Chapter9: Receivables [Type text] [Type text] Receivables

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1 Chapter9: Receivables [Type text] [Type text] Receivables The receivables that result from sales on account are normally: accounts receivable or notes receivables. Receivables includes all money claims against other entities, including people, companies, and other organization. The common classes of receivables: 1. Accounts receivable are normally expected to be collected within a relatively short period, such as 30 or 60 days. The most common transaction creating a receivable is selling goods or services on account (on credit). 2. Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued. *Often used for credit periods of more than 60 days. 3. Other receivables expected to be collected within one year are classified (separately) as current assets. If collection is expected beyond one year, the receivables are classified as non-current assets and reported under the caption Investments. Examples of other receivables include: Interest receivable Taxes receivable Receivables from officers or employees Accounting for uncollectible receivables (Some accounts receivable will be uncollectable) Companies often sell their receivables to other companies. This is called factoring the receivables, and the buyer of the receivables is called a factor. Regardless of how careful a company is in granting credit, some credit sales will be uncollectible. The operating expense recorded from uncollectible receivables is called bad debt expense, uncollectible accounts expense, or doubtful accounts expense. Some indications that an account may be uncollectible include the following: The receivable is past due. The customer does not respond to the company s attempts to collect. The customer files for bankruptcy. The customer closes its business. The company cannot locate the customer. Shatha Alsalem 1

2 [Type text] [Type text] [Type text] Two methods of accounting for uncollectible receivables are as follows: 1. The direct write-off method of accounting for uncollectible receivables records bad debt expense only when an account is determined to be worthless (usually used by small companies and companies with few receivables) 2. The allowance method records bad debt expense by estimating uncollectible accounts at the end of the accounting period (used by companies that have large amount of receivables). 1. Direct write-off method of accounting for uncollectible receivables. Bad Debt Expense is not recorded until the customer s account is determined to be worthless. At that time, the customer s account receivable is written off. Exercise: On May 10, a $4,200 account receivable from D. L. Ross has been determined to be uncollectible. The account written off on May 10 is later collected on November 21. (PE 9-1A, PE 9-1B page 425 & EX 9-3 page 427) 2. The allowance method of accounting for uncollectible receivables estimates the uncollectable accounts receivable at the end of the accounting period. Exercise: On December 31, ExTone Company estimates that a total of $30,000 of the $200,000 balance of their accounts receivable will eventually be uncollectible. The specific customer accounts cannot be decreased, so a contra account, Allowance for Doubtful Accounts, is credited. The net amount that is expected to be collected $170,000 ($200,000 $30,000) is called Net realizable value (NRV) of the receivables. The adjusting entry reduces receivables to the NRV, and matches uncollectible/bad debt expenses (30,000) with revenues in the Income statement. Accounts Receivable still has a debit balance of $200,000 at that time 2 [Type the document title]

3 Chapter9: Receivables [Type text] [Type text] On January 21, John Parker s account of $6,000 is written off because it is uncollectible. Assuming that during 2012, ExTone Company writes off $26,750 of uncollectible accounts, including the $6,000 account of John Parker. After posting all entries to write off uncollectible amounts, Allowance for Doubtful Accounts will have a credit balance of $3,250 ($30,000 $26,750). If ExTone Company had written off $32,100 in accounts receivable during 2012, Allowance for Doubtful Accounts would have a debit balance of $2,100. 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. (PE9-2A, PE9-2B page 425 & EX 9-4 page 427) Shatha Alsalem 3

4 [Type text] [Type text] [Type text] *The allowance method requires an estimate of uncollectible accounts at the end of the period. The estimate is normally based on past experience, industry averages, and forecasts of the future. Two methods are used to estimate the amount debited to Bad Debt Expense: 1. Percent of sales method 2. Analysis of receivable method 1. Percent of sales method: Since accounts receivable are created by credit sales, uncollectable accounts can be estimated as a percent of credit sales, if the portion of credit sales to sales is relatively constant, the percent may be applied to total sales or net sales. Example: If ExTone Company s credit sales for the period are $3,000,000 and it is estimated that 3/4% will be uncollectible; Bad Debt Expense is debited for $22,500 ($3,000,000 x.0075). This approach disregards the balance of $3,250 in the allowance account before the adjustment. After the following adjusting entry on December 31 is posted, Allowance for Doubtful Accounts will have a balance of $25,750 ($3,250 + $22,500). PE9-3A: At the end of the current year, Accounts Receivable has a balance of $325,000; Allowance for Doubtful Accounts has a credit balance of $3,900; and net sales for the year total $4,500,000. Bad debt expense is estimated at ½ of 1% of net sales Determine (a) the amount of the adjusting entry for uncollectable accounts; 4,500,000 x.005= 22,500 (b) the adjusted balances of Accounts Receivable, Allowance for Doubtful account, and Bad Debt Expense; Account receivables= 325,000 Allowance for Doubtful account= 3,900+22,500= 26,400 Bad Debt Expense= 22,500 (c) The net realizable value of accounts receivable. 325,000-26,400 = $298,600 (P-E 9-3B page 425) 4 [Type the document title]

5 Chapter9: Receivables [Type text] [Type text] 2. Analysis of receivable method The longer an account receivable is outstanding, the less likely it is that it will be collected. Basing the estimate of uncollectible accounts on how long specific amounts have been outstanding is called aging the receivables. ExTone Company has an unadjusted credit balance of $3,250 in Allowance for Doubtful Accounts. In Exhibit 1, the estimated uncollectible accounts totaled $26,490. The amount to be added to the allowance account is $23,240 ($26,490 $3,250). The adjusting entry is as follows: After the preceding adjusting entry is posted to the ledger, ExTone Company s Allowance for Doubtful Accounts will have an adjusted balance of $26,490. This is the amount that was determined by aging the accounts. (PE9-4A, PE9-4B page 426) Comparing Methods The primary differences between the direct write-off and allowance methods are summarized below. Shatha Alsalem 5

6 [Type text] [Type text] [Type text] Notes Receivables A note receivable, or promissory note, is a written document containing a promise to pay the face amount, usually with interest. Characteristics of Notes Receivable/ promissory note are as follows: The maker is the party making the promise to pay. The payee is the party to whom the note is payable. The face amount is the amount the note is written for on its face. The issuance date is the date a note is issued. The due date or maturity date is the date the note is to be paid. The term of a note is the amount of time between the issuance and due dates The interest rate is the rate of interest that must be paid on the face amount for the term of the note. The maturity value is the amount that must be paid at the due date of the note, which is the sum of the face amount and the interest. Due Date of a 90-day Note (issued 16 March) Total days in note 90 days Number of days in March 31 Issue date of note, March 16 (16) Remaining days in March 15 days Number of days in April 30 Number of days in May 31days Residual days in June (14) days Received a $6,000, 12%, 30-day note dated November 21, 2012, in settlement of the account of W. A. Bunn Company. 6 [Type the document title]

7 Chapter9: Receivables [Type text] [Type text] On December 21, when the note matures, the firm receives $6,060 from W. A. Bunn Company ($6,000 face amount plus $60 interest). Interest= Face Amount x Interest Rate x (term/ 360 days) 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 back to the customer s account receivable. Example: A 90-day, 12% note dated December 1, 2012, is received from Crawford Company to settle its account, which has a balance of $4,000. 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). On March 1, 2013, $4,120 is received for the note ($4,000) and interest ($120). (PE 9-5A, PE9-5B page 426) Shatha Alsalem 7

8 [Type text] [Type text] [Type text] Reporting Receivables on the Balance Sheet 8 [Type the document title]