FINANCIAL ACCOUNTING

Chapter 9: Accounts Receivable

ACG2022
CLASSIFICATION OF RECEIVABLES
Receivables: Includes all money clams against other entities, including people, business firms, and other
organization.
 Accounts receivable: The most common transaction creating a receivable is selling merchandise or services on
credit. The receivable is recorded as a debit to the accounts receivable account. Accounts receivable are
normally expected to be collected within a relatively short period, such as 30 or 60 days. They are classified on
the balance sheet as a current asset.
 Notes receivable: Are amounts that customers owe for which a formal, written instruction of credit has been
issued. It’s classified as a current asset if it can be collected within a year.
UNCOLLECTIBLE RECEIVABLES
Bad debt expense: The operating expense recorded from uncollectible accounts receivables. Accounts become
uncollectible when a customer does not pay after a specified period, declares bankruptcy, or dies. Companies use
several different methods to recognize the uncollectible account as follows:
 Direct write-off method: Records bad debt expense only when an account is judged to be worthless.
DIRECT WRITE-OFF METHOD
When an account becomes uncollectable we write the account off to bad debt expense. This removes the
receivable and recognizes an expense in the period in which it becomes uncollectable.
 Assume that on March 3rd, a $4,200 account receivable from Rosalyn Monte has been determined to be uncollectible. The
entry to write off each individual account as it becomes uncollectible is:
General Journal Page 1
3-3 Bad Debt Expense 4,200
Accounts Receivable-Monte 4,200

This reduces Rosalyn Monte’s account to zero and recognizes the expense.
Accounts Receivable Bad Debt Expense
538,000 4,200 4,200
533,800

The problem with this method is that it does not match the revenues with the expenses in the same period.
ALLOWANCE METHOD
When we use the allowance method for uncollectable accounts, the company is following
the idea of the matching concept. The matching concept requires us to match the revenues
earned with the expenses incurred to earn them
 Allowance method: Records bad debt expense by estimating uncollectible accounts at
the end of the accounting period.
 Allowance for Doubtful Accounts: The contra asset is used to recognize the
decrease in the accounts receivable account rather than reducing the balance directly.
When a fisherman goes fishing, he must first get bait. The credit adjustment to the
Allowance account fills our Allowance (bait) bucket with our estimated uncollectible.
Throughout the accounting period as accounts become uncollectible, we simply debit the
allowance account and zero out their accounts receivable. We don’t use the Bad Debt
Expense account because we recognized all the bad debts at the beginning of the period when we did the adjustment.
Analysis Of Receivables Method Percentage Of Sales Method
(Aging Of Receivables) This method estimates the expected uncollectable amount
The analysis of receivables method is based on the based on industry averages or past history. If Azteck Co,
assumption that the longer an account receivable is found that 2% of all sales in 2012 became uncollectible,
outstanding, the less likely that it will be collected. 1.98%, in 2011 and 2.1% in 2010, then they can use 2% as a
realistic expectation of what will become uncollectible in the
Receivables are grouped by the length of time outstanding current year.
and then each age group is multiplied by the percentage that (2% + 1.98% + 2.1% = 6.08% ÷ 3 = 2.026666667 = 2%)
is believed to become uncollectible.

Carl Horlitz and Dawn McDonough Page 1

FINANCIAL ACCOUNTING
Chapter 9: Accounts Receivable
ACG2022
 Azteck Co. had a balance in accounts receivable of  Azteck Co. had a balance in accounts receivable of
$538,000, and based upon the aging schedule it is $538,000, and based on our percentage they estimate that
determined that on our percentage they estimate that $10,760 (538,000×2%) will become uncollectible.
$26,490 will become uncollectible . (see aging schedule General Journal Page 1
on page 409) 3-1 Bad Debt Expense 10,760
General Journal Page 1 Allowance for Doubtful Accounts 10,760
3-1 Bad Debt Expense 24,170
This increases the bad debt expense, and creates a balance in
Allowance for Doubtful Accounts 24,170
the allowance for doubtful accounts.
(26,490-2,320 = 24,170)
Accounts Receivable Bad Debt Expense
This method tells us the amount of the ending balance of the 538,000 10,760
allowance account. We must then determine how much to Allowance for Doubtful Accounts
add to the allowance account to get that balance. 2,320 Beginning Balance
Accounts Receivable Bad Debt Expense
10,760
538,000 24,170 Ending Balance
13,080
Allowance for Doubtful Accounts The reason for this is that we must present all information
2,320 Beginning Balance fully, so this method shows both the actual balance of
24,170 Adjustment
accounts receivable and the estimated balance of the
26,490 Ending Balance =>26,490
allowance account.
The beginning balance in the allowance account is
The beginning balance in the allowance account is
VITAL for this method.
UNIMPORTANT for this method.
NOTES RECEIVABLE
A note receivable is a written promise to pay some amount at a future time with interest.
It is legal document which provides protection in case the maker fails to pay.
Characteristics of Notes Receivable Important formulas for Notes Receivables
A promissory note is a written promise to pay  Number of Days:
the face amount, usually with interest, on A 90 day note dated January 5, 2014 has a maturity date of? The interest rate is 6%
demand or at a date in the future. on $10,000 note.
 Characteristics of a promissory note are: January 31 days 26 (31 days -5 days)
February 28 days 28 (54 days so far)
 The maker is the party making the promise to March 31 days 31 (85 days so far)
pay. April 30 days 5 (90 days – 85 days)
 The payee is the party to whom the note is  Maturity Date of January 5 Note = April 5. The cash will be received on
payable. April 5th for this note.
 The face amount is the amount for which the Principle × Interest Rate × Time (Term/360)
 Interest
note is written on its face also called (10,000 × 6% × (90÷360) = 150
principle. Principle + Interest
 Maturity Value
 The issuance date is the date a note is issued. ($10,000 + 150 = $10,150)
 The due date or maturity date is the date the  Dishonored Note A dishonored not is where the customer does not pay the note
note is to paid. by the Maturity Date.
 The Principle + Interest is transferred to the customer’s account receivable
 The term of a note is the amount of time and the note receivable is reduced to zero.
between the issuance and due dates. General Journal Page 1
 The interest rate is that rate of interest that 4-5 Accounts Receivable - Joe Nopayme 10,150
must be paid on the face amount for the term Notes Receivable – Joe Nopayme 10,150
of the note.
REPORTING RECEIVABLES ON THE BALANCE SHEET
The accounts receivable account is always shown on the balance followed by the allowance account which provides investors
a clear picture of exactly how much we think we can collect, which we call the Net Realizable Balance.
FINANCIAL ANALYSIS AND INTERPRETATION:
 Accounts Receivable Turnover measures how frequently during the year the A/R is converted to cash.
Net Sales 3,375,200 3,375,200 6.4
= = =
Average Accounts Receivables [(538,000+513,250)÷2] 525,625 The A/R is collected 6.4 times a year
(current year + prior year)÷2 (2013 + 2012)
 Number of Days Sales in Receivables estimates the length of time received has been outstanding.
Average Accounts Receivables 525,625 525,625 56.4 The average time it takes to
= = =
Average Daily Sales 3,375,200 ÷ 365 9,247 collect is 56 days.
Sales ÷ 365

Carl Horlitz and Dawn McDonough Page 2