Accounting Principles, 7th Edition

Weygandt • Kieso • Kimmel

Chapter 9

Accounting for
Receivables

Prepared by Naomi Karolinski

Monroe Community College
and
Marianne Bradford
Bryant College

John Wiley & Sons, Inc. © 2005

 CHAPTER 9
ACCOUNTING FOR RECEIVABLES
After studying this chapter, you should be able to:
1 Identify the different types of receivables.
2 Explain how accounts receivable are
recognized in the accounts.
3 Distinguish between the methods and bases
used to value accounts receivable.
4 Describe the entries to record the disposition
of accounts receivable.
5 Compute the maturity date of and interest on
notes receivable.
 CHAPTER 9
ACCOUNTING FOR
RECEIVABLES
After studying this chapter, you should be able to:
6 Explain how notes receivable are recognized in
the accounts.
7 Describe how notes receivable are valued.
8 Describe the entries to record the disposition of
notes receivable.
9 Explain the statement presentation and analysis
of receivables.
 RECEIVABLES
STUDY OBJECTIVE 1

•Amounts due from individuals and other companies

– claims expected to be collected in cash
• Three major classes of receivables are
1 Accounts Receivable
- amounts owed by customers on account
2 Notes Receivable
- claims for which formal instruments of credit are
issued
3 Other Receivables –
- non-trade receivables
Examples: interest receivable and advances to
employees
 ACCOUNTS RECEIVABLE

Three primary accounting issues with

accounts receivable:
1 Recognizing accounts receivable.
2 Valuing accounts receivable.
3 Disposing of accounts receivable.
 RECOGNIZING ACCOUNTS
RECEIVABLE
STUDY OBJECTIVE 2

General Journal
Date Account Titles Debit Credit
July 1 Accounts Receivable – Polo Co. 1,000
Sales 1,000

When a business sells merchandise to a customer on credit,

Accounts Receivable is debited and Sales is credited.
Assume credit terms are 2/10, n/30.
 RECOGNIZING ACCOUNTS
RECEIVABLE

General Journal
Date Account Titles Debit Credit
July 5 Sales Returns and Allowances 100
Accounts Receivable – Polo Company 100

When a business receives returned merchandise previously

When a business sells merchandise to a customer on credit,
sold to a customer on credit, Sales Returns and Allowances
Accounts Receivable is debited and Sales is credited.
is debited and Accounts Receivable is credited.
RECOGNIZING ACCOUNTS
RECEIVABLE

882
18
900

When a business collects cash from a customer for

When a business
merchandise previously
sells merchandise
sold on credit
to during
a customer
the discount
on credit,
Accounts
period, Cash
Receivable
and Salesis Discounts
debited andare
Sales
debited
is credited.
and Accounts
Receivable is credited.
 VALUING ACCOUNTS
RECEIVABLE
STUDY OBJECTIVE 3
• Cash (net) realizable value
– net amount expected to be received in cash and excludes
amounts that the company estimates it will not be able to
collect
• Credit losses
– debited to Bad Debts Expense
– considered a normal and necessary risk of doing business.
• Two methods of accounting for uncollectible
accounts are:
1 Direct write-off method
2 Allowance method
 DIRECT WRITE-OFF
METHOD
• Direct write-off method
– Bad debt losses are not anticipated and no
allowance account is used
– No entries are made for bad debts until an
account is determined to be uncollectible at which
time the loss is charged to Bad Debts Expense
• No matching
• No cash realizable value of accounts
receivable on the balance sheet
• Not acceptable for financial reporting
purposes
 DIRECT WRITE-OFF
METHOD

General Journal
Date Account Titles Debit Credit
Dec. 12 Bad Debts Expense 200
Accounts Receivable – M.E. Doran 200

Warden Co. writes off M. E. Doran’s $200 balance as

uncollectible on December 12. When this method is used,
Bad Debts Expense will show only actual losses from
uncollectibles.
THE ALLOWANCE METHOD

• Allowance method
– required when bad debts are deemed
to be material in amount.
• Uncollectible accounts are
estimated
– expense for the uncollectible accounts
is matched against sales in the same
accounting period in which the sales
occurred.
 THE ALLOWANCE METHOD

General Journal
Date Account Titles Debit Credit
Dec. 31 Bad Debts Expense 12,000
Allowance for Doubtful Accounts 12,000

Estimated uncollectibles are debited to Bad

Debts Expense and credited to Allowance for
Doubtful Accounts at the end of each period.
 THE ALLOWANCE METHOD

General Journal
Date Account Titles Debit Credit
Mar. 1 Allowance for Doubtful Accounts 500
Accounts Receivable - R. A. Ware 500

Actual uncollectibles are debited to Allowance for Doubtful

Accounts and credited to Accounts Receivable at the time
the specific account is written off.
 THE ALLOWANCE METHOD

General Journal
Date Account Titles Debit Credit
July 1 Accounts Receivable – R. A. Ware 500
Allowance for Doubtful Accounts 500

When there is recovery of an account that has been written

off: 1 reverse the entry made to write off the account and...
 THE ALLOWANCE METHOD

General Journal
Date Account Titles Debit Credit
July 1 Cash 500
Accounts Receivable 500

2 record the collection in the usual manner.

 BASES USED FOR THE
ALLOWANCE METHOD
• Companies use one of two methods in
the estimation of uncollectibles:
1 Percentage of sales
2 Percentage of receivables
• Both bases are GAAP; the choice
is a management decision.
 COMPARISON OF BASES OF
ESTIMATING
UNCOLLECTIBLES

Percentage of
Percentage of Sales Receivables

Emphasis on Income Statement Emphasis on Balance Sheet

Relationships Relationships
 PERCENTAGE OF
SALES BASIS
• Management estimates what percentage of
credit sales will be uncollectible.
• Expected bad debt losses are
determined by applying the
percentage to the sales base
of the current period.
• Better match
– Expenses with revenues
 PERCENTAGE OF
SALES BASIS

General Journal
Date Account Titles Debit Credit
Dec. 31 Bad Debts Expense 8,000
Allowance for Doubtful Accounts 8,000

If net credit sales for the year are $800,000, the estimated bad
debts expense is $8,000 (1% X $800,000).
 PERCENTAGE OF
RECEIVABLES BASIS

• Management estimates what percentage

of receivables will result in losses from
uncollectible accounts.
• Amount of the adjusting entry
– difference between the required balance
and the existing balance in the allowance
account
• Produces the better estimate of cash
realizable value of receivables.
Which of the following approaches for bad
debts is best described as a balance sheet
method?
a. Percentage of receivables basis.
b. Direct write-off method.
c. Percentage of sales basis.
d. Both a and b.
Which of the following approaches for bad
debts is best described as a balance sheet
method?
a. Percentage of receivables basis.
b. Direct write-off method.
c. Percentage of sales basis.
d. Both a and b.
 PERCENTAGE OF
RECEIVABLES BASIS

General Journal
Date Account Titles Debit Credit
Dec. 31 Bad Debts Expense 1,700
Allowance for Doubtful Accounts 1,700

If the trial balance shows Allowance for Doubtful Accounts

with a credit balance of $528, and the required ending
balance in the account is $2,228, an adjusting entry for
$1,700 ($2,228 - $528) is necessary.
 DISPOSING OF ACCOUNTS
RECEIVABLE
STUDY OBJECTIVE 4

• Companies frequently dispose of accounts

receivable in one of two ways:
1 sell to a factor such as a finance company
or a bank
─ factor buys receivables from businesses for a
fee and collects the payments
directly from customers
2 make credit card sales
 SALE OF RECEIVABLES

General Journal
Date Account Titles Debit Credit
Cash 588,000
Service Charge Expense (2% x $600,000) 12,000
Accounts Receivable 600,000

Hendrendon Furniture factors $600,000 of

receivables to Federal Factors, Inc. Federal
Factors assesses a service charge of 2% of the
amount of receivables sold.
 CREDIT CARD SALES

• Credit cards
– used by retailers who wish to avoid the
paperwork of issuing credit
– cash is received quickly from the credit card
issuer
• National credit cards
– Visa, MasterCard, Discover, and American
Express
 CREDIT CARD SALES

• Three parties
1 credit card issuer
2 retailer
3 customer
• Retailer pays the credit card issuer a fee of
2-6% of the invoice price for its services.
• From an accounting standpoint, sales from
Visa, MasterCard, and Discover are
treated differently than sales from
American Express.
 VISA, MASTERCARD,
AND DISCOVER SALES
• VISA, MasterCard, and Discover
– cards issued by banks
– considered cash sales by the retailer
• Upon receipt of credit card sales slips from a
retailer
– the bank immediately adds the amount to the
seller’s bank balance
 VISA, MASTERCARD,
AND DISCOVER SALES

General Journal
Date Account Titles Debit Credit
Cash 970
Service Charge Expense 30
Sales 1,000

Anita Ferreri purchases a

number of compact discs for
her restaurant from Karen Kerr
Music Co. for $1,000 using her
VISA First Bank Card. The
service fee that First Bank
charges is 3%.
 AMERICAN EXPRESS
SALES

• American Express cards

– reported as credit sales, not cash
sales
• Conversion to cash does not
occur until the American
Express remits the net
amount to the seller.
 AMERICAN EXPRESS
SALES

General Journal
Date Account Titles Debit Credit
Accounts Receivable – American Express 285
Service Charge Expense 15
Sales 300

Four Seasons Restaurant

accepts an American
Express card for a $300 bill.
The service fee that
American Express charges is
5%.
 NOTES RECEIVABLE

• Promissory note
– written promise to pay a specified amount
of money on demand or at a definite time.
• Maker
– The party making the promise.
• Payee
– The party to whom
payment is made.
 NOTES RECEIVABLE

• Life of the note expressed in terms of

months
– the due date is found by counting the
months from the date of issue
• Example: The maturity date of a 3-
month note dated May 31 is August 31.
 DETERMINING THE
MATURITY DATE
STUDY OBJECTIVE 5

• Life of the note is expressed in terms of days

– you need to count the days.
– the date of issue is omitted but the due date is
included.
• Example: The maturity date of a 60-day note
dated July 17 is:

Term of note 60
July 31 – 17 14
August 31 45
Maturity date: September 15
 FORMULA FOR COMPUTING
INTEREST

The basic formula for computing

interest on an interest-bearing note is:
Annual Time
Face Value X Interest X in Terms of = Interest
of Note Rate One Year
 COMPUTATION OF
INTEREST

$ 730 X 18% X 120/360 = $ 43.80

$1,000 X 15% X 6/12 = $ 75.00
$2,000 X 12% X 1/1 = $240.00

Helpful hint: The interest rate specified is the annual rate.

 RECOGNIZING NOTES
RECEIVABLE
STUDY OBJECTIVE 6

General Journal
Date Account Titles Debit Credit
May 1 Notes Receivable 1,000
Accounts Receivable – Brent Company 1,000

Wilma Company receives a $1,000, 2-month, 12% promissory

note from Brent Company to settle an open account.
 VALUING NOTES
RECEIVABLE
STUDY OBJECTIVE 7
• Like accounts receivable, short-term
notes receivable are reported at their
cash (net) realizable value.
• The notes receivable
allowance account is
Allowance for
Doubtful Accounts.
 HONOR OF
NOTES
RECEIVABLE
STUDY OBJECTIVE 8

 A note is honored when it is paid in full at its maturity date.

 For an interest-bearing note, the amount due at maturity
is
the face value of the note plus interest for the length of
time specified on the note.
 Betty Co. lends Wayne Higley Inc. $10,000 on June 1,
accepting a 5-month, 9% interest-bearing note.
 Betty Co. collects the maturity value of the note from
HONOR OF NOTES RECEIVABLE

300
300

If Betty Co. prepares prepares financial statements

as of September 30, interest for 4 months, or $300,
would be accrued.
HONOR OF NOTES RECEIVABLE

When interest has been accrued, it is

necessary to credit Interest Receivable
at maturity.
 DISHONOR OF
NOTES RECEIVABLE

General Journal
Date Account Titles Debit Credit
Nov. 1 Accounts Receivable 10,375
Notes Receivable 10,000
Interest Revenue 375

 A dishonored note is a note that is not paid in full

at maturity.
 A dishonored note receivable is no longer
negotiable.
 Since the payee still has a claim against the maker
of the note, the balance in Notes Receivable is
usually transferred to Accounts Receivable.
BALANCE SHEET PRESENTATION
OF RECEIVABLES
STUDY OBJECTIVE 9

• In the balance sheet, short-term

receivables are reported in the
current assets section below short-
term investments.
• Report both the gross amount of
receivables and the allowance for
doubtful accounts.
 ACCOUNTS RECEIVABLE
TURNOVER RATIO AND
COMPUTATION
• Ratios are computed to evaluate the liquidity of a company’s
accounts receivable.
• Accounts receivables turnover ratio used to assess the liquidity of
the receivables.
• If Cisco had net credit sales of $18, 915 million for the year and
beginning net accounts receivable balance of $1,466 million and
ending net accounts receivable balance of $1,105 million, then:

Average Net Accounts

Net Credit
/ Receivables = Receivable
$18,915 / ($1,466 + $1,105)/2 = 14.7 times Turnover
Sales
 AVERAGE COLLECTION PERIOD
FOR RECEIVABLES FORMULA
AND COMPUTATION
• Variant of the turnover ratio that makes liquidity even
more evident.
• This is done by dividing the turnover ratio into 365 days.
The general rule is that the collection period should not
exceed the credit term period.
• Cisco’s turnover ratio is computed as:

Days in Year/AR Turnover = Average Collection Period in Days

365 days / 14.7 times = 24.8 days

Which of the following statements about
VISA credit card sales is incorrect?

a. The credit card issuer makes the

credit investigation of the customer.
b. The retailer is not involved in the
collection process.
c. Two parties are involved.
Which of the following statements about
VISA credit card sales is incorrect?

a. The credit card issuer makes the

credit investigation of the customer.
b. The retailer is not involved in the
collection process.
c. Two parties are involved.
 COPYRIGHT

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