Explain how companies recognize and

LEARNING
OBJECTIVE 3 value receivables.

Receivables - Amounts due from individuals and companies

that are expected to be collected in cash.

ILLUSTRATION 6-12
Receivables as a percentage of assets

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TYPES OF RECEIVABLES

Receivables - Amounts due from individuals and companies

that are expected to be collected in cash.

Amounts customer owe on Written promises for

account that result from the amounts to be received on
sale of goods and services. a specified future date.

Accounts Notes
Receivable Receivable

Other receivables include nontrade receivables such as interest

receivable, loans to company officers, advances to employees, and
income taxes refundable.
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 RECOGNIZING ACCOUNTS RECEIVABLE

 Service organization records a receivable when it

performs service on account.

 Merchandiser records accounts receivable at the point

of sale of merchandise on account.

 Seller may offer a discount to encourage early

payment.

 Buyer might return goods found to be unacceptable.

► Sales returns reduce revenues and receivables.

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VALUING ACCOUNTS RECEIVABLE

 Reported on the balance sheet as an asset.

 Two methods are used in accounting for

uncollectible accounts:
1. Direct write-off method.

2. Allowance method.

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 VALUING ACCOUNTS RECEIVABLE

Methods of Accounting for Uncollectible Accounts

Direct Write-Off Allowance Method

Theoretically undesirable: Losses are estimated:
 No matching.  Better matching.
 Receivable not stated at  Receivable stated at net
net realizable value. realizable value.
 Not acceptable for financial  Required by GAAP.
reporting.

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ACCOUNTS RECEIVABLE

ABC Corporation
Balance Sheet (partial)
Current Assets:
Cash 330
Accounts receivable 500
Less: Allowance for doubtful accounts (25) 475
Inventory 812
Prepaid expense 40
Total current assets 1,657

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 ACCOUNTS RECEIVABLE
Alternate
ABC Corporation Presentation
Balance Sheet (partial)
Current Assets:
Cash 330
Accounts receivable, net of $25 allowance 475
Inventory 812
Prepaid expense 40
Total current assets 1,657

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Direct Write-Off Method for Uncollectible

Accounts

Illustration: Assume that Warden Co. writes off M. E. Doran’s

$200 balance as uncollectible on December 12. Warden
records the write-off as follows:

INCOME
STATEMENT

Bad Debt
Expense

This transaction has no effect on cash flow.

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 Allowance Method for Uncollectible
Accounts

1. Companies estimate uncollectible accounts

receivable.

2. Increase Bad Debt Expense and increase

Allowance for Doubtful Accounts (a contra
account).

3. Companies decrease Allowance for Doubtful

Accounts and decrease Accounts Receivable at
the time the specific account is written off as
uncollectible.

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Allowance Method for Uncollectibles

RECORDING ESTIMATED UNCOLLECTIBLES

Illustration: Hampson Furniture has credit sales of
$1,200,000 in 2017, of which $200,000 remains uncollected at
December 31. The credit manager estimates that $12,000 of
these sales will prove uncollectible.

INCOME
STATEMENT

Bad Debt
Expense

This transaction has no effect on cash flow.

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 Allowance Method for Uncollectibles

Illustration 6-13
Presentation of allowance
for doubtful accounts

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Allowance Method for Uncollectibles

WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT

Illustration: The vice-president of finance of Hampson Furniture
on March 1, 2018, authorizes a write-off of the $500 balance
owed by R. A. Ware. The entry to record the write-off is:

INCOME
STATEMENT

This transaction has no effect on cash flow.

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 Allowance Method for Uncollectibles

WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT

A write-off affects only balance sheet accounts. Cash realizable
value in the balance sheet, therefore, remains the same before
and after the write-off.

Illustration 6-14
Cash realizable value comparison

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ESTIMATING THE ALLOWANCE

Under the percentage-of-receivables basis, management

establishes a percentage relationship between the amount of
receivables and expected losses from uncollectible accounts.
Amount of bad debt expense that should be recorded in the
adjustment is the difference between the required balance
and the existing balance in the allowance account.

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 ▼ HELPFUL HINT
ESTIMATING THE ALLOWANCE Where appropriate,
the percentage-of-
receivables basis
may use only a single
Aging of Accounts Receivable percentage rate.

Illustration 6-
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Aging schedule

54

ESTIMATING THE ALLOWANCE

Illustration: If the unadjusted trial balance in Allowance for

Doubtful Accounts is $528, then an adjustment for $1,700 is
necessary:

INCOME
STATEMENT

Bad Debt
Expense

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 DO IT! 3 Bad Debt Expense

Brule Co. has been in business five years. The unadjusted trial
balance at the end of the current year shows:
Accounts Receivable $30,000
Sales Revenue $180,000
Allowance for Doubtful Accounts $500
Bad debts are estimated to be 10% of accounts receivables. Record
the adjustment to Allowance for Doubtful Accounts.

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Prepare a multiple-step income statement

LEARNING
OBJECTIVE 4 and a comprehensive income statement.

MULTIPLE-STEP INCOME STATEMENT

 Highlights the components of net income.
 Three important line items:
► gross profit,

► income from operations, and

► net income.

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 MULTIPLE-STEP INCOME STATEMENT

Key
Line
Items

ILLUSTRATION 6-
16
Multiple-step income
statements
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MULTIPLE-
STEP

Key Items:
 Sales

ILLUSTRATION 6-19
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 MULTIPLE-
STEP

Key Items:
 Sales

 Gross Profit

ILLUSTRATION 6-19
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MULTIPLE-
STEP

Key Items:
 Sales

 Gross Profit

 Operating
Expenses

ILLUSTRATION 6-19
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 MULTIPLE-
STEP

Key Items:
 Sales

 Gross Profit

 Operating
Expenses

 Nonoperating
Activities

ILLUSTRATION 6-19
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MULTIPLE-
STEP

Key Items:
 Sales

 Gross Profit

 Operating
Expenses

 Nonoperating
Activities

ILLUSTRATION 6-19
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 MULTIPLE-
STEP

Key Items:
 Sales

 Gross Profit

 Operating
Expenses

 Nonoperating
Activities

 Net income

ILLUSTRATION 6-19
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COMPREHENSIVE INCOME STATEMENT

Comprehensive income statement presents items that are

not included in the determination of net income.
Items excluded from net income but included in
comprehensive income are either reported in a combined
statement of net income and comprehensive income, or in a
separate comprehensive income statement.
ILLUSTRATION 6-20
Combined statement of net
income and comprehensive
income

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 DO IT! 4 Multiple-Step Income Statement

The following information is available for Art Center Corp. for the year
ended December 31, 2017.
Other revenues and gains $ 8,000 Sales revenue $462,000
Other expenses and losses 3,000 Operating expenses 187,000
Cost of goods sold 147,000 Sales discounts 20,000
Other comprehensive
income 10,000
Prepare a multiple-step income statement and comprehensive income
statement for Art Center Corp. The company has a tax rate of 25%. This
rate also applies to other comprehensive income.

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Prepare a multiple-step income statement and comprehensive

income statement for Art Center Corp. (statement heading omitted).

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 Prepare a multiple-step income statement and comprehensive income
statement for Art Center Corp.

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Compute and analyze gross profit rate

LEARNING
OBJECTIVE 5 and profit margin.

GROSS PROFIT RATE

May be expressed as a percentage by dividing the amount
of gross profit by net sales.
A decline in the gross profit rate might have several causes.
► Selling products with a lower “markup.”

► Increased competition may result in a lower selling price.

► Company forced to pay higher prices to its suppliers

without being able to pass these costs on to its customers.

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 GROSS PROFIT RATE

ILLUSTRATION 6-22
Gross profit rate
Why does REI’s gross profit rate differ so
much from that of Dick’s Sporting Goods and
the industry average?

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PROFIT MARGIN

The profit margin measures the percentage of each

dollar of sales that results in net income.

How do the gross profit rate and profit margin ratio differ?
► Gross profit rate measures the margin by which
selling price exceeds cost of goods sold.

► Profit margin ratio measures the extent by which

selling price covers all expenses (including cost of
goods sold).

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 PROFIT MARGIN

ILLUSTRATION 6-24
Profit margin How does REI compare to its competitors? Its
profit margin was lower than Dick’s in 2014 and
was less than the industry average. Thus, its profit
margin does not suggest exceptional profitability.
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DO IT! 5 Gross Profit Rate and Profit Margin

Rachel Rose, Inc. reported the following in its 2017 and 2016 income
statements.
2017 2016
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $ 20,000

Determine the company’s gross profit rate and profit margin.

2017 2016
($80,000 − $40,000) ($120,000 − $60,000)
= 50% = 50%
$80,000 $120,000

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 DO IT! 5 Gross Profit Rate and Profit Margin

Rachel Rose, Inc. reported the following in its 2017 and 2016 income
statements.
2017 2016
Net sales $80,000 $120,000
Cost of goods sold 40,000 60,000
Operating expenses 14,000 28,000
Income tax expense 8,000 12,000
Net income $18,000 $ 20,000

Determine the company’s gross profit rate and profit margin.

2017 2016
$18,000 ÷ $80,000 = 22.5% $20,000 ÷ $120,000 = 16.7%

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