8.10 MODEL EXAMINATION QUESTIONS

1.1. Prepare journal entries to record the following transactions entered in to by MeskelPrepare journal entries to record the following transactions entered in to by Meskel

Company during the year 20X2.Company during the year 20X2.

170


18/20

September 1- Received a Br. 10,000, 12%, 60-day note from Yasin Co. as fullSeptember 1- Received a Br. 10,000, 12%, 60-day note from Yasin Co. as full

settlement of his open account.settlement of his open account.

October 20- Sold merchandise on account to Heaven Co. for B.r 25,000 by receiving aOctober 20- Sold merchandise on account to Heaven Co. for B.r 25,000 by receiving a

90-day, 10% note.90-day, 10% note.

October 31- Received full payment from Yasin Co. for notes received on September 1.October 31- Received full payment from Yasin Co. for notes received on September 1.

December 31- Record the adjusting entry required for accrued interest from October 20.December 31- Record the adjusting entry required for accrued interest from October 20.

Transaction. (assume that the Accounting period ends on December 31.)Transaction. (assume that the Accounting period ends on December 31.)

2.2. Nazareth cosmetics Co. is undecided about which base to use in estimatingNazareth cosmetics Co. is undecided about which base to use in estimating

uncollectibles accounts. On December 31, 20X2, the balance in Account Receivable wasuncollectibles accounts. On December 31, 20X2, the balance in Account Receivable was

Br. 800,000 and net credit sales amounted to Br. 1,500,000 during 20X2. An agingBr. 800,000 and net credit sales amounted to Br. 1,500,000 during 20X2. An aging

analysis of the account receivable indicated that Br. 12,000 in accounts receivable areanalysis of the account receivable indicated that Br. 12,000 in accounts receivable are

expected to be uncollectible. Past experience has shown that about of 1% of net creditexpected to be uncollectible. Past experience has shown that about of 1% of net credit

sales eventually are uncollectibles.sales eventually are uncollectibles.

Prepare the adjusting entries to record estimated bad debit expense using thePrepare the adjusting entries to record estimated bad debit expense using the

(1)(1) Percentage of sales basis, andPercentage of sales basis, and

(2)(2) The percentage of receivable basis under each of the following independentThe percentage of receivable basis under each of the following independent

assumptionsassumptions

a)a) Allowance for Doubtful Accounts has a credit balance of Br. 2000Allowance for Doubtful Accounts has a credit balance of Br. 2000

before adjustment.before adjustment.

b)b) Allowance for Doubtful Account has a debit balance of Br. 600Allowance for Doubtful Account has a debit balance of Br. 600

before adjustmentbefore adjustment

3.3. The Lasta Co. uses the allowance method for estimating uncollectibles accounts.The Lasta Co. uses the allowance method for estimating uncollectibles accounts.

Prepare journal entries to record the following transactions.Prepare journal entries to record the following transactions.

January 02- Sold merchandise to Nile Co. for Br. 30,000, term n/15.January 02- Sold merchandise to Nile Co. for Br. 30,000, term n/15.

February 15- Received Br. 20,000 from Nile Co. on account.February 15- Received Br. 20,000 from Nile Co. on account.

April 20- Written-off as uncollectible the remaining balance of Nile Co. account when theApril 20- Written-off as uncollectible the remaining balance of Nile Co. account when the

business declared bankruptcy.business declared bankruptcy.

June 1- unexpectedly received a check for Br. 6000 from Nile Co.June 1- unexpectedly received a check for Br. 6000 from Nile Co.

171


19/20

4. Compute the missing amounts for each of the following notes.4. Compute the missing amounts for each of the following notes.

PrincipalPrincipal Interest RateInterest Rate TimeTime Total InterestTotal Interest

(a) Br. 60,000(a) Br. 60,000 10 %10 % 1.5 years1.5 years ??

(b) Br. 200,000(b) Br. 200,000 ?? 9 months9 months Br. 17,250Br. 17,250

(c) ?(c) ? 12 %12 % 60 days60 days Br. 1,500Br. 1,500

(d) Br. 85,000(d) Br. 85,000 7 %7 % ?? 1,487.501,487.50

5.5. Meskerem Co. holds a 90-day, 10% note for Br. 100,000 dated June-12, that was receivedMeskerem Co. holds a 90-day, 10% note for Br. 100,000 dated June-12, that was received

from a customer on account. On June 30, the note is discounted at Borena Bank at the ratefrom a customer on account. On June 30, the note is discounted at Borena Bank at the rate

of 12.5 %.of 12.5 %.

a)a) Determine the maturity value of the note.Determine the maturity value of the note.

b)b) Determine the number of days in the discount periodDetermine the number of days in the discount period

c)c) Determine the amount of the discount.Determine the amount of the discount.

d)d) Determine the amount of the proceedsDetermine the amount of the proceeds

e)e) Present the journal entry required to record the discounting of the note on June 30.Present the journal entry required to record the discounting of the note on June 30.

8.11 GLOSSARY OF TERMS8.11 GLOSSARY OF TERMS

Account Receivable: -Account Receivable: - A claim against a customer for services rendered or goods sold onA claim against a customer for services rendered or goods sold on

credit.credit.

Aging the receivable: -Aging the receivable: - The process of analyzing the account receivable and classifying themThe process of analyzing the account receivable and classifying them

according to various age groupings, with the due date being the base point for determine age.according to various age groupings, with the due date being the base point for determine age.

Allowance method: -Allowance method: - A method of accounting for uncollectible receivables, wherebyA method of accounting for uncollectible receivables, whereby

advance provision for the uncollectibles is made.advance provision for the uncollectibles is made.

Current assetCurrent asset: - Cash or other assets that are expected to be converted to cash or sold or used: - Cash or other assets that are expected to be converted to cash or sold or used

up, usually within a year or less, through the normal operations of business.up, usually within a year or less, through the normal operations of business.

Direct write-off method: -Direct write-off method: - A method of accounting for uncollectibles receivables, wherebyA method of accounting for uncollectibles receivables, whereby

an expense is recognized only when specific accounts are judged to be uncollectible.an expense is recognized only when specific accounts are judged to be uncollectible.

Dishonored note receivable:Dishonored note receivable: - A note that the maker fails to pay on its due date.- A note that the maker fails to pay on its due date.

172


20/20

Notes Receivable: -Notes Receivable: - A written promise to pay by the maker, representing an amount to beA written promise to pay by the maker, representing an amount to be

received by the payee.received by the payee.

Uncollectibles accounts Expense: -Uncollectibles accounts Expense: - The operating expense incurred because of the failure toThe operating expense incurred because of the failure to

collect receivables.collect receivables.

173

recivables.doc

Documents