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A receivable is a company’s claims for money,

goods, or services.

An account receivable is classified as a current

asset representing money due for services

performed or merchandise sold on credit.

When an account becomes uncollectible, a bad

debt expense is incurred.

Example: Accounts Receivable

Assume merchandise is sold on account for $1,000. The terms of the agreement were 2/10, n/30. The entries are as follows:


Credit Sale:

Accounts Receivable 1,000

Sales Revenue 1,000



Credit Sale:

Accounts Receivable..... 1,000

Sales Revenue......... 1,000

Collection--2/10,n/30:

Cash.............................. 980

Sales Discounts............. 20



Some receivables will never be

collected and must be written off

as uncollectible.

Occurs when customers do not pay for items or

services purchased on credit.

Bad Debts are uncollectible accounts

receivables.

The uncollectible expense is placed on the

income statement as a selling expense.

Direct Method

Or:

•Allowance Method

EXAMPLE:

If We Have $100,000 in A/R

• All invoices are presumed to be good . . .

• (Valued at $100,000)

They would be represented by a

stack of invoices

Invoice

ABC Inc. $

Direct MethodUnder the

• until we discover someone can’t pay

the amount owed.

Direct Method

• When an invoice is discovered to

be uncollectible — it must be

removed from A/R.

• That is it must be expensed or

written off.

Invoice

ABC Inc. $

Direct Method

Journal Entry to record Bad Debt:

Invoice

ABC Inc. $

Dr. Cr.

Bad Debt Expense 500

Accounts Receivable 500

Direct Method

Problem:Invoice

ABC Inc. $

Accounts Receivable is reported at

the full $100,000 until bad debts are

specifically identified.

But, we know some customers in the

stack will not pay.

So, what is the real value of A/R?

Direct Method

Like all assets, the value of A/R is

only what you expect to collect.

Invoice

ABC Inc. $

1. Accounts Receivable is overstated.

2. Bad debt expense is understated!

It is not recorded in the same period the sale

was made.

• Requires expenses be recorded in the

same period the corresponding revenue

is recognized.

Direct Method is in conflict with the

Matching Principle

Not accepted under GAAP

Under the

Allowance Method

• We presume some invoices will not

be good . . .

• We just don’t know which ones.

Invoice

ABC Inc. $ If We Have $100,000

in A/R

Allowance Method

ESTIMATE the amount, but don’t remove any invoices from A/R

How do we write off an unknown

amount of Accounts Receivable?

An estimate can be based on:a) Size of the receivablesb) Age of the receivablesc) Past loss experienced) All of the above

Allowance Method

Assume you made an estimate that

$2000 will not be collectable. What

journal entry would you make?

Dr. Cr.

Hint: Accounts Receivable is NOT reduced because

which invoices will become uncollectable is unknown!

Allowance Method

Dr. Cr.


Allowance for Doubtful Accounts 2000

To record estimated bad debts

Allowance Method

Assets:

Cash 20,000


Supplies 2,500

PP&E 3,000,000

Total Assets 3,120,500

The Allowance

for Doubtful

Accounts is a

contra asset

that follows A/R

Assets:

Cash 20,000


Less Allowance for DA 2,000

Net Accounts Receivable 98,000

Supplies 2,500

PP&E 3,000,000

Total Assets 3,120,500

Note: Accounts Receivable is NOT reduced but the

net receivable is!

Journal Entry needed when an account

is identified as uncollectible:

Dr. Cr.



To write off Smith Co. (in bankruptcy)

Allowance Method

Dr. Cr.



Allowance Method

Allowance for DA 2000

Allowance for DA 500May 5

Dec 31

Dr. Cr.



Direct Method

May 5

(1) The Allowance for Doubtful Accounts is a

contra-asset account which is subtracted from

accounts receivable on the balance sheet.

(2) The actual write-off entry does not reduce net

receivables, as shown below:

Acct Receivable $100,000 Acct Receivable $99,500Less Allowance for Less Allowance forDoubtful Accounts 2,000 Doubtful Accounts 1,500Net Receivables $ 98,000 Net Receivables $98,000

Allowance Method

(1) The Allowance for Doubtful Accounts is a

contra-asset account which is subtracted from

accounts receivable on the balance sheet.

(2) The actual write-off entry does not reduce net

receivables.

(3) The estimation error inherent in this approach is

more acceptable than the violation of matching

with the direct write-off method.

Allowance Method

Reverse Write Off:



To reinstate a written-off receivable.

Reverse Write Off:



To reinstate a written-off receivable.

Eliminate Receivable:

Cash 500


Payment for written-off receivable.

Reversing Written-Off Receivables

Percentage of Total Receivables-- Determines

the desired balance for Allowance for Doubtful

Accounts. The difference between the actual

and the desired balance is the expense entry.

Aging Method--The process of categorizing

each account receivable by the number of days

it has been outstanding.

Example: Bad Debt Expense

The ABC company had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for doubtful accounts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected.


Bad Debt Expense

350 Balance

Expense 2,701 2,701 Expense

End. Balance 2,701 3,051 End. Bal.

Allowance for Doubtful Accounts


Bad Debt Expense 2,701Allowance for Doubtful Accounts 2,701

To adjust the Allowance account to desired balance.


Bad Debt Expense

350 Balance

Expense 2,701 2,701 Expense

End. Bal. 2,701 3,051 End. Bal.

Allowance for Doubtful Accounts


The XYZ Company had credit sales during the year of $200,000. Using the Aging Method, determine the journal entry needed. The beginning balance for the Allowance for Doubtful accounts is $150.

Example 2: Bad Debt Expense

Percentage

Estimated to be

Age Balance Uncollectible Amount

Current.............. $10,000 1.5 $ 150

1-30 days.......... 4,000 4.0 160

31-90 days........ 2,100 20.0 420

Over 90 days..... 1,000 40.0 400

$17,000 $1,130


Uncollectible Account

Expense

Allowance for

Doubtful Accounts

150 Balance

Expense 980 980 Expense

End. Bal. 1,130 End. Bal.


980


Uncollectible Account

Expense

Allowance for

Doubtful Accounts

150 Balance

Expense 980 980 Expense

End. Bal. 980 1,130 End. Bal.

Uncollectible Account Expense 980Allowance for Doubtful Accounts 980

To adjust the Allowance account to desired balance.


The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary?

Accounting for Uncollectible Receivables (Percentage of Credit Sales)

The ABC company had credit sales during the year of $100,000. They estimate that 3% of all credit sales will be uncollectible. Assuming the allowance for doubtful accounts has a debit balance of $ 1,000 what entry is necessary?

Uncollectible Accounts Expense 4,000

Allowance for Uncollectible Accounts 4,000

To record estimated uncollectible accounts for the year.

Accounting for Uncollectible Receivables (Percentage of Credit Sales)

Accounts Receivable Turnover--A measure used

to determine a company’s average collection

period for receivables. Computed by dividing net

sales (credit sales) by average accounts

receivables.

• Accounts Receivable Turnover

• Number of Days in Receivables--A

measure of the average number of days

it takes to collect a credit sale. It is

computed by dividing 365 days by the

accounts receivable turnover.

Assessing Management of Receivables

Example

The Wheeler Company had Net Credit Sales

of $150,000 during 2009. The accounts

receivables increased $5,000 to $40,000

during the same time. Calculate the Accounts

Receivable Turnover and Number of Days in

Receivables.






Receivables.

Accounts Receivable Turnover:

Net Sales $150,000 = 4.0Average Accounts Receivable $ 37,500

Example

Number of Days in Receivables:

Number of Days 365 = 91.25Accounts Receivable Turnover 4.0






Receivables.

Example

A written promise that allows someone to pay a

certain amount of money on or before a

specific future date.

Notes are classified as current or long-term

assets, depending on the due date.

Maker--The individual who signs the note and

assumes responsibility.

Payee--The person to whom payment is made.

Principal--The face amount of the note.

Maturity Date--The date the note becomes due.

Interest Rate--Annualized percentage of the

principal the maker is charged to borrow money.

Interest--The cost of borrowing money.

Notes Receivable -- Components

Computing Interest

Principal

(amount)

Principal

(amount)

Interest

Rate (%)X

Computing Interest

Principal

(amount)

Interest

Rate (%)

Time

(years)X X

Computing Interest

Principal

(amount)

Interest

Rate (%)

Time

(years)

Interest

Owed

X X

Equals

Computing Interest

Example: Interest

The Ohio Company signed a 90-day, $5,000 note

payable to the Florida Company in settlement of

existing accounts payable. The interest rate of the

agreement is 14 percent. Calculate the interest

cost.

The Ohio Company signed a 90-day, $5,000 note

payable to the Florida Company in settlement of

existing accounts payable. The interest rate of the

agreement is 14 percent. Calculate the interest

cost.

Principal x Interest Rate x Time = Interest

$5,000 x 0.14 x 90/365 = $172.60

What journal entries are required for the Ohio

Company? For the Virginia Company?

Example: Interest

Accept Note:

Accounts Payable............ 5,000.00

Note Payable............. 5,000.00

Pay Note Plus Interest:

Note Payable................... 5,000.00

Interest Expense.............. 172.60

Cash.......................... 5,172.60

The Ohio Company--Maker

Journalizing Notes Receivable

Accept Note:

Note Receivable............... 5,000.00

Accounts Receivable.. 5,000.00

Collect Note Plus Interest:

Cash................................. 5,172.60

Note Receivable......... 5,000.00

Interest Revenue........ 172.60

The Virginia Company--Payee

Journalizing Notes Receivable

Receivables are sold to factoring companies for

cash.

The factoring companies charge a percentage

of the receivable as a service cost.

Factoring allows companies to receive cash

now, instead of waiting to collect on the

receivable.

08

Business

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