CHAPTER

8
Accounting for Receivables

LEARNING OBJECTIVES

Chapter 8 After studying this chapter, you should be able to:

1. Identify the different types of receivables.
2. Explain how companies recognize accounts receivable.
3. Distinguish between the methods and bases companies use to value accounts receivable.

Accounting for
4. Describe the entries to record the disposition of accounts receivable.
5. Compute the maturity date of and interest on notes receivable.
6. Explain how companies recognize notes receivable.

Receivables 7. Describe how companies value notes receivable.

8. Describe the entries to record the disposition of notes receivable.
9. Explain the statement presentation and analysis of receivables.

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Learning Objective 1
Types of Receivables Identify the different types of receivables.
PREVIEW OF CHAPTER 8
Amounts due from individuals and companies that are expected to be collected in cash.

Amounts customers owe on Written promise (formal Nontrade receivables such as

account that result from the sale instrument) for amount to be interest, loans to officers,
of goods and services. received. Also called trade advances to employees, and
receivables. income taxes refundable.

Accounts Receivable Notes Receivable Other Receivables

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 TYPES OF RECEIVABLES TYPES OF RECEIVABLES

Question
Amounts due from individuals and companies that are expected to be collected in cash.
Receivables are frequently classified as:

a. accounts receivable, company receivables, and other receivables.

b. accounts receivable, notes receivable, and employee receivables.

c. accounts receivable and general receivables.

d. accounts receivable, notes receivable, and other receivables.

Illustration 8-1
Receivables as a percentage of assets

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Accounts Receivable Recognizing Accounts Receivable

Learning Objective 2
Explain how companies recognize
Recognizing Accounts Receivable accounts receivable. Illustration: Assume that Hennes & Mauritz (SWE) Co. on July 1, 2017, sells merchandise on
account to Polo Company for $1,000 terms 2/10, n/30. Prepare the journal entry to record this
 Service organization records a
transaction on the books of Hennes & Mauritz.
receivable when it performs service on account.

 Merchandiser records accounts receivable at the point of sale of merchandise on

Jul. 1
account.

 Seller may offer a discount to encourage early payment.

 Buyer might return goods found to be unacceptable.

► Sales returns reduce receivables.

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 Recognizing Accounts Receivable Recognizing Accounts Receivable

Illustration: On July 5, Polo returns merchandise worth $100 to Hennes & Mauritz. Illustration: Some retailers issue their own credit cards. Assume that you use your JCPenney
Company credit card to purchase clothing with a sales price of $300.

Jul. 5

Illustration: On July 11, Hennes & Mauritz receives payment from Polo Company for the balance due.
Assume that you owe $300 at the end of the month, and JCPenney charges 1.5% per month on
the balance due.
Jul. 11

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> DO IT! Valuing Accounts Receivable

Learning Objective 3
On May 1, Wilton sold merchandise on account to Bates for €50,000 terms 3/15, net 45. On May 4, Bates  Current asset.
Distinguish between the methods and
bases companies use to value accounts
returns merchandise with a sales price of €2,000. On May 16, Wilton receives payment from Bates for the receivable.

balance due. Prepare journal entries to record the May transactions on Wilton’s books. (Ignore cost of goods  Valuation (net realizable value).
sold entries.)
Uncollectible Accounts Receivable
 Sales on account raise the possibility of accounts not being collected.
May 1
 Seller records losses that result from extending credit as Bad Debt Expense.

16

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 Valuing Accounts Receivable Accounts Receivable

Methods of Accounting for Uncollectible Accounts How are these accounts presented on the Statement of Financial Position?

Direct Write-Off Allowance Method

Allowance for Doubtful
Theoretically undesirable: Losses are estimated: Accounts Receivable Accounts
 No matching.  Better matching. Beg. 500 25 Beg.
 Receivable not stated at amount expect to  Receivable stated at cash (net) realizable
be received. value.
 Not acceptable for financial reporting.  Required by IFRS.

End. 500 25 End.

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Accounts Receivable Accounts Receivable

Alternate
Presentation

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 Accounts Receivable Accounts Receivable

Journal entry for credit sale of €100. Journal entry for credit sale of €100.

Allowance for Doubtful Collected €333 on account.

Accounts Receivable Accounts
Beg. 500 25 Beg.

Adjustment of €15 for estimated bad debts.

End. 500 25 End.

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Accounts Receivable Accounts Receivable

Write-off of uncollectible accounts for €10.

Allowance for Doubtful

Accounts Receivable Accounts
Beg. 500 25 Beg.

End. End.

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 DIRECT WRITE-OFF METHOD FOR UNCOLLECTIBLE ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS
ACCOUNTS

Illustration: Assume that Warden Ltd. writes off M. E. Doran’s HK$1,600 balance as 1. Companies estimate uncollectible accounts receivable.
uncollectible on December 12. Warden’s entry is:
2. Debit Bad Debt Expense and credit Allowance for Doubtful Accounts (a contra-
asset account).

3. Companies debit Allowance for Doubtful Accounts and credit Accounts

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

Theoretically undesirable:
 No matching.
 Receivable not stated at cash realizable value.
 Not acceptable for financial reporting.

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ALLOWANCE METHOD 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.

Dec. 31
Illustration 8-3
Presentation of allowance for doubtful accounts

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 Allowance Method for Uncollectibles Allowance Method for Uncollectibles

WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT WRITE-OFF OF AN UNCOLLECTIBLE ACCOUNT

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

Mar. 1 Mar. 1

Illustration 8-4
General ledger balances after write-off
Illustration 8-5
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Allowance Method for Uncollectibles Allowance Method for Uncollectibles

Illustration 8-6
RECOVERY OF AN UNCOLLECTIBLE ACCOUNT ESTIMATING THE ALLOWANCE Comparison of bases for
estimating uncollectibles

Illustration: On July 1, R. A. Ware pays the €500 amount that Hampson Furniture had written off
on March 1.

July 1

Emphasis on Income Statement Relationships Emphasis on Statement of Financial Position

Relationships

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 Allowance Method for Uncollectibles Allowance Method for Uncollectibles

ESTIMATING THE ALLOWANCE Percentage-of-Sales

Illustration 8-6
Illustration: Assume that Gonzalez SA elects to use the percentage-of-sales basis. It concludes that
Management estimates what percentage of
1% of net credit sales will become uncollectible. If net credit sales for 2017 are €800,000, the
credit sales will be uncollectible. This
adjusting entry is:
percentage is based on past experience
and anticipated credit policy.
Dec. 31

Emphasis on Income Statement Relationships

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Allowance Method for Uncollectibles Allowance Method for Uncollectibles

Percentage-of-Sales ESTIMATING THE ALLOWANCE

Illustration 8-6

 Emphasizes matching of expenses with revenues. Management establishes a percentage

 Adjusting entry to record bad debts disregards the existing balance in Allowance for Doubtful relationship between the amount of
Accounts. receivables and expected losses from
uncollectible accounts.

Emphasis on Statement of Financial Position

Illustration 8-7
Bad debt accounts after posting
Relationships

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 Allowance Method for Uncollectibles Allowance Method for Uncollectibles

Aging the accounts receivable - customer balances are classified by the length of time they Percentage-of-Receivables (₩ in thousands)
have been unpaid. Illustration 8-8
Aging schedule Illustration: Assume the unadjusted trial balance shows Allowance for Doubtful Accounts with a credit
balance of ₩528. Prepare the adjusting entry assuming ₩2,228 is the estimate of uncollectible
receivables from the aging schedule.

Dec. 31

Illustration 8-9 Bad debt

accounts after posting

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> DO IT! Allowance Method for Uncollectibles

Brule Co. has been in business five years. The ledger at the end of the current year shows: Question
Accounts Receivable $30,000 Dr.
Sales Revenue $180,000 Cr. Which of the following approaches for bad debts is best described as a statement of
Allowance for Doubtful Accounts $2,000 Dr. financial position method?
Bad debts are estimated to be 10% of receivables. Prepare the entry to adjust Allowance for Doubtful
a. Percentage-of-receivables basis.
Accounts.
b. Direct write-off method.
Solution: c. Percentage-of-sales basis.

d. Both percentage-of-receivables basis and direct write-off method.

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 Disposing of Accounts Receivables SALE OF RECEIVABLES
Learning Objective 4
Describe the entries to record the
SALE OF RECEIVABLES disposition of accounts receivable. Illustration: Assume that Tsai Furniture factors NT$600,000 of receivables to Federal Factors.
Federal Factors assesses a service charge of 2% of the amount of receivables sold. The journal entry
 Finance company or bank.
to record the sale by Tsai Furniture is as follows.
 Buys receivables from businesses and then collects the payments directly from the
customers.

 Typically charges a commission to the company that is selling the receivables.

 Fee ranges from 1% to 3% of the receivables purchased.

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Disposing of Accounts Receivables CREDIT CARD SALES

CREDIT CARD SALES Illustration: Lee Co. purchases NT$6,000 of music downloads for its restaurant from Yang Music
Co., using a Visa First Bank Card. First Bank charges a service fee of 3%. The entry to record this
 Retailer pays card issuer a fee of 2 to 6% of the invoice price for its services.
transaction by Yang Music is as follows.
 Recorded the same as cash sales.

 Advantages to retailer:
► Issuer does credit investigation of customer.
► Issuer maintains customer accounts.
► Issuer undertakes collection and absorbs losses.
► Receives cash more quickly.

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 > DO IT! Notes Receivable
Learning Objective 5
Compute the maturity date of and
Mehl Wholesalers NV needs to raise €120,000 in cash to safely cover next Friday’s employee payroll. Companies may grant credit in exchange interest on notes receivable.
Mehl has reached its debt ceiling. Mehl’s balance of outstanding receivables totals €750,000. Mehl for a promissory note. A promissory note
decides to factor €125,000 of its receivables on September 7, 2017, to alleviate this cash crunch.
is a written promise to pay a specified amount of money on demand or at a definite time.
Record the entry that Mehl would make when it raises the needed cash. (Assume a 1% service charge.)
Promissory notes may be used
1. when individuals and companies lend or borrow money,

2. when amount of transaction and credit period exceed normal limits, or

3. in settlement of accounts receivable.

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Notes Receivable Determining the Maturity Date

To the payee, the promissory note is a note receivable. Maturity date of a promissory note may be stated in one of three ways:
To the maker, the promissory note is a note payable.
1. On demand.
2. On a stated date.
3. At the end of a stated period of time.

Note terms are expressed in:

 Months
 Days

Illustration 8-11
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 Computing Interest Notes Receivable

Question
One of the following statements about promissory notes is incorrect. The incorrect
Illustration 8-14
Formula for computing interest
statement is:

a. The party making the promise to pay is called the maker.

When counting days, omit the date the note is issued, but include the due date.
b. The party to whom payment is to be made is called the payee.

c. A promissory note is not a negotiable instrument.

d. A promissory note is often required from high-risk customers.

Illustration 8-15
Computation of interest
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Recognizing Notes Receivable Valuing Notes Receivable

Learning Objective 6 Learning Objective 7
Explain how companies recognize Describe how companies value
Illustration: Calhoun Company wrote a ₤1,000, notes receivable.  Report short-term notes receivable at notes receivable.
two-month, 12% promissory note dated May 1, their cash (net) realizable value.
to settle an open account. Prepare entry would
 Estimation of cash realizable value and recording bad debt expense and related
Wilma Company makes for the receipt of the note.
allowance are similar to accounts receivable.

 Allowance for Doubtful Accounts is used.

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 Disposing of Notes Receivable Disposing of Notes Receivable
Learning Objective 8
Describe the entries to record the
1. Notes may be held to their maturity date. disposition of notes receivable. HONOR OF NOTES RECEIVABLE
2. Maker may default and payee must make A note is honored when its maker pays it in full at its maturity date.
an adjustment to the account.

3. Holder speeds up conversion to cash by selling the note receivable.

DISHONOR OF NOTES RECEIVABLE
A dishonored note is not paid in full at maturity. Dishonored note receivable is no longer
negotiable.

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HONOR OF NOTES RECEIVABLE ACCRUAL OF INTEREST RECEIVABLE

Illustration: Wolder Co. lends Higley Inc. €10,000 on June 1, accepting a five-month, 9% Illustration: Suppose instead that Wolder Co. prepares financial statements as of September 30.
interest note. If Wolder presents the note to Higley Inc. on November 1, the maturity date, The adjusting entry by Wolder is for four months ending Sept. 30.
Wolder’s entry to record the collection is: Illustration 8-16
Timeline of interest earned

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 ACCRUAL OF INTEREST RECEIVABLE DISHONOR OF NOTES RECEIVABLE

Illustration: Prepare the entry Wolder’s would make to record the honoring of the Higley note on Illustration: Assume that Higley Co. on November 1 indicates that it cannot pay at the present time.
November 1. If Wolder Co. does expect eventual collection, it would make the following entry at the time the note is
dishonored (assuming no previous accrual of interest).

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> DO IT! Statement Presentation and Analysis

Learning Objective 9
Explain the statement presentation
Gambit Stores accepts from Leonard SpA a €3,400, 90-day, 6% note dated May 10 in settlement of Presentation and analysis of receivables.

Leonard’s overdue open account. The note matures on August 8. What entry does Gambit make at the
 Identify in the statement of financial
maturity date, assuming Leonard pays the note and interest in full at that time?
position or in the notes each major type of receivable.
SFP
 Report short-term receivables as current assets.

 Report both gross amount of receivables and allowance for doubtful account.

 Report bad debt expense and service charge expense as selling expenses.
IS
 Report interest revenue under “Other income and expense.”

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 Statement Presentation and Analysis Statement Presentation and Analysis

Analysis Analysis
Illustration: In a recent year Lenovo Group (CHN) (which reported in U.S. dollars) had net sales of Illustration: Variant of the accounts receivable turnover ratio is average collection period in terms of
$38,707 million for the year. It had a beginning accounts receivable (net) balance of $2,885 million and days.
Illustration 8-17
an ending accounts receivable (net) balance of $3,171 million. Assuming that Lenovo’s sales were all on
credit, its accounts receivable turnover is computed as follows.

Illustration 8-18

2
Illustration 8-17
Accounts receivable turnover and computation

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> DO IT! Statement Presentation and Analysis

In 2017, Rafael Nadal SA had net credit sales of €923,795 for the year. It had a beginning accounts Question
receivable (net) balance of €38,275 and an ending accounts receivable (net) balance of €35,988. Compute
Rafael Nadal SA’s accounts receivable turnover and average collection period in days. Accounts and notes receivable are reported in the current assets section of the statement of
financial position at:

a. cash (net) realizable value.

b. net book value.

c. lower-of-cost-or-net realizable value.

d. invoice cost.

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