CHAPTER 9 Receivables

Introduction to Receivables
A. Receivables are monetary claims against businesses and individuals. These claims arise from

selling goods or services on credit or from lending money. 1. Each credit transaction involves a creditor who sells something and obtains a receivable, and a debtor who makes the purchase and has a payable. E hibit !"1 is the asset portion of a balance sheet, with receivables highlighted.

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#. An account receivable or trade receivable represents an amount due from a customer. 1.

An account receivable is an amount due from a customer for goods or services sold. The account is classified as a current asset on the balance sheet. A subsidiary ledger includes a separate account for each customer.

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%. A note receivable is more formal than an account receivable. 1.

A note receivable is a written promise to receive cash& a promissory note is a negotiable document that serves as evidence of the receivable. A note receivable may be classified as either current or long-term, depending on its maturity date.

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'. Other receivables may include loans to employees or subsidiary companies& these may be

either current or long"term assets.

Objective 1: Design internal controls for receivables

A. (nternal control over collections of cash on account is important. 1. 2. Cash-handling duties should be separate from cash-accounting duties. The bookkeeper should not also handle cash receipts. A bank loc bo! accomplishes the same control over receipts of cash.
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The person posting the accounts receivable subsidiary ledger should not also handle cash receipts.

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The credit department is responsible for evaluating and approving new credit customers as well as monitoring the payment history of current customers. The credit department should not have access to cash. "ecision #uidelines discuss controlling, managing, and accounting for receivables. )elling on credit creates both a bene$it *sales+ and a cost *some customers won,t pay+. 1. %ncollectible-account e!pense results from charge sales that customers cannot or will not pay. The account may also be called doubt$ul-account e!pense or bad-debt e!pense.

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This is a normal e pense for any business that sells on credit& two methods are used for recording this e pense1. The allo&ance method . preferred because it matches collection losses with revenues in the period in which the sales were made. The direct &rite-o$$ method . fails to match the e pense with the sales revenue.

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The allo&ance method of recording uncollectible"account *or bad"debt+ e pense is based on estimates of collection losses.
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Allo&ance $or %ncollectible Accounts *or Allo&ance $or "oubt$ul Accounts+ is a contra account, an asset account with a credit balance. This account represents the estimated amount of collection losses, or the amount of receivables the business expects not to collect. 0n the balance sheet, net accounts receivable e1uals Accounts Receivable minus Allowance for 2ncollectible Accounts. 3et accounts receivable is the amount of receivables the business expects to collect. 2ncollectible"Account E pense is reported on the income statement.

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Objective 2: Use the allowance method to account for uncollectibles

A. 2nder the allowance method, there are two ways to estimate uncollectible"account e pense- percent"of"sales and aging"of"accounts. 1. The percent-o$-sales method *also called the income statement approach+ considers the credit sales for the period. (f focuses on the amount of expense to be reported on the income statement. a. The percentage used is an historical percentage based on prior uncollectible accounts and past collection e perience. To calculate the uncollectible"account e pense, the percentage is multiplied by the credit sales. At the end of each accounting period this ad4usting entry is made2ncollectible"Account E pense Allowance for 2ncollectible Accounts c. 2. 55 55

b.

This entry ad4usts the Allowance account by the amount of e pense.

The aging-o$-accounts method *also called the balance-sheet approach+ considers the age and amount of accounts receivable at the end of the period. This method focuses on the amount of net accounts receivable to be reported on the balance sheet. a. /irst, the accounts are aged *classified according to the age of the account+, as illustrated in E hibit !"2. A historical percentage is applied to each age category. This amount represents the estimated amount of uncollectible accounts from each age category. 6hen these amounts are added together, the total is the desired ending balance in the Allowance account. The longer an account goes uncollected, the more likely it is to become a bad debt& therefore a higher percentage is applied to accounts that are long past due. The amounts of uncollectible accounts from each category are added together. This amount is the desired ending balance in the Allowance Account. *)ee E hibit !"2.+

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To calculate the e!pense, consider the unad4usted balance in the Allowance account and the desired ending balance, based on the calculation described above. The e pense is the amount that will be added to *or deducted from+ the Allowance account to achieve the desired ending balance. At the end of each accounting period this ad4usting entry is made2ncollectible"Account E pense Allowance for 2ncollectible Accounts 55 55

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3ote that this entry ad4usts the Allowance account to the estimated amount of uncollectible accounts.

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'et reali(able value is the net amount of accounts receivable . Accounts Receivable less Allowance for 2ncollectible"Accounts. The percent of sales and aging methods may be used together. /or interim statements, the percent of sales method is easy to use& at year"end, the aging method is more accurate because it ad4usts accounts receivable to the e pected reali7able value. /or a comparison of the two methods, see E hibit !"$. An account is &ritten o$$ when it is determined to be uncollectible. No e pense is recorded at this time. (nstead, the Allowance account is reduced with a debit. 1. 6hen an account is deemed to be uncollectible, the entry to write"off this accountAllowance for 2ncollectible Accounts Accounts Receivable *customer name+ 2. 55 55

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The write"off of an account has no effect on net income& it does not have any effect on net receivables. (n other words, net receivables are the same before and after the write"off because the company still e pects to collect the net amount.

Objective 3: Use the direct write-off method to account for uncollectibles

A. 6hen using the direct &rite-o$$ method of accounting for uncollectible receivables, the company waits until a customer,s account is deemed uncollectible to write off the account.

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At the time an account is written off, this entry is made2ncollectible"Account E pense Accounts Receivable *customer name+ 55 55

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This method is defective because it does not set up an allowance for uncollectibles, resulting in accounts receivable that may be overstated on the balance sheet. The direct write"off method does not match revenue and uncollectible"account e pense. (n some cases, the e pense may be recorded in a later period than the revenue. 9owever, the direct write"off method is easy to use and will not create significant distortions in income or assets if collection losses are insignificant.

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(f an account written off is later collected, two entries are re1uired- one entry to reverse the original write"off of that account and a second entry to record the cash collection. Accounts Receivable *customer name+ Allowance for 2ncollectible Accounts To reverse previous write-off. %ash 55 Accounts Receivable *customer name+ To record collection of account receivable. 55 55

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Credit-card and ban card sales benefit both consumers and retailers. 1. 6ith cards such as American E press, :()A, and 'iscover, the customer does not have to pay cash immediately, but is instead billed monthly. The customer then writes only one check for the statement balance. The retailer receives cash almost immediately for the sale *rather than having to wait until the customer is billed+ and does not have to check a customer,s credit or send bills. a. The retailer,s entry when there are credit"card sales isAccounts Receivable . 'iscover
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2.

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%redit"%ard 'iscount E pense )ales Revenue b. 6hen the retailer collects the discounted amount%ash Accounts Receivable . 'iscover c. 55

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The retailer,s entry when there are bankcard sales such as :()A is%ash #ankcard 'iscount E pense )ales Revenue 55 55 55

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"ebit cards do not re1uire a third party *such as :()A+. 6hen the buyer uses the card, his cash account is immediately decreased and the vendor,s cash is immediately increased.

Objective : !ccount for notes receivable

A. A note receivable represents a written promise to pay a specific sum of money on a particular date. ;ey terms and features related to a promissory note are illustrated in E hibit !"8 and given below1. The principal is the amount borrowed by the debtor. 2. $. The ma er of the note is the debtor& the payee is the creditor. The interest is revenue to the payee and the borrower,s cost of using the creditor,s money. (t is always stated on an annual basis unless specified. The te t uses a $<="day year. )nterest is calculated asPrincipal ! Rate ! Time * )nterest 8. +aturity value *principal plus interest+ is due on the maturity date. To determine maturity date, count the e act days or months from the issue date of the note. #e sure to begin counting on the day following the date of the note.

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Accounting for notes receivable is illustrated below-

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A note receivable may be received $or cash, $or a sale, or in settlement o$ an account. The entry is3ote Receivable . >aker 55 %ash *or )ales Rev. or Accounts Rec.+

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The entry to accrue interest revenue at the end of the accounting period is(nterest Receivable (nterest Revenue 55 55

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The entry to record collection o$ the note and interest revenue on the maturity date is%ash 3ote Receivable (nterest Receivable (nterest Revenue 55 55 55 55

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A company holding a note receivable may sell the note before its maturity date& this is referred to as discounting a note receivable. Refer to the appendi to the chapter for further e planation. (f a note receivable is not paid at maturity, the maker of the note is said to dishonor or de$ault on the note. The payee records interest revenue earned on the note and debits Accounts Receivable for the full maturity value of the noteAccounts Receivable 3ote Receivable (nterest Revenue 55 55 55

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Objective ": Re#ort receivables on the balance sheet

A. A business usually reports its accounts receivable at net reali(able value and discloses the allowance account parenthetically. Alternately, the firm may report net reali(able value for receivables on the balance sheet and include details in the footnotes.

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(n many large companies, computers aid in accounting for receivables. E hibit !"? illustrates the integration of order entry, shipping, and billing for >@> >ars.

Objective $: Use the acid-test ratio and da%s& sales in receivables to evaluate a com#an%
A. ,ey ratios can help managers and owners make decisions about the li-uidity of a business. #. 0n the balance sheet, cash is always listed first because it is the most li1uid asset& cash is followed by short"term investments, then current receivables, then inventory. The balance sheet in E hibit !"< is used to illustrate the two ratios- acid"test and days, sales in receivables.

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The acid-test .or -uic / ratio measures a company,s ability to pay current liabilities. (n general, an acid"test ratio of 1.= is considered safe. The computation isAcid-test ratio * Cash 0 1hort-term investments 0 'et current receivables Total current liabilities

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The days2 sales in receivables .or collection period/ indicates how many days it takes to collect the average level of receivables. The number of days should be very near the days in the credit period. There are two steps to the computationa. One day2s sales * 'et sales 345 days

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"ays2 sales in average accounts * Average net accts recble receivable One day2s sales

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A meaningful analysis of financial information is best achieved by calculating many ratios over a number of years.

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"ecision #uidelines summari7e the accounting for receivables and using ratios related to receivables.

!##endi' to (ha#ter ):
A. 3otes receivable may be discounted .or sold/ by the payee for cash prior to maturity date. 1. 0ften, present value calculations are used to determine the discounted price of a note receivable that is sold to a bank prior to maturity. The bank calculates the interest .or discount/ based on the maturity value of the note, the bank,s holding period, and the bank,s discount rate. The maturity value less the bank,s discount e1uals the proceeds or discounted value.

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The payee records receipt of the proceeds of a discounted note with this entry%ash *proceeds+ (nterest E pense 3ote Receivable 55 55 55

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3ote- the entry may instead re1uire a credit to (nterest Revenue *rather than a debit to (nterest E pense+ if the interest included in the maturity value is greater than the bank,s discount.

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The steps to discounting a note receivable are illustrated in E hibit !A"1.

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