Chapter 8.

Accounting for Receivables

Prof. Sorah Park

Ewha Womans University
Topics

• Accounts Receivable
• Uncollectibles
• Bad debt expense
• Write-offs
• Recoveries

• Allowance method vs. Direct write-off method

• Decision making
• IFRS vs. GAAP
Recognition of Accounts Receivables

• The term receivables refers to amounts due from individuals and companies
• Receivables are claims that are expected to be collected in cash
• Management of receivables is a very important activity for any company that
sells goods or services on credit
• Receivables are important because they represent one of a company’s most
liquid assets

Copyright ©2019 John Wiley & Sons, Inc.

Recognition of Accounts Receivables

Amounts due from individuals and companies that are expected to be

collected in cash.

Receivables as a Company
Company Percentage of Total Assets
Adidas (DEU) 16%
Hyundai (KOR) 5
Samsung (KOR) 13
Nestlé (CHE) 41
China Mobile Limited (HKG) 2

Copyright ©2019 John Wiley & Sons, Inc.

Types of Receivables

Amounts due from individuals and companies that are expected to be

collected in cash.

Nontrade receivables
Amounts Written promise
such as interest,
customers owe on (formal instrument) for
loans to officers,
account that result amount to be
advances to
from the sale of received. Normally
employees, and
goods and requires the collection
income taxes
services. of interest.
refundable.

Accounts Notes Other

Receivable Receivable Receivables

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Uncollectible Accounts Receivable

• Some customers who promise to pay later don’t. Thus:

• These “Bad Debts” reduce the cash expected to be collected from A/R
• Proper accounting requires Gross A/R to be reduced to Net value that better
reflects the amount that we expect to collect
• We accomplish this by recording losses using estimates based on historical
data.
• In other words, we don’t wait to record losses when we know exactly who
won’t pay. We plan for it based on past experience.
Uncollectible Accounts Receivable

• Uncollectible Accounts – Receivables determined to be uncollectible because

debtors can’t or won’t pay
• Bad Debt Expense – Cost of granting credit to “bad” customers
• Two basic ways to record uncollectibles:
• Allowance method – make estimates of the portion of accounts receivable
that will not be collected and allow for them at the same period when
recording the sale
• Direct write-off method – wait to see which receivables will not be collected
and write them off at that time
Allowance Method

• The allowance method records collection losses on the basis of estimates

instead of waiting to see which customers the business will not collect from.
• Relies heavily on historical experience, customer composition and current
economic trends
• Does not need to identify which customer won’t pay
Allowance Method

Income statement effect

• An expense for Bad Debt Expense

Statement of financial position effect

• A contra-asset shown as a reduction to gross A/R:
Allowance for Uncollectible (Doubtful) Accounts
3 Steps for Allowance Method

1. Estimate the dollar amount of bad debts at the end of accounting period
2. Record an Adjusting journal entry that
debits (increases) bad debt expense and
credits the Allowance for uncollectibles (which reduces Net A/R)
3. When a bad debt actually occurs, record a Write-off journal entry
Allowance Method

• There are two basic ways to estimate uncollectible accounts that are
acceptable under IFRS:

1. Percent-of-sales method
2. Percent-of-accounts receivable method
Allowance Method (1)
Percent-of-sales method

• Computes bad debt expense as a percentage of net credit sales

• Income statement approach

• Based on an I/S number : Sales
• Calculates an I/S number : Bad Debt Expense
Percent-of-Sales Method: Example

• On 12/31/20XX, Buy More has the following account balances (in

thousand) before the year-end adjustments:

Accounts Receivable Allowance for Uncollectibles

120,000 500
Percent-of-Sales Method: Example

• Big Mike, a store manager of Buy More, estimates that bad debt expense is
1.5% of net credit sales, which were $500,000 for 20XX. The adjusting entry
to record bad-debt expense and to update the allowance is:

12/31 Dr. Bad Debt Expense 7,500

Cr. Allowance for Uncollectibles 7,500
Recorded bad debt expense for the year 20XX: 1.5% of 500,000
Percent-of-Sales Method: Example

• Now the accounts are ready for the 20XX financial statements:

Accounts Receivable Allowance for Uncollectibles Bad Debt Expense

120,000 500

Accounts Receivable, Net Bad Debt Expense on the

on SOFP is $________. Income Statement is $________.

(what Buy More expects to collect)

Allowance Method (2)
Percent-of-Accounts-Receivable

• Percentage of Accounts Receivable method

• Estimates the desired ending balance of the Allowance for Uncollectible
Accounts as a percentage of the current ending balance of Accounts
Receivable (based on historical rates of AR that is uncollected)

• Statement of financial position approach

• Based on a SOFP number : Accounts Receivable
• Calculates a SOFP number : Allowance for Uncollectible Accounts
Percent of A/R Method: Example

Customer Total
Customer A 200,000
• Buy More expects 2% of all Customer B 100,000
accounts receivable to be
uncollectible. Customer C 230,000
• Buy More records a bad debt Customer D 120,000
expense so that the allowance
account equals $_________ at the Other Accts 550,000
end of the period (it was $22,000 Total 1,200,000
before adjustment):
Estimated %
2%
Uncollectible
Allowance for 24,000
Uncollectibles

Dec. 31 Dr. Bad Debt Expense 2,000

Cr. Allowance for Uncollectibles 2,000
Addition to the Allowance is (24,000-22,000)=2,000
3 Steps for Allowance Method

1. Estimate the dollar amount of bad debts at the end of accounting period
2. Record an Adjusting journal entry that
debits (increases) bad debt expense and
credits the Allowance for uncollectibles (which reduces Net A/R)
3. When a bad debt actually occurs, record a Write-off journal entry
Writing Off A/R: Allowance Method

• When the credit department determines that specific accounts will not be
collected, the company must write-off those specific accounts
• Accounts Receivable normally has a debit balance. Thus, a write off includes a
credit to accounts receivable
• Allowance for doubtful accounts normally has a credit balance. Thus, a write off
includes a debit to the allowance

Dr. Allowance for Uncollectibles XXX

Cr. Accounts Receivable XXX
To write off an uncollectible account

• Does the write-off entry affect Net Income on Income statement?

• Does it affect NET account receivables?

Writing Off A/R: Allowance Method

• Early in 20XX, Buy More collects on most of its $112,000 accounts receivable as
follows:
Dr. Cash 92,000
Cr. Accounts Receivable 92,000
Collected 92,000 on account

• On March 31, Buy More determines that it cannot collect $900 and $300
respectively from Customer A and B. Buy More’s accountant writes off
receivables from the delinquent customers with the following entry:

Mar. 31 Dr. Allowance for Uncollectibles 1,200

Cr. Accounts Receivables 1,200
To write off uncollectible accounts
 Writing Off A/R: Allowance Method

• Because the write-off entry affects no expense account, it does not affect net
income. The write-off has no effect on NET receivables either, as shown
below:

Before Write-off After

Write-off Entry Write-off

Accounts
20,000 18,800
Receivable -1,200
Allowance for (2,569)
(3,769) -1,200
Doubtful Accounts

Net AR 16,231 16,231

Recording Recovery

• Though infrequent, if we unexpectedly recover money from a previously

written-off account, we record the following recovery journal entry:

Dr. Accounts Receivables 100

Cr. Sales
100
Dr. Bad Debt Expense 20
• Sales on Credit Cr. Allowance 20
• Bad Debt Expense
Dr. Allowance 10
• Write-off Cr. Accounts Receivables 10

• Recovery :
• Reverse Write-Off Dr. Accounts Receivables 10
• Collection of Cash Cr. Allowance 10
Dr. Cash 10
Cr. Accounts Receivables 10
Valuing Accounts Receivable

• How are these accounts presented on the Statement of Financial

Position?

Allowance for
Accounts Receivable Doubtful Accounts
Bal. 200,0000 12,000 Bal.

Bal. Bal.

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Valuing Accounts Receivable

Hampson Furniture
Statement of Financial Position (partial)
Current Assets
Supplies € 25,000
Inventory 310,000
Accounts receivable €200,000
Less: Allowance for doubtful accounts 12,000 188,000
Cash 14,800
Total current assets €537,800

Copyright ©2019 John Wiley & Son, Inc.

Valuing Accounts Receivable

Alternate
Presentation
Hampson Furniture
Statement of Financial Position (partial)
Current Assets
Supplies € 25,000
Inventory 310,000
Accounts receivable, net of €12,000 allowance 188,000
Cash 14,800
Total current assets €537,800

Copyright ©2019 John Wiley & Son, Inc.

Valuing Accounts Receivable

Journal entry for credit sale of €100

Accounts Receivable 100

Sales Revenue 100

Allowance for
Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal.
Sale 100

Bal. 600 25 Bal.

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Valuing Accounts Receivable

Collect €333 on account?

Cash 333
Accounts Receivable 333

Allowance for
Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal.
Sale 100 333 Coll.

Bal. 267 25 Bal.

Copyright ©2019 John Wiley & Son, Inc.

Valuing Accounts Receivable

Adjustment of €15 for estimated bad debts?

Bad Debt Expense 15

Allowance for Doubtful Accounts 15

Allowance for
Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal.
Sale 100 333 Coll. 15 BDE

Bal. 267 40 Bal.

Valuing Accounts Receivable

Write-off of uncollectible accounts of €10?

Allowance for Doubtful Accounts 10

Accounts Receivable 10

Allowance for
Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal.
Sale 100 333 Coll. 15 Exp.
10 w/o w/o 10
Bal. 257 30 Bal.

Copyright ©2019 John Wiley & Son, Inc.

Direct Write Off Method

• Why not just wait until a specific account is deemed uncollectible and then record a bad
debt expense that exactly equals the uncollectible amount?
• Direct Write-off: Alternative to allowance method for accounting for uncollectible
accounts receivable
• The company waits until it decides that a specific customer’s account receivable is
uncollectible
• NOT ALLOWABLE FOR FINANCIAL REPORTING PURPOSES UNLESS BAD DEBT
EXPENSE IS AN IMMATERIAL AMOUNT
• This method is defective for two reasons:
• Since no Allowance for Uncollectibles is established, assets are overstated on the
balance sheet
• The direct write-off may not match the bad debt expense of each period against the
revenue of the period in which the sale was made

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Managers’ Decision Making

• How well does the firm handle issuing credit and collecting from
customers?
• Accounts Receivable Turnover
• Average Collection Period

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Credit Efficiency Ratios

Accounts Receivable Turnover:

AR Net Credit Sales*
Turnover =
Average Gross AR

* Technically, credit sales should be used; however, typically firms do

not separate credit and cash sales so use total sales

• The number of times receivables are recorded and collected, and recorded again during
the period
• How rapidly do collections occur?
• A higher turnover indicates that a firm collects its receivables more quickly (or is more
cash driven)

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Credit Efficiency Ratios

Average Collection Period:

365
Avg. Collection
Period =
AR Turnover

• It measures how many days it takes to collect receivables (aka “days sales
outstanding”)

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AR Turnover and Average Collection Period are useful in assessing
the “quality” of receivables. Are firms extending credit to bad
customers to pump up lagging sales?
• Compare to prior periods
• Compare to different firms in the same industry

Days to collect AR Turnover

Best Buy 4.9 74.94
Limited 11.9 30.6
Boeing 34.4 10.6
Verizon 60.8 6.0

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Presentation and Analysis

• Income Statement
• Report bad debt expense in operating expenses section
• Report interest revenue under “Other income and expense” in non-
operating section

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IFRS VS GAAP

Similarities & Differences

• The recording of receivables, recognition of sales returns and allowances and
sales discounts, and the allowance method to record bad debts are the same
between G A A P and I F R S.
• Both I F R S and G A A P often use the term impairment to indicate that a
receivable or a percentage of receivables may not be collected.
• Although I F R S implies that receivables with different characteristics should
be reported separately, there is no standard that mandates this segregation.

Copyright ©2019 John Wiley & Sons, Inc.

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To wrap up,

• In this class...
• Accounts receivable
• Bad debt expense
• AR Turnover
• Next class...
• Long term assets
• PPE - Depreciation. Disposal. Revaluation
• Intangibles