Accounting

P i i l
Principles

Second Canadian Edition

Weygandt Kieso Kimmel Trenholm

P
Prepared
d by:
b

Carole Bowman, Sheridan College

CHAPTER

9
ACCOUNTING FOR
RECEIVABLES

RECEIVABLES
y The term receivables refers to amounts due

p
; theyy
from individuals and other companies;
are claims expected to be collected in cash.
y Three major classes of receivables are:
1. Accounts Receivable
2. Notes Receivable
3. Other Receivables

ACCOUNTS RECEIVABLE
The three primary accounting problems
associated with accounts receivable are:
1. Recognizing accounts receivable.
2 Valuing accounts receivable.
2.
receivable
3. Disposing of accounts receivable.

RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 1

Account Titles and Explanation

Accounts Receivable - Adorable Junior
Sales
To record sales on account.

Debit

Credit

1,000

When a business sells merchandise to a

customer on credit, Accounts Receivable is
debited and Sales is credited.

1,000

RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 5

Account Titles and Explanation

Sales Returns and Allowances
Accounts Receivable - Adorable
To record merchandise returned.

Debit

Credit

100
100

When a business receives returned merchandise

previously sold to a customer on credit, Sales
Returns and Allowances is debited and
A
Accounts
t R
Receivable
i bl is
i credited.
dit d

RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 31

Account Titles and Explanation

Cash ($1,000 - $100)
Accounts Receivable - Adorable
To record collection of account.

Debit

Credit

900
900

When a business collects cash from a customer

for merchandise previously sold on credit, Cash
is debited and Accounts Receivable is credited.

RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 31

Account Titles and Explanation

Accounts Receivable - Adorable
Interest Revenue
To record interest on amount due.

Debit

Credit

13.50
13.50

When financing charges are added to a balance

owing, Accounts Receivable is debited and
Interest Revenue is credited.

VALUING
ACCOUNTS RECEIVABLE
y To ensure that receivables are not

overstated on the balance sheet, they are

stated at their net realizable value.
y Net realizable value is the net amount
expected to be received in cash and
excludes amounts that the company
estimates it will not be able to collect.
collect

VALUING
ACCOUNTS RECEIVABLE
Two methods of accounting
g for
uncollectible accounts are:
1. Allowance method
2 Direct
2.
Di t write-off
it ff method
th d

DIRECT WRITE
WRITE--OFF METHOD
y Under the direct write-off method, 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.
Expense
y No attempt is made to match bad debts to sales
revenues or to show
h
the
h net realizable
li bl value
l off
accounts receivable on the balance sheet.

DIRECT WRITEWRITE-OFF METHOD

GENERAL JOURNAL
Date
Jan. 12
Ja

Account Titles and Explanation

Debit
200
00
Bad
ad Debts
ebts Expense
pe se
Accounts Receivable E. Schaefer
For write-off of E. Schaefer account.

Credit

200

Periera Company writes off E. Schaefers $200

balance
b
ce ass u
uncollectible
co ec b e on
o January
J u y 12.. When
W e
this method is used, Bad Debts Expense will
show onlyy actual losses from uncollectibles.

THE ALLOWANCE METHOD

y The allowance method is required when bad

debts are deemed to be material in amount.

y Uncollectible accounts are estimated and
the expense for the uncollectible accounts is
matched against sales in the same
accounting
ti period
i d in
i which
hi h th
the sales
l
occurred.

THE ALLOWANCE METHOD

GENERAL JOURNAL
Date

Account Title and Explanation

Dec. 31 Bad Debts Expense

Allowance for Doubtful Accounts
To record estimate of uncollectible accounts.

Debit

Credit

24,000
24,000

Estimated uncollectible amounts are debited to

Bad Debts Expense and credited to Allowance
for Doubtful Accounts (a contra asset account) at
p
the end of each period.

ADORABLE JUNIOR GARMET

Balance Sheet (partial)
Current assets
Cash
Accounts receivable
Less: Allowance for doubtful accounts

$ 14,800
$200,000
24,000

Net Realizable Value

176,000

THE ALLOWANCE METHOD

GENERAL JOURNAL
Date
Mar 1
Mar.

Account Titles and Explanation

Allowance for Doubtful Accounts
Accounts Receivable Nadeau
Write-off of Nadeau account.

Debit

500

Credit

500

Actual uncollectible accounts are debited to

All
Allowance
for
f Doubtful
D b f lA
Accounts and
d credited
di d to
Accounts Receivable at the time the specific
acco nt is written
account
ritten off.
off

THE ALLOWANCE METHOD

GENERAL JOURNAL
Date
July 1

Account Titles and Explanation

Accounts Receivable Nadeau
Allowance for Doubtful Accounts
To reverse write-off of Nadeau
account.

Debit

500

Credit

500

When there is recovery of an account that has

been written
bee
w e off:
o :
1. reverse the entry made to write off the account
and ...

THE ALLOWANCE METHOD

GENERAL JOURNAL
Date
July 1

Account Titles and Explanation

Cash
Accounts Receivable Nadeau
To record collection from Nadeau.

Debit

500

2. Record the collection in the usual manner.

Credit

500

BASES USED FOR THE

ALLOWANCE METHOD
y Companies
p
use either of two methods in

the estimation of uncollectible accounts:

1 Percentage of sales
1.
2. Percentage of receivables
y Both bases are GAAP; the choice is a
management decision.

ILLUSTRATION 9-4

COMPARISON OF BASES OF
ESTIMATING UNCOLLECTIBLES

Percentage of Sales
Matching
Sales

Percentage of Receivables
Net Realizable Value

Bad Debts
Expense

Emphasis on
Income Statement
Relationships

Accounts
Receivable

Allowance
for
Doubtful
Accounts

Emphasis on
Balance Sheet
Relationships

PERCENTAGE OF SALES BASIS

y In the percentage of sales basis,
basis management

establishes a percentage relationship between

the amount of credit sales and expected
e pected losses
from uncollectible accounts.
y Expected bad debt losses are
determined by applying the
percentage to the sales base
p
of the current period.
y This basis better matches expenses
with revenues.
revenues

PERCENTAGE OF
RECEIVABLES BASIS
y Under the percentage of receivables basis,

management
g
establishes a percentage
p
g
relationship between the amount of
accounts receivable and the required
q
balance in the allowance account.
y This p
percentage
g can be applied
pp
to
the total accounts receivable balance,
or to individual accounts receivable
balances stratified by age.

PERCENTAGE OF
RECEIVABLES BASIS
The required balance in the allowance
account is determined by applying the
percentage to the accounts receivable balance
at the end of the current period.
The
Th amount off the
h adjusting
dj i entry to record
d
expected bad debt losses for the current
period is the difference between the required
balance and the existing balance in the
allowance account.
This basis produces the better estimate of net
realizable value of receivables.

DISPOSING OF
ACCOUNTS RECEIVABLE
To accelerate the receipt of cash from
receivables,
i bl owners frequently:
f
tl
1. sell to a factor, such as a finance company
or a bank, and
2. make credit card sales.

DISPOSING OF
ACCOUNTS RECEIVABLE
y A factor buys receivables from businesses

ffor a fee
f and
d collects
ll t th
the payments
t
directly from customers.
y Credit
C di cards
d are ffrequently
l used
db
by retailers
il
who wish to avoid the paperwork of issuing
credit.
dit
y Retailers can receive cash more quickly
f
from
the
h credit
di card
d iissuer.

CREDIT CARD SALES

y Three p
parties are involved when credit cards are

used in making retail sales:

1. the credit card issuer,
2. the retailer, and
3 the customer.
3.
customer
y The retailer pays the credit card issuer a
percentage
t
fee
f off the
th invoice
i
i price
i for
f it
its services.
i
y From an accounting standpoint, sales from bank
cards (e.g., Visa and MasterCard) are treated
y than sales from non-bank cards ((e.g.,
g
differently
American Express).

BANK CARD SALES

y Sales
l resulting
l i ffrom the
h use off VISA and
d

MasterCard are considered cash sales by the

retailer.
y These cards are issued by
y banks.
y Upon receipt of credit card sales slips from a
retailer the bank immediately adds the
retailer,
amount to the sellers bank balance.

BANK CARD SALES

GENERAL JOURNAL
Date
July 31

Account Titles and Explanation

Cash
Credit Card Expense
E pense ($1,000
($1 000 x 3
3.5%)
5%)
Sales
To record VISA credit card sales.

Debit

Anita Ferreri purchases a number of

compact discs for her restaurant from
Karen Kerr Music Co. for $1,000 using
her Royal Bank VISA card. The service
f th
fee
thatt th
the R
Royall charges
h
iis 33.5
5 percent.
t

965
35

Credit

1,000

NON--BANK CARD SALES

NON
y Sales using American Express and other

non bank cards are reported as credit sales,

non-bank
not cash sales.
y Conversion into cash does not occur until
American Express remits the net amount
t th
to
the seller.
ll

NON--BANK CARD SALES

NON
GENERAL JOURNAL
Date
July 31

Account Titles and Explanation

Accounts Receivable- Amex
Credit Card Expense ($500 x 5%)
Sales
To record American Express
credit card sales.
sales

Kerr Music Co. accepts an

AMERICAN EXPRESS card
for a $500 sale. The service fee
that AMERICAN EXPRESS
charges
h
iis 5 percent.
t

Debit

475
25

Credit

500

NOTES RECEIVABLE
y A promissory note is a written promise to pay

p
amount of moneyy on demand or at
a specified
a definite time.
y The party making the promise is the maker.
maker
y The party to whom payment is made is
called
ll d the
h payee.

ILLUSTRATION 9-8

FORMULA FOR
CALCULAT
ALCULATING
ING INTEREST
The basic formula for calculating interest on an
interest-bearing note is:
Face Value
of Note

Annual
Interest
Rate

Time
in Terms of
One Year

The interest rate specified on the note is

an annual rate of interest.

Interest

RECOGNIZING NOTES RECEIVABLE

GENERAL JOURNAL
Date
Account Titles and Explanation
May 1 Notes Receivable
Accounts Receivable Brent Company
To record acceptance of Brent
Company
p y note.

Debit

Credit

1 000
1,000
1,000

Wilma Company receives a $1,000, 6%

promissory note,
note due in two months (July 1)
from Brent Company to settle an open account.

HONOUR OF NOTES RECEIVABLE

GENERAL JOURNAL
Date

Account Title and Explanation

Sept. 30 Cash
Notes Receivable - Higly
Interest Revenue
To record collection of Higly note.

Debit

Credit

10,150
10,000
10
000
150

A note is honoured
hono red when
hen it is paid in ffull
ll at its mat
maturity
rit date.
date
Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5%
interest-bearing
interest
bearing note, due in 4 months, on September 30.
Wolder collects the maturity value of the note from Higley on
September 30.

DISHONOUR OF NOTES RECEIVABLE

GENERAL JOURNAL
Date

Account Title and Explanation

Sept. 30 Accounts Receivable - Higly

Notes Receivable - Higly
I t
Interest
t Revenue
R
To record the dishonour of Higly note.

Debit

Credit

10,150
10,000
150

A dishonoured note is a note that is not p

paid in full at
maturity.
g negotiable.
g
A dishonoured note receivable is no longer
Since the payee still has a claim against the maker
of the note,, the balance in Notes Receivable is
usually transferred to Accounts Receivable.

VALUING NOTES RECEIVABLE

y Like accounts receivable, short-term notes

receivable are reported at their net

realizable value.
y The notes receivable allowance account is
Allowance for Doubtful Notes.

DISHONOUR OF NOTES RECEIVABLE

GENERAL JOURNAL
Date

Account Title and Explanation

Sept. 30 Allowance for Doubtful Notes

Notes Receivable - Higly

Debit

Credit

10,000
10,000

To record the dishonour of Higly note that wil never

be paid

A dishonoured note is a note that is not paid in full at

maturity.
A dishonoured note receivable is no longer negotiable.
negotiable
If there is not reasonable chance of payment, write off
the note to Allowance for doubtful notes.
notes

BALANCE SHEET PRESENTATION

OF RECEIVABLES
Each of the major types of receivables

should be identified in the balance sheet or

in the notes to the financial statements.
In the balance sheet,, short-term receivables
are reported within the current assets
section below cash and temporary
p
y
investments.
Both the gross amount of receivables and the
allowance for doubtful accounts should be
reported.
reported

USING THE INFORMATION IN THE

FINANCIAL STATEMENTS
Financial ratios are calculated to evaluate the
short-term
h tt
li
liquidity
idit off a company.
These ratios include the
1. current ratio,
2. acid test (q
(quick)) ratio,,
3. receivables turnover ratio, and the
4 collection period ratio.
4.
ratio

CURRENT RATIO
The current ratio is a widely used measure
g a companys
p y liquidity
q
y and
for evaluating
short-term debt-paying ability.
CURRENT ASSETS
CURRENT RATIO =
CURRENT LIABILITIES

= ?:1

ACID TEST RATIO

The acid test ratio (quick ratio) is a

measure of a companys
p y short-term
liquidity.

CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET)

ACID TEST RATIO =
CURRENT LIABILITIES

= ?:1

ACCOUNTS RECEIVABLE
TURNOVER RATIO
The ratio used to assess the liquidity
q
y of the
receivables is the receivables turnover ratio.
Net Credit
Sales

Average Net
Receivables

Receivables
Turnover

= ? times

COLLECTION PERIOD
The
h collection
ll i period
i d in
i days
d
is
i a variant
i
off the
h
receivables turnover ratio and makes liquidity
even more evident.
The ggeneral rule is that the collection p
period
should not exceed the credit term period.
Days in Year
(365)

Receivables
Turnover

Collection
Period in Days

= ? days