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1 1 9 Receivables 1

2 2 After studying this chapter, you should be able to: 1. Describe the common classifications of receivables. 2. Describe the nature of and the accounting for uncollectible receivables. 3. Describe the direct write-off method of accounting for uncollectible receivables. 2

3 3 After studying this chapter, you should be able to: 4. Describe the allowance method of accounting for uncollectible receivables. 5. Compare the direct write-off and allowance methods of accounting for uncollectible accounts. 3

4 4 After studying this chapter, you should be able to: 6. Describe the nature, characteristics, and accounting for notes receivables. 7. Describe the reporting of receivables on the balance sheet. 4

5 5 9-1 Objective 1 Describe the common classifications of receivables. 5

6 6 Classification of Receivables 9-1 The term receivables includes all money claims against other entities, including people, business firms, and other organizations. 6

7 7 Accounts Receivable 9-1 Accounts receivable are normally expected to be collected within a relatively short period, such as 30 or 60 days. 7

8 8 Notes Receivable 9-1 Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued. 8

9 9 Other Receivables 9-1 Other receivables expected to be collected within one year are classified as current assets. If collection is expected beyond one year, these receivables are classified as noncurrent assets and reported under the caption Investments. 9

10 Objective 2 Describe the nature of and the accounting for uncollectible receivables. 10

11 Companies often sell their receivables to other companies. This transaction is called factoring the receivables, and the buyer of the receivables is called a factor. 11

12 12 Uncollectible Receivables 9-2 There are two methods of accounting for receivables that appear to be uncollectible: the direct write off method and the allowance method. 12

13 The direct write off method records bad debt expense only when an account is judged to be worthless. The allowance method records bad debt expense by estimating uncollectible accounts at the end of the accounting period. 13

14 Objective 3 Describe the direct writeoff method of accounting for uncollectible receivables. 14

15 15 Direct Write-Off Method On May 10, a $4,200 accounts receivable from D. L. Ross has been determined to be uncollectible. 9-3 May 10 Bad Debt Expense Accounts Receivable D. L. Ross

16 The amount written off is later collected on November 21. Nov. 21 Accounts Receivable D. L. Ross Bad Debt Expense Cash Accounts Receivable D. L. Ross

17 Example Exercise 9-1 Journalize the following transactions using the direct write-off method of accounting for uncollectible receivables. July 9 Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as uncollectible. Oct. 11 Reinstated the account of Jay Burke and received $3,900 cash in full payment. 17

18 Follow My Example 9-1 July 9 Cash 1,200 Bad Debt Expense 3,900 Accounts Receivable Jay Burke 5,100 Oct. 11 Accounts Receivable Jay Burke 3,900 Bad Debt Expense 3, Cash 3,900 Accounts Receivable Jay Burke 3,900 For Practice: PE 9-1A, PE 9-1B 18

19 Objective 4 Describe the allowance method of accounting for uncollectible receivables. 19

20 20 Allowance Method On December 31, ExTone Company estimates that a total of $40,000 of the $1,000,000 balance in her company s Accounts Receivable will eventually be uncollectible. 9-4 Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate. 20

21 21 Net Realizable Value 9-4 The net amount that is expected to be collected, $960,000 ($1,000,000 $40,000), is called the net realizable value (NRV). The adjusting entry reduces receivables to the NRV and matches uncollectible expenses with revenues. 21

22 On January 21, John Parker s account totaling $6,000 is written off because it is uncollectible. Jan. 21 Allowance for Doubtful Accounts Accounts Receivable John Parker To write off the uncollectible account. 22

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24 During 2008, ExTone Company writes off $36,750 of uncollectible accounts, including the $6,000 account of John Parker. After posting all entries to write-off uncollectible amounts, the Allowance for Doubtful Accounts will have a credit balance of $3,250 ($40,000 $36,750). 24

25 ALLOWANCE FOR DOUBTFUL ACCOUNTS Total Jan. 1, 2008 Bal. 40,000 accounts Jan. 21 6,000 written off {Feb. 2 3,900 $36,750 Dec. 31 Unadjusted bal 3,250 25

26 If ExTone Company had written off $44,100 in accounts receivable during 2008, the Allowance for Doubtful Accounts would have a debit balance of $4,

27 ALLOWANCE FOR DOUBTFUL ACCOUNTS Total Jan. 1, 2008 Bal. 40,000 accounts Jan. 21 6,000 written off {Feb. 2 3,900 $44,100 Dec. 31 Unadjusted bal 4,100 27

28 28 Collecting a Written-Off Account 9-4 Nancy Smith s account of $5,000 which was written off on April 2 is later collected on June 10. Two entries are needed: one to reinstate Nancy Smith s account and a second to record receipt of the cash. 28

29 Entry 1: Reinstate the account. June 10 Accounts Receivable Nancy Smith Allowance for Doubtful Accounts To reinstate the account written off on Jan

30 Entry 2: Record collection of cash. June 10 Cash Accounts Receivable Nancy Smith Collection of written-off account. 30

31 Example Exercise 9-2 Journalize the following transactions using the allowance method of accounting for uncollectible receivables. July 9 Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as uncollectible. Oct. 11 Reinstated the account of Jay Burke and received $3,900 cash in full payment. 31

32 Follow My Example 9-2 July 9 Cash 1,200 Allowance for Doubtful Accounts 3,900 Accounts Receivable Jay Burke 5,100 Oct. 11 Accounts Receivable Jay Burke 3,900 Allowance for Doubtful Accounts 3, Cash 3,900 Accounts Receivable Jay Burke 3,900 For Practice: PE 9-2A, PE 9-2B 32

33 33 Estimating Uncollectibles 9-4 The allowance method uses two ways to estimate the amount debited to Bad Debt Expense. 1. Estimate based on a percentage of sales. 2. Estimate based on analysis of receivables. 33

34 34 Estimate Based on a Percentage of Sales 9-4 If credit sales for the period are $3,000,000 and it is estimated that 1½ % will be uncollectible, the Bad Debt Expense is debited for $45,000 ($3,000,000 x.015). This approach disregards the balance in the allowance account before the adjustment. 34

35 After this adjusting entry is posted, Allowance for Doubtful Accounts will have a balance of $48,250. Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts ($3,000,000 x = $45,000). 35

36 BAD DEBT EXPENSE Dec. 31 Adj entry 45,000 Dec. 31 Adjusted bal. 45,000 ALLOWANCE FOR DOUBTFUL ACCOUNTS Total { Jan. 1, 2008 Bal. 40,000 Jan. 21 6,000 Feb. 2 3,900 accounts written off $36,750 Dec. 31 Unadjusted bal 3,250 Dec. 31 Adj. entry 45,000 Dec. 31 Adjusted bal. 48,250 36

37 Example Exercise 9-3 At the end of the current year, Accounts Receivable has a balance of $800,000; Allowance for Doubtful Accounts has a credit balance of $7,500; and net sales for the year total $3,500,000. Bad debt expense is estimated at ½ of 1% of net sales. Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense; and (c) the net realizable value of accounts receivable. 37

38 Follow My Example 9-3 (a) $17,500 ($3,500,000 x.005) Adjusted Balance (b) Accounts Receivable $800,000 Allowance for Doubtful Accounts ($7,500 + $17,500) 25,000 Bad Debt Expense 17,500 (c) $775,000 ($800,000 $25,000) For Practice: PE 9-3A, PE 9-3B 38

39 39 Estimating Uncollectibles Based on Analysis of Receivables 9-4 The longer an account receivable is outstanding, the less likely that it will be collected. Basing the estimate of uncollectible accounts on how long specific amounts have been outstanding is called aging the receivables. 39

40 40 Click Aging to edit of Accounts Master title style Receivables

41 41 Estimate of Uncollectible Accounts

42 42 Collection Rates by Number of Months Past Due

43 43 Estimate Based on Analysis of Receivables 9-4 If it is estimated that $3,390 of the receivables will be uncollectible and the Allowance for Uncollectible Accounts currently has a balance of $510, the Bad Debt Expense must be debited for $2,880 ($3,390 $510). 43

44 44 Estimate Based on Analysis of Receivables 9-4 Aug. 31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts ($3,390 $510). 44

45 BAD DEBT EXPENSE Aug. 31 Adj. entry 2,880 Aug. 31 Adj. bal. 2,880 ALLOWANCE FOR DOUBTFUL ACCOUNTS Aug. 31 Unadj. bal. 510 Aug. 31 Adj. entry 2,880 Aug. 31 Adj. bal. 3,390 45

46 If the unadjusted balance of Allowance for Uncollectible Accounts had been a debit balance of $300, the amount of the adjustment would have been $3,690 ($3,390 + $300). 46

47 BAD DEBT EXPENSE Aug. 31 Adj. entry 3,690 Aug. 31 Adj. bal. 3,690 ALLOWANCE FOR DOUBTFUL ACCOUNTS Aug. 31 Unadj. bal. 300 Aug. 31 Adj. entry 3,690 Aug. 31 Adj. bal. 3,390 47

48 Example Exercise 9-4 At the end of the current year, Accounts Receivable has a balance of $800,000; Allowance for Doubtful Accounts has a credit balance of $7,500; and net sales for the year total $3,500,000. Using the aging method, the balance of Allowance for Doubtful Accounts is estimated as $30,000. Determine (a) the amount of the adjusting entry for uncollectible accounts; (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense, and (c) the net realizable value of accounts receivable. 48

49 Follow My Example 9-4 (a) $22,500 ($30,000 $7,500) Adjusted Balance (b) Accounts Receivable $800,000 Allowance for Doubtful Accounts 30,000 Bad Debt Expense 22,500 (c) $770,000 ($800,000 $30,000) For Practice: PE 9-4A, PE 9-4B 49

50 Objective 5 Compare the direct writeoff and allowance methods of accounting for uncollectible accounts 50

51 51 Click Comparing to edit Direct-Write-Off Master title style and Allowance Methods 9-5 Direct Write-Off Method Allowance Method 51

52 52 Comparing the Direct Write-Off and Allowance Methods Direct Write-Off Method 9-5 Amount of bad debt expense recorded Allowance account Primary users When the actual accounts receivable are determined to be uncollectible No allowance account is used Small companies and companies with relatively few receivables 52

53 53 Comparing the Direct Write-Off and Allowance Methods Allowance Method 9-5 Amount of bad debt expense recorded Allowance account Primary users Using estimate based on either (1) a percentage of sales or (2) analysis of receivables. The allowance account is used Large companies and those with a large amount of receivables 53

54 Objective 6 Describe the nature, characteristics, and accounting for notes receivable. 54

55 55 Characteristics of Notes Receivable 9-6 A note receivable, or promissory note, is a written document containing a promise to pay: a specific amount of money (face amount) on demand or at a definite time to an individual or a business (payee), or to the bearer or holder of the note. 55

56 56 Characteristics of Notes Receivable 9-6 The one making the promise is called the maker. The date a note is to be paid is called the due date or maturity date. 56

57 57 Payee $ 2, Fresno, California 20 March Ninety days _AFTER DATE We PROMISE TO PAY TO THE ORDER OF Judson Company Two DOLLARS thousand five hundred 00/ PAYABLE AT City National Bank VALUE RECEIVED WITH INTEREST AT 10% NO. 14 DUE June 14, 2008 Maker H. B. Lane TREASURER, WILLIARD COMPANY

58 58 What is the due date of a 90-day note dated March 16? Total days in note Number of days in March 31 Issue date of note March 16 Remaining days in March Number of days in April Number of days in May Residual days in June 90 days 15 days 75 days 30 days 45 days 31 days 14 days Answer: June

59 59 Accounting for Notes Receivable 9-6 Received a $6,000, 12%, 30-day note dated November 21, 2008 in settlement of the account of W. A Bunn Co. Nov. 21 Notes Rec. W. A. Bunn Co Accts. Rec. W. A Bunn Co Received 30-day, 12% note dated November 21,

60 On December 21, when the note matures, the firm receives $6060 from W. A. Bunn Company ($6,000 plus $60 interest). Dec. 21 Cash Notes Rec. W. A. Bunn Co Interest Revenue* Received principal and interest on matured note. *$6,000 x 12% x 30/360 = $60 60

61 61 If W. A. Bunn Company fails to pay the note on the due date, it is considered a dishonored note receivable. The note and interest are transferred to the customer s account. 9-6 Dec. 21 Accts Rec. W. A. Bunn Co Notes Rec. W. A. Bunn Co Interest Revenue Recorded dishonored note, plus interest. 61

62 62 A 90-day, 12% note dated December 1, 2008, is received from Crawford Company to settle its account, which has a balance of $4, Dec. 1 Notes Rec. Crawford Co Accts. Rec. Crawford Co Accepted note in settlement of account. 62

63 63 Assuming that the accounting period ends on December 31, an adjusting entry is required to record the accrued interest of $40 ($4,000 x 0.12 x 30/360) Dec. 31 Interest Receivable Interest Revenue Accrued interest ($4,000 x 12% x 30/360). 63

64 On March 1, 2009, $4,120 is received for the note ($4,000) and interest ($120). Mar. 1 Cash Notes Rec. Crawford Co Interest Receivable Interest Revenue Collected note and accrued interest. ($4,000 x 12% x 30/360). 64

65 Example Exercise 9-5 Same Day Surgery Center received a 120-day, 6% note for $40,000, dated March 14 from a patient on account. a. Determine the due date of the note. b. Determine the maturity value of the note. c. Journalize the entry to record the receipt of the payment of the note at maturity. 65

66 66 Follow My Example a. July 12 determined as follows: March 17 days (31 14) April 30 days May 31 days June 30 days July 12 days Total 120 days b. $40,800 [$40,000 + ($40,000 x 6% x 120/360)] c. Cash 40,800 Notes Receivable 40,000 Interest Revenue 800 For Practice: PE 9-5A, PE 9-5B 66

67 Objective 7 Describe the reporting of receivables on the balance sheet. 67

68 68 Receivables on Balance Sheet Crabtree Co. Balance Sheet December 31, 2008 Assets Current assets: Cash $119,500 Notes receivable 250,000 Accounts receivable $445,000 Less allowance for doubtful accounts 15, ,000 Interest receivable 14,500 Merchandise inventory 714,000 Receivables (including the allowance account) are highlighted

69 69 Accounts Receivable Turnover 9-7 The accounts receivable turnover measures how frequently during the year the accounts receivable are being converted to cash. Accounts Receivable Turnover = Net sales Average accounts receivable 69

70 70 Federal Express Corporation Net sales $19,364 $17, Accounts receivable 2,703 2,475 $2,199 Average accounts receivable 2,589 2,337 * *[($2,475 + $2,199)/2] 9-7 Accounts Receivable Turnover (2004) = $17,383 $2,337 Accounts Receivable Turnover (2004) =

71 71 Federal Express Corporation Net sales $19,364 $17, Accounts receivable 2,703 2,475 $2,199 Average accounts receivable * 2,589 2,337 * [($2,703 + $2,475)/2] 9-7 Accounts Receivable Turnover (2005) = $19,364 $2,589 Accounts Receivable Turnover (2005) =

72 72 Number of Days Sales in Receivables 9-7 Use: To assess the efficiency in collecting receivables and in the management of credit. Number of Days Sales in Receivables = Average Accounts receivable Average daily sales 72

73 73 Federal Express Corporation Net sales $19,364 $17, Accounts receivable 2,703 2,475 $2,199 Average accounts receivable 2,589 2,337 * Average daily sales ** * [($2,475 + $2,119)/2] ** ($17,383/365) 9-7 Number of Days Sales in Receivables (2004) = $2, Number of Days Sales in Receivables (2004) =

74 74 Federal Express Corporation Net sales $19,364 $17, Accounts receivable 2,703 2,475 $2,199 Average accounts receivable 2,589* 2,337 Average daily sales 53.1** * [($2,703+ $2,475)/2] **($19,364/365) Number of Days Sales in Receivables (2005) = $2, Number of Days Sales in Receivables (2005) =