9 Receivables After studying this chapter you should

9 – Receivables After studying this chapter, you should be able to: Objective 1 - Describe the common classifications of receivables. Objective 2 - Describe the nature of and the accounting for uncollectible receivables Objective 3 - Describe the direct write-off method of accounting for uncollectible receivables. Objective 4 - Describe the allowance method of accounting for uncollectible receivables. Objective 6 - Describe the nature, characteristics, and accounting for notes receivables. Objective 7 - Describe the reporting of receivables on the balance sheet. 1

Objective 1 9 -1 Describe the common classifications of receivables. The term receivables includes all money claims against other entities, including people, business firms, and other organizations. Accounts receivable are normally expected to be collected within a relatively short period, such as 30 or 60 days. Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued. 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 2 assets and reported under the caption Investments.

Objective 2 9 -2 Describe the nature of and the accounting for uncollectible receivables. 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. Uncollectible Receivables There are two methods of accounting for receivables that appear to be uncollectible: 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 3 the accounting period.

Objective 3 9 -3 Describe the direct write-off method of accounting for uncollectible receivables. Direct Write-Off Method On May 10, a $4, 200 accounts receivable from D. L. Ross has been determined to be uncollectible. May 10 Bad Debt Expense Accounts Receivable—D. L. Ross 4 200 00 4

9 -3 The amount written off is later collected on November 21. Nov. 21 Accounts Receivable—D. L. Ross Bad Debt Expense 21 Cash Accounts Receivable—D. L. Ross 4 200 00 5

Objective 4 9 -4 Describe the allowance method of accounting for uncollectible receivables. Allowance Method On December 31, Ex. Tone Company estimates that a total of $40, 000 of the $1, 000 balance in her company’s Accounts Receivable will eventually be uncollectible. Dec. 31 Bad Debt Expense Allowance for Doubtful Accounts 40 000 00 Uncollectible accounts estimate. 6

Net Realizable Value 9 -4 The net amount that is expected to be collected, $960, 000 ($1, 000 – $40, 000), is called the net realizable value (NRV). The adjusting entry reduces receivables to the NRV 7

9 -4 On January 21, John Parker’s account totaling $6, 000 is written off because it is uncollectible. Jan. 21 Allowance for Doubtful Accounts Receivable—John Parker 6 000 00 To write off the uncollectible account. 8

9 -4 During 2008, Ex. Tone 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). ALLOWANCE FOR DOUBTFUL ACCOUNTS Jan. 1, 2008 Bal. Total Jan. 21 6, 000 accounts Feb. 2 3, 900 written off “ “ $36, 750 “ “ Dec. 31 Unadjusted bal { 40, 000 3, 250 9

Collecting a Written-Off Account 9 -4 John Parker’s account of $6, 000 which was written off on Jan 21 is later collected on June 10. Two entries are needed: one to reinstate John Parker’s account and a second to record receipt of the cash. 10

Entry 1: Reinstate the account. June 10 Accounts Receivable—John Parker 9 -4 6 000 00 Allowance for Doubtful Accounts 6 000 00 To reinstate the account written off on Jan. 21. Entry 2: Record collection of cash. June 10 Cash Accounts Receivable—John Parker Collection of written-off account. 6 000 00 11

9 -4 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. 12

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. • A straight percentage calculation of sales 2. Estimate based on analysis of receivables. n 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. 13

Aging of Accounts Receivables 9 -4 14

Estimate Based on Analysis of Receivables 9 -4 If, based on analysis of receivables, 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). 15

Estimate Based on Analysis of Receivables Aug. 31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts ($3, 390 – $510). 9 -4 2 880 00 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 16

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). 9 -4 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 17

9 -4 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 new balance of Accounts Receivable, Allowance for Doubtful Accounts, and Bad Debt Expense, and (c) the net realizable value of accounts receivable. 18

Objective 6 9 -6 Characteristics of, and accounting for Notes Receivable 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. • 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. 19

9 -6 2, 500. 00 $_______ Fresno, California_______20___ March 16 08 Ninety days ________ _AFTER DATE _______ We PROMISE TO PAY TO THE ORDER OF ______________________ Judson Company Two thousand five hundred 00/100 -------------_________________________DOLLARS City National Bank PAYABLE AT _______________________ VALUE RECEIVED WITH INTEREST AT ____ 10% NO. _______ DUE__________ 14 June 14, 2008 H. B. Lane TREASURER, WILLIARD COMPANY What is the due date of the above note? 20

9 -6 Accounting for Notes Receivable 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. 6 000 00 Received 30 -day, 12% note dated November 21, 2008. 21

9 -6 On December 21, when the note matures, the firm receives $6060 from W. A. Bunn Company ($6, 000 plus $60 interest). Dec. 21 Cash 6 060 00 Notes Rec. —W. A. Bunn Co. Interest Revenue* Received principal and 6 000 00 60 00 interest on matured note. *$6, 000 x 12% x 30/360 = $60 22

9 -6 A 90 -day, 12% note dated December 1, 2008, is received from Crawford Company to settle its account, which has a balance of $4, 000. 2008 Dec. 1 Notes Rec. —Crawford Co. Accts. Rec. —Crawford Co. 4 000 00 Accepted note in settlement of account. 23

9 -6 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). 2008 Dec. 31 Interest Receivable Interest Revenue 40 00 Accrued interest ($4, 000 x 12% x 30/360). 24

9 -6 On March 1, 2009, $4, 120 is received for the note ($4, 000) and interest ($120). 2009 Mar. 1 Cash 4 120 00 Notes Rec. —Crawford Co. Interest Receivable Interest Revenue Collected note and accrued interest. 4 000 00 40 00 80 00 ($4, 000 x 12% x 30/360). 25

Objective 7 Describe the reporting of receivables on the balance sheet. 9 -7 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, 000 430, 000 Interest receivable Receivables (including the allowance account) are highlighted 14, 500 26

Accounts Receivable Turnover 9 -7 The accounts receivable turnover measures how frequently during the year the accounts receivable are being converted to cash. Net sales Accounts Receivable = Average accounts receivable Turnover 27

9 -7 Federal Express Corporation 2005 Net sales Accounts receivable Average accounts *[($2, 475 2004 $19, 364 $17, 383 2, 703 2, 475 receivable 2, 589 2003 * --$2, 199 2, 337 + $2, 199)/2] Accounts Receivable = Turnover (2004) $17, 383 $2, 337 Accounts Receivable = 7. 4 Turnover (2004) 28

9 -7 Federal Express Corporation 2005 Net sales Accounts receivable Average accounts *[($2, 703 2004 $19, 364 $17, 383 2, 703 2, 475 receivable 2, 589 * 2003 --$2, 199 2, 337 + $2, 475)/2] Accounts Receivable = Turnover (2005) $19, 364 $2, 589 Accounts Receivable = 7. 5 Turnover (2005) 29

Number of Days’ Sales in Receivables 9 -7 Use: To assess the efficiency in collecting receivables and in the management of credit. Average Accounts receivable Number of Days’ = Average daily sales Sales in Receivables 30

9 -7 Federal Express Corporation 2005 2004 2003 Net sales $19, 364$17, 383 --Accounts receivable 2, 703 2, 475 $2, 199 Average accounts receivable 2, 589 * 2, 337 Average daily sales 53. 1 47. 6 ** * [($2, 475 + $2, 119)/2] ** ($17, 383/365) $2, 337 Number of Days’ Sales = 47. 6 in Receivables (2004) Number of Days’ Sales = 49. 1 in Receivables (2004) 31

9 -7 Federal Express Corporation 2005 2004 2003 Net sales $19, 364$17, 383 --Accounts receivable 2, 703 2, 475 $2, 199 Average accounts receivable 2, 589 * 2, 337 Average daily sales 53. 1** 47. 6 * [($2, 703+ $2, 475)/2] ** ($19, 364/365) $2, 589 Number of Days’ Sales = 53. 1 in Receivables (2005) Number of Days’ Sales = 48. 8 in Receivables (2005) 32