Download Accounting for Receivables

Chapter 8
Accounting for Receivables
• A receivable is a company’s 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 Receivable
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 Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:
Credit Sale:
Accounts Receivable
Sales Revenue
1,000
1,000
Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:
Credit Sale:
Accounts Receivable..... 1,000
Sales Revenue.........
1,000
Collection--2/10,n/30:
Cash..............................
Sales Discounts.............
Accounts Receivable
1,000
980
20
Uncollectible Accounts
Some receivables will never be
collected and must be written off
as uncollectible.
Uncollectible Accounts
• Occurs 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 Accounts
•Direct Method
Or:
•Allowance Method
EXAMPLE:
If We Have $100,000 in A/R
Invoice
ABC Inc.
$
They would be represented by a
stack of invoices
Under the
Direct Method
• All invoices are presumed to be good . . .
• (Valued at $100,000)
• until we discover someone can’t pay
the amount owed.
Direct Method
Invoice
ABC Inc.
$
• 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
Invoice
ABC Inc.
$
Journal Entry to record Bad Debt:
Dr.
Bad Debt Expense
Accounts Receivable
Cr.
500
500
Direct Method
Invoice
ABC Inc.
$
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
Invoice
ABC Inc.
$
Like all assets, the value of A/R is
only what you expect to collect.
1. Accounts Receivable is overstated.
2. Bad debt expense is understated!
It is not recorded in the same period the sale
was made.
The Matching Principle
• Requires expenses be recorded in the
same period the corresponding revenue
is recognized.
Direct Method is in conflict with the
Matching Principle
Not accepted under GAAP
Under the
Allowance Method
Invoice
ABC Inc.
$
If We Have $100,000
in A/R
• We presume some invoices will not
be good . . .
• We just don’t know which ones.
Allowance Method
How do we write off an unknown
amount of Accounts Receivable?
ESTIMATE the amount,
but don’t remove any
invoices from A/R
Allowance Method
• An estimate can be based on:
a)
b)
c)
d)
Size of the receivables
Age of the receivables
Past loss experience
All of the above
Allowance Method
• An estimate can be based on:
a)
b)
c)
d)
Size of the receivables
Age of the receivables
Past loss experience
All of the above
Allowance Method
Assume you made an estimate that
$2000 will not be collectable. What
journal entry would you make?
Dr.
Cr.
Hint: Accounts Receivable is NOT reduced because
which invoices will become uncollectable is unknown!
Allowance Method
Dr.
Bad Debt Expense
Allowance for Doubtful Accounts
To record estimated bad debts
Cr.
2000
2000
Balance Sheet Presentation
Assets:
Cash
Accounts Receivable
Supplies
PP&E
Total Assets
20,000
100,000
2,500
The Allowance
3,000,000
for Doubtful
3,120,500
Accounts is a
contra asset
that follows A/R
Balance Sheet Presentation
Assets:
Cash
20,000
Accounts Receivable
100,000
Less Allowance for DA
2,000
Net Accounts Receivable
98,000
Supplies
2,500
PP&E
3,000,000
Total Assets
3,120,500
Note: Accounts Receivable is NOT reduced but the
net receivable is!
Allowance Method
Journal Entry needed when an account
is identified as uncollectible:
Dr.
Cr.
Allowance for Doubtful Accounts 500
Accounts Receivable
500
To write off Smith Co. (in bankruptcy)
Direct vs. Allowance Methods
Direct Method
May 5
Bad Debt Expense
Dr.
Cr.
500
Accounts Receivable
500
The
difference is
Allowance Method
Dec 31 Bad Debt Expense
Allowance for DA
May 5
Allowance for DA
Accounts Receivable
Dr.
TIMING
Cr.
2000
2000
500
500
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, as shown below:
Acct Receivable
$100,000
Less Allowance for
Doubtful Accounts
2,000
Net Receivables
$ 98,000
Acct Receivable
$99,500
Less Allowance for
Doubtful Accounts
1,500
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.
Reversing Written-Off Receivables
Reverse Write Off:
Accounts Receivable
500
Allowance for Doubtful Accounts
To reinstate a written-off receivable.
500
Reversing Written-Off Receivables
Reverse Write Off:
Accounts Receivable
500
Allowance for Doubtful Accounts
To reinstate a written-off receivable.
Eliminate Receivable:
Cash
Accounts Receivable
Payment for written-off receivable.
500
500
500
Estimating the Allowance for
Uncollectible Accounts
• Percentage 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 Expense
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 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.
Bad Debt
Expense
Allowance for
Doubtful Accounts
350 Balance
Expense
2,701
2,701 Expense
End. Balance 2,701
3,051 End. Bal.
Example: Bad Debt Expense
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.
Bad Debt
Expense
Allowance for
Doubtful Accounts
350 Balance
Expense
2,701
2,701 Expense
End. Bal.
2,701
3,051 End. Bal.
Bad Debt Expense
2,701
Allowance for Doubtful Accounts
2,701
To adjust the Allowance account to desired balance.
Example 2: 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.
Age
Balance
Current.............. $10,000
1-30 days..........
4,000
31-90 days........
2,100
Over 90 days.....
1,000
$17,000
Percentage
Estimated to be
Uncollectible Amount
1.5
$ 150
4.0
160
20.0
420
40.0
400
$1,130
Example 2: 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.
Uncollectible
Account
Expense
Allowance for
Doubtful Accounts
150 Balance
Expense
980
980 Expense
End. Bal.
980
1,130 End. Bal.
Example 2: 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.
Uncollectible
Account
Expense
Allowance for
Doubtful Accounts
150 Balance
Expense
980
980 Expense
End. Bal.
980
1,130 End. Bal.
Uncollectible Account Expense
980
Allowance for Doubtful Accounts
980
To adjust the Allowance account to desired balance.
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?
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.
Assessing Management of Receivables
• Accounts Receivable Turnover--A
measure used to determine a
company’s average collection period for
receivables. Computed by dividing net
sales (credit sales) by average accounts
receivables.
Assessing Management of Receivables
• Accounts Receivable Turnover
• Number 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.
Example
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.
Example
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
Average Accounts Receivable
$150,000 = 4.0
$ 37,500
Example
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.
Number of Days in Receivables:
Number of Days
Accounts Receivable Turnover
365 = 91.25
4.0
Notes Receivable
• A 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 longterm assets, depending on the due
date.
Notes Receivable -- Components
• 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.
Computing Interest
Principal
(amount)
Computing Interest
Principal
(amount)
X
Interest
Rate (%)
Computing Interest
Principal
(amount)
X
Interest
Rate (%)
X
Time
(years)
Computing Interest
Principal
(amount)
X
Interest
Rate (%)
Equals
Interest
Owed
X
Time
(years)
Example: Interest
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.
Example: Interest
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 = $172.60
What journal entries are required for the Ohio
Company? For the Virginia Company?
Journalizing Notes Receivable
The Ohio Company--Maker
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
Journalizing Notes Receivable
The Virginia Company--Payee
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
Selling or Factoring Receivables
• Receivables 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.