Fundamentals of Accounting I

Chapter 5
ACCOUNTING FOR
CASH AND RECEIVABLES
PART-II
ACCOUNTING FOR RECEIVABLES

Thursday, January 11, 2024 1

Instructor: Kassaye Tuji
 ACCOUNTING FOR RECEIVABLES

Accounts Receivable are:

Amounts owed by customers on account.
Result from the sale of goods/merchandise &
services on account.
▼ The three primary accounting problems
associated with the A/R are:
 1- Recognizing A/R
 2- Valuing A/R
 3- Disposing of A/R

Instructor: Kassaye Tuji 1/11/2024 2

Thursday, January 11, 2024 Fundamentals of Accounting-I Instructor:
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Kassaye Tuji
 Recognizing Accounts Receivable
Illustration 1
 Assume that ABC Company, on July 1, 2022 sells merchandise
on account to DDC Company for Br. 1,000 terms 2/10, n/30.
 On July 5, merchandise worth Br. 100 is returned to ABC Co.
 On July 11, payment is received from DDC Company for the
balance due.
 The journal entries to record these transactions on the books of ABC Co. are:
July 1 A/R DDC .Co 1000
Sales 1000
July 5 Sales R. & Allowances 100
A/R DDC .Co 100
July 11 Cash (900-18) 882
Sales Discount (900x2%) 18
Accounts Receivable DDC .Co 900
Instructor: Kassaye Tuji 1/11/2024 4
Thursday, January 11, 2024 Fundamentals of Accounting-I Instructor:
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Kassaye Tuji
 Valuing Accounts Receivable
Valuing A/R is determining the amount to be reported
as an asset, on the B/S, after estimating & deducting
uncollectible.
Receivables should not be overstated on the B/S,
rather, they should be stated at their cash or net
realizable value.
 Cash (Net) Realizable Value- is the net amount
expected to be received in cash.
The I/S also is affected by the amount of
uncollectible, through “Bad Debts Expense” or
“Uncollectible Accounts Expense” account.
Instructor: Kassaye Tuji 1/11/2024 6
 Methods of Accounting for Bad Debts
 Methods to be used for uncollectible accounts:
(1) The allowance method &
(2) The direct write off method.
Allowance Method
1. Uncollectible A/R are estimated and matched against sales in the
same accounting period.
2. Estimated Uncollectible are:
 debited to Bad Debts Expense and
 credited to Allowance for Doubtful Accounts
through an adjusting entry.
3. Actual Uncollectible are:
 debited to Allowance for Doubtful Accounts &
 credited to Accounts Receivable at the time the
specific account is written off.
Instructor: Kassaye Tuji 1/11/2024 7
 Recording Estimated Uncollectible
Illustration 2
Assume that ABC Company has credit sales of Br.
1,200,000 in 2022; of which Br. 200,000 remain uncollected
at December 31. The credit manager estimates that Br.
12,000 of these sales will prove uncollectible.
Dec. 31
Bad Debts Expense - - - - - - - - - 12,000
Allowance for Doubtful Accounts - - - 12,000
 Allowance for Doubtful Accounts is not closed at the end
of the fiscal year.
 It is deducted from A/R in the current asset section of the
Statement of Financial Position
Instructor: Kassaye Tuji 1/11/2024 8
 Presentation of Cash and Receivables on the
Statement of Financial Position

Current assets:
Cash __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ __ Br. 14,800
Accounts receivable ___ ___ ___ ___ ___ ___ ___ ___ ___ __ 200, 000
Less: Allowance for doubtful accounts ___ ___ ___ ___ ___ _ 12, 000 188,000
Merchandize inventory ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ 310,000
Prepaid Insurance --------------------------------------------------------------------- 25,000
Total current asset ___ ___ ___ ___ ___ ___ __ ___ ___ ___ ___ ___ ___ 537, 800

The amount of Br. 188,000 represents the expected cash/net

realizable value of the A/R at the statement date.

Instructor: Kassaye Tuji 1/11/2024 9

 Recording the Write-off of an Uncollectible Account

Illustration 3
Assume, that the Vice President of Finance of ABC
Company authorizes the write – off of the Br. 500
balance owed by Mehari Co. on March 1, 2022.

March1
Allowance for Doubtful Accounts - - - 500
Accounts Receivable–Mehari Co. - - - - - - 500

Instructor: Kassaye Tuji 1/11/2024 10

 Recording the Write-off of an Uncollectible Account…

 Note:
 A writer-off affects only Balance Sheet accounts
 The write-off of the account reduces both A/R
and the Allowance for Doubtful Accounts.
 Cash/net realizable value in the B/S, therefore,
remains the same as illustrated below:
Before write off After write- off
Accounts receivable 200,000 199,500
Allowance for doubtful accounts 12,000 11,500
Cash Realizable Value 188,000 188,000

Instructor: Kassaye Tuji 1/11/2024 11

 Recovery of Uncollectible Accounts
Two entries are required to record the recovery of bad debts:
A. The entry made in writing off the account is reversed to
reinstate the customer’s account.
B. The collection is journalized in the usually manner.

Illustration 4
Assume that on July 1, Mehari Co. pays the br. 500 amounts that
had been written off on March 1.
July 1 Accounts Receivable- Mehari Co. 500
Allowance for Doubtful Accounts 500
July 1 Cash 500
Account Receivable- Mehari Co. 500
`
 Note that the recovery of bad debt, like the writer off of bad debt,
affects only B/S accounts.

Instructor: Kassaye Tuji 1/11/2024 12

 Estimating Bad Debts Expense
1.Percentage of Sales Method, &
2.Percentage of Receivables Method.
Percentage of Sales Method
 Results in a better matching of expenses with revenues-an
I/S viewpoint.
 The percentage is usually applied to either total credit
sales or net credit sales of the current year.
 The Bad Debts Expense will show a direct % r/p to the
sales base on which it is computed.
 When the adjusting entry is made, the existing balance in
the Allowance for Doubtful Accounts is disregarded
(ignored).
Instructor: Kassaye Tuji 1/11/2024 13
 Estimating Bad Debts Expense…
Illustration 5
Assume Gonzalez Company elects to use the percentage of
sales basis and concludes that 1% of net credit sales will
become uncollectible. If net credit sales for 2022 are Br.
800,000, the estimated bad debts expense is Br. 8,000 (1%
of Br 800,000).

▼The adjusting entry is:

Dec. 31
Bad Debts Expense --------------- 8,000
Allowance for Doubtful Accounts ------ 8,000

Instructor: Kassaye Tuji 1/11/2024 14

 Estimating Bad Debts Expense…

Percentage of Receivables Method

 Produces the better estimate of cash realizable value – a
B/S viewpoint.
 It establishes a % r/p b/n the amount of receivables and
expected losses from uncollectible accounts.
 A schedule (often called Aging Schedule) is prepared, in
which customer balances are classified by length of time
they have been unpaid.
 The estimated % of uncollectible debts increases as the
number of days past due increases!

Instructor: Kassaye Tuji 1/11/2024 15

 Estimating Bad Debts Expense…
 An Aging Schedule for Dart Company is shown in the ff illustration:
Customer Total Not yet Number of Days Past Due
Due 1 – 30 31 – 60 61 – 90 Over 90
T.E. Adert 600 300 200 100
R.C. Bortz 300 300
B.A. Carl 450 200 250
O.L. Diker 700 500 200
T.O. Ebbet 600 300 300
Others 36,950 26,200 5,200 2,450 1,600 1,500
39,600 27,000 5,700 3,000 2,000 1,900
Estimated Percentage Uncollectible 2% 4% 10% 20% 40%
Total Estimated Bad Debts 2,228 540 228 300 400 760
▼ Total Uncollectible for Dart Company (Br. 2, 228) represents:
1. The amount of existing customer claims expected to become uncollectible in the future.
2. The required balance in Allowance for Doubtful Accounts at the balance sheet date.

Accordingly, the amount of the bad debt adjusting entry is the d/c b/n the
required balance (2, 228) & the existing balance in the allowance account.

Instructor: Kassaye Tuji 1/11/2024

 Estimating Bad Debts Expense…
▼ Percentage of Receivables…
Illustration 6
For example, if the T/B shows Allowance for Doubtful Accounts with:
(A) A Zero Balance the adjusting entry would be:
Dec. 31 Bad Debts Expense 2,228
Allowance for Doubtful Accounts – 2,228
(B) A Credit Balance of Br. 528, an adjusting entry for Br. 1,700
(2,228 – 528) is:
Dec. 31 Bad Debts Expense --------------------1,700
Allowance for Doubtful Accounts ----1,700
▼ After the adjusting entry is posted, the accounts of the Dart Company will show:
Bad Debts Expense Allowance for Doubtful Accounts
Adjustment 1700 Previous Balance 528
Adjustment 1700
Ending Bal. 2,228

Instructor: Kassaye Tuji 1/11/2024 17

 Estimating Bad Debts Expense…
▼ Percentage of Receivables…
(C) A Debit Balance of Br. 500, An adjusting entry for Br. 2,728
(2, 228 – – 500) or (2, 228+500) is:
Dec. 31 Bad Debts Expense 2,728
Allowance for Doubtful accounts 2,728

 After the adjusting entry is posted, the account of Dart Company will show:
Bad Debts Expense Allowance for Doubtful Accounts
Adjustment 2,728 Previous Bal. 500
Adjustment 2,728
Ending Bal. 2,228

 This kind of balance is seen, when write – offs during the year have
exceeded previous provision for bad debts. Because, when you Write
off, Allowance for Doubtful Accounts is debited & the A/R is
credited directly.
Instructor: Kassaye Tuji 1/11/2024 18
 Direct Write-Off Method
 Bad debt losses are not estimated & no allowance account is used
 Bad debts expense will show only actual losses from uncollectible
 A/R will be reported at its gross amount.
 Since the Government of many countries allow a tax
deduction for uncollectible accounts only when specific A/R is
deemed uncollectible, this method is suitable for tax purpose!

Illustration 7
 Assume that Warden Co. Writes off M.E. Doran’s Br. 200 balance
as uncollectible on December 12.
▼The entry is:
Dec. 12 Bad Debts Expense 200
A/R – M.E. Doran 200

Instructor: Kassaye Tuji 1/11/2024

Thursday, January 11, 2024 Fundamentals of Accounting-I Instructor:
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Kassaye Tuji
 Disposing of Accounts Receivable
1. Sale of Receivables
 A common sale of receivables is a sale to a factor.
 A factor is a finance company or bank that buys receivables from
businesses for a fee and then collects the payment directly from the
customers.
Illustration 8
 Assume that Hendredon-Furniture factor Br 600,000 of receivables to
Federal Factors, Inc. Federal Factors assesses a service charge of 2%
of the amount of receivables sold.

 The journal entry to record the sale by Hendredone is:

Cash 588,000
Service Charge Expense 12,000
Account Receivable 600,000

Instructor: Kassaye Tuji 1/11/2024

 Disposing of Accounts Receivable…
2. Credit Card
A common types of Credit Cards are a National Credit Cards such as:
 VISA,
 Master Card, &
 American Express.
 A retailer’s acceptance of a National Credit Card is another form of
selling (factoring) the receivable.
▼ Three parties are involved when national credit cards are used in
making retail sales:
(1) The Credit Card Issuer, who is independent of the retailer,
(2) The Retailer, and
(3) The Customer.
 The retailer pays to the credit card issuer a fee, which is some %
of the invoice price for its service.
Instructor: Kassaye Tuji 1/11/2024
 Disposing of Accounts Receivable…
2.1. Visa and Master Card Sales:
These cards are issued by bank, charging fees for their
service.
Sales resulting from the use of VISA and Master Card are
considered cash sales by the retailer.
Up on receipts of credit card sales slips from a retailer, the
bank immediately adds the amount to the seller’s bank
balance.

The credit card sales slips are therefore recorded in the

same manner as checks deposited from a cash sale.

Instructor: Kassaye Tuji 1/11/2024

 Disposing of Accounts Receivable…
Illustration 9
Assume Anita Ferreri purchases a number of compact
discs for her restaurant from Karren Kerr Music Co. for
Br. 1000 using her VISA First Bank Card. The service
fee that First Bank charges is 3%.

▼The entry to record this transaction by Karren Kerr Music is:

Cash - - - - - - - - - - - - - - - - 970
Service Charge Expense - - - 30
Sales - - - - - - - - - - - - - - - - - - - - 1000

Instructor: Kassaye Tuji 1/11/2024

 Disposing of Accounts Receivable…
2.2. American Express Sales:
 Sales using America Express Cards are reported as Credit Sales, not
Cash Sales!
 Conversion in to cash does not occur until American Express remits
the net amount to the seller.
Illustration 10
Assume that Four Seasons Restaurant accepts an American Express
Card a Br. 300 bill.
A) The entry for the sale by Four Seasons (assuming a 5% fee) is;
Accounts Receivable-American Express - - - 285
Service Charge Expense - - - - - - - - - - - - - -15
Sales - - - - - - - - - - - - - - - - - - - - - - 300
B) Thus American Express will subsequently pay the restaurant Br. 285
which the restaurant will record as:
Cash - - - - - - - - - - - - - - - - - - - - - - 285
Accounts Receivable – American Express - - - 285
Thursday, January 11, 2024 Fundamentals of Accounting-I
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Instructor: Kassaye Tuji
 Accounting for Notes Receivable
 Promissory Notes
 A promissory note is a written promise to pay a specified amount
of money on demand or at a definite time.
Promissory Notes may be used:
(1) When individuals and companies lend or borrow money,
(2) When the amount of the transaction and credit period exceed
normal limits, &
(3) In settlement of accounts receivable.
 N/R gives the holder a stronger legal claim to assets than A/R.
 Like A/R, notes receivable can be readily sold to another party.
 Promissory notes are negotiable instruments (as are checks),
which means that, when sold they can be transferred to another
party by endorsement.

Instructor: Kassaye Tuji 1/11/2024

 Accounting for Notes Receivable…
 Promissory Notes…
The basic issues in accounting for N/R are the same
as those for A/R:
1- Recognizing notes receivable
2- Valuing notes receivable
3- Disposing of notes receivable
 Maker : the party making the promise to pay!
 Payee/ Bearer of the Note: the party to whom payment
is to be made.

Instructor: Kassaye Tuji 1/11/2024

 Promissory Notes…
 Determining the Maturity Date (Due Date)
• The date a note is to be paid is called the due date or maturity
date.
 The period of time between the issuance date and the due date
of a short-term note may be stated in either days or months.
When the life of a note is expressed in terms of months, the due
date is found by counting the months from the date of issue.
 For example:
The maturity date of a 3-month note dated May 1- is August 1
A note drawn on the last day of a month matures on the last
day of a subsequent month, that is, a July 31 note due in 2
months - matures on September 30.

Instructor: Kassaye Tuji 1/11/2024

 Promissory Notes…
 Determining the Maturity Date (Due Date)…
When the due date is stated in terms of days, it is necessary to
count the exact number of days to determine the maturity date.
In counting, if the date the note is issued is omitted, the due
date should be included; and vice versa.
▼For e.g., the maturity date of a 90-day note dated March 16 is
computed as follows:
Term of the Note - - - - - - - - - - - - - - - - - - ---- - - - 90
March (days) _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 31
Date of note _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ 16 15
Number of days remaining - - - - - - - - - - - - - - - - 75
April (days) - - - - - - - - - - - - -- - - - - - - - - - - - - - 30
45
May (days)- - - - - - - - - - - - - - - - - - - - - - - - - - - - 31
Maturity date, June - - - - - -- - - - - - - - - - - - - - - - 14

Instructor: Kassaye Tuji 1/11/2024

 Promissory Notes…
 Determining the Maturity Date (Due Date)…
 A note that provides for payment of interest for the period b/n the
issuance date & the maturity date is called an Interest-bearing Note
 If a note makes no provision for interest, it is said to be
Non-Interest Bearing Note.
▼ The basic formula for computing interest on an interest-bearing note is:
Face value Annual Time in Terms Interest
of Note X Interest X of one – year =
Rate
 The interest rate specified on the note is an annual rate of interest.
▼ Example of the computation of interest is shown below
Terms of note Interest computation
Face x Rate x Time = Interest
Br. 730, 18%, 120 days 730 x18% x 120/360 = Br. 43.80
Br. 1,000, 15%, 6 months 1,000 x 15% x 6/12 = 75.00
Br 2,000, 12%, 1 year’s 2,000 x 12% x 1/1 = 240.00

Instructor: Kassaye Tuji 1/11/2024

 1. Recognizing Notes Receivable
Illustration 11
 To illustrate the basic entry for notes receivable assuming
that ABC Company accepted a Br. 1,000, 2-month, 12%
promissory note, dated May 1 from XYZ Company.
 Assume also that the note was written to settle an open
account.

 The entry for the receipt of the note is:

May 1.
Note Receivable 1000
Accounts Receivable – XYZ Co. 1000

Instructor: Kassaye Tuji 1/11/2024

 2. Valuing Notes Receivable
Like A/R, short – term N/R are reported at their Cash
(Net) Realizable Value.
 The N/R allowance account is Allowance for Doubtful
Accounts.
Valuing short-term Notes Receivable is the same as
valuing Accounts Receivable.

Because of high risk of futurity, determining the

proper allowance of long-term receivables is
difficult than others!
Instructor: Kassaye Tuji 1/11/2024
 3. Disposing of Notes Receivable
Note may be held to their maturity date, at which time the
face value plus accrued interest is due.
In some situations the maker of the note defaults and
appropriate adjustment must be made.
In other situations, similar to A/R, the holder of the note
speeds up the conversion to cash by selling the receivables.
Honor of Notes Receivable
A note is honored when it is paid in full at its maturity date.
For each interest-bearing note, the amount due at maturity is
the face value of the note plus interest for the length of
time specified on the note.

Instructor: Kassaye Tuji 1/11/2024

 Honor of Notes Receivable…
Illustration 12
 Assume that ABC Company accepted a Br.10,000; 90 – day; 12% note;
dated Oct. 18 from XYZ Company on settlement of open account.
A) To record the entry, (assuming the cash is collected in the maturity date):
Oct.18 Notes Receivable 10, 000
Account Receivable 10,000
B) If ABC Company prepares financial statements as of Dec. 31, it would be
necessary to accrue interest (from Oct. 18 up to Dec. 31).
▼ In this case, the adjusting entry would be:
 (Interest Accrued = 10,000x 12% x 74/360 = 246.67)
Dec.31 Interest Receivable 246.67
Interest Revenue 246.67
C) The entry to record the honoring of XYZ Co. Note at Maturity is:
Jan. 16 Cash 10,300 .00
Notes Receivable 10,000.00
Interest Receivable 246.67
Interest Revenue 53.33
 Total Interest Amount = 10,000 x 0.12 x 90/360 = 300
 Dishonor of Notes Receivable
 A dishonored note is a note that is not paid in full at maturity.
A dishonored N/R is no longer negotiable.
However, the payee still has a claim against the maker of the note.
Therefore the N/R account is usually transferred to an A/R
Illustration 13
 Assume ABC Company a Br. 60,000; 60 days; 12% note; dated July 1
on settlement of A/R had been dishonored at maturity.
▼ The entry would be:
July 1 Notes Receivable – 60,000
Accounts Receivable – 60,000
(Originally, to record acceptance of note)
Aug. 30 Accounts Receivable - - 61,200
Notes Receivable - - - - - - 60,000
Interest Revenue - - - - - - 1,200
(Finally, to record the dishonor of the note)
 Discounting Note Receivable
Notes Receivable can be converted to cash before they mature.
 This can be done by discounting notes receivable at a financial
institution or bank.
Illustration 14
 Assume that ABC Co. hold a Birr 3,000, 90 days 12% note, dated May
15. On July 5, the note is discounted at DASHEN BANK at the rate of
12% ABC’s Co. proceeds from the bank are computed as follows:
Principal of the note - - - - - - - - - - - - - - - - - - - Br. 3,000.00
(+) Interest from the note (3000 x 12% x 90/360) - - - - 90.00
= Maturity value - - - - - - - - - - - - - - - - - - - - -- - - - 3090.00
(-) Bank discount (3090x 12% x 40/360)* - - - - - - - 41.20
= Proceeds - - - - - ---- - ---- - - - --------------------- - - 3,048.80

*ABC Company held the note for 50 of the 90 days before discounting.
 The entry to record discounting of the note is:
July 4 Cash 3048.80
Interest Revenue 48.80
Notes Receivable 3000.00
 Discounting Note Receivable…
 Points to remember
 The proceeds from discounting a N/R might be less than the face
value. (Depending on the amount & direction of the d/c b/n the
interest-rate & the discount- rate)
 When this situation occurs, the excess of the face value over
the proceeds is recorded as interest expense.
 N/R are discounted with recourse or without recourse.
 If a note is discounted with recourse and the original maker
of the note fails to pay the bank when it matures, the original
payee of the note must pay for it.
 When a note is discounted without recourse, the bank
assumes the risk of a bad debt loss and the original payee
doesn’t have a contingent liability.
Instructor: Kassaye Tuji 1/11/2024
 THE END

Thank You!!!

39
Instructor: Kassaye Tuji 1/11/2024
 End of the Course!

Instructor: Kassaye Tuji 1/11/2024

 Cheers!!!

Celebrate
Hard
work is
your
the key to Achievement
success!!! !!!

41

Instructor: Kassaye Tuji 1/11/2024

Thursday, January 11, 2024 End of the Course!