Reporting and analyzing receivables

Cr.Bad Debt Expense 2000Allowance for Doubtful Accounts 2000 To record estimated bad debts Allowance Method... 1 The Allowance for Doubtful Accounts is a contra-asset account which is su

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

Example: Accounts Receivable

Uncollectible Accounts

Some receivables will never be collected and must be written off

as uncollectible.

Two Methods of Accounting for

Uncollectible Accounts

• Direct Method

Or:

• Allowance Method

• until we discover someone can’t 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

Invoice

ABC Inc $

But, we know some customers in the stack will not pay.

So, what is the real value of A/R?

1 Accounts Receivable is overstated.

2 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 Principle

Not accepted under GAAP

The Matching Principle

• An estimate can be based on:

a) Size of the receivables

b) Age of the receivables

c) Past loss experience

d) All of the above

Allowance Method

• An estimate can be based on:

a) Size of the receivables

b) Age of the receivables

c) Past loss experience

d) 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 Cr.Bad Debt Expense 2000

Allowance for Doubtful Accounts 2000

To record estimated bad debts

Allowance Method

Balance Sheet Presentation

Balance Sheet Presentation

Assets:

20,000

Accounts Receivable 100,000

Less Allowance for DA 2,000

Net Accounts Receivable

Note: Accounts Receivable is NOT reduced but the

net receivable is!

Journal Entry needed when an account

TIMING

(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 $99,500 Less Allowance for Less Allowance for

Doubtful Accounts 2,000 Doubtful Accounts

1,500

Net 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 Receivables

Reverse 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:

Accounts Receivable 500

Payment for written-off receivable.

Reversing Written-Off Receivables

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

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

350 Balance

Expense 2,701 2,701 Expense End Balance 2,701 3,051 End Bal.

Allowance for Doubtful Accounts

Example: Bad Debt Expense

Bad Debt Expense 2,701

Allowance for Doubtful Accounts 2,701

To 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

Bad Debt Expense

350 Balance

Expense 2,701 2,701 Expense End Bal 2,701 3,051 End Bal.

Allowance for Doubtful Accounts

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 be

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 1,130 End Bal.

Example 2: Bad Debt Expense

980

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.

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 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.

• 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.

Assessing Management of 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

The Wheeler Company had Net Credit Sales

of $150,000 during 2009 The accounts

Number of Days in Receivables:

Accounts Receivable Turnover 4.0

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

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 term assets, depending on the due

long-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 Interest

Principal

(amount)

Principal

(amount)

Interest Rate (%)

X

Computing Interest

Principal

(amount)

Interest Rate (%)

Time (years)

Computing Interest

Principal

(amount)

Interest Rate (%)

Time (years)

Interest Owed

Equals

Computing Interest

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

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

The Ohio Company Maker

Journalizing Notes Receivable

The Virginia Company Payee

Journalizing Notes Receivable

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.