Chapter Five

Accounting for
Receivables
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Define receivables.
2. Identify the different types of receivables.
3. Explain how companies recognize accounts receivable.
4. Distinguish between the methods and bases companies use to
value A/R.
5. Describe the entries to record the disposition of A/R.
6. Compute the maturity date of and interest on N/R.
7. Explain how companies recognize notes receivable.
8. Describe how companies value notes receivable.
9. Describe the entries to record the disposition of N/R.
5.1. Definition of Receivables
 The term receivables refers to amounts due from
individuals and companies. They are claims that are
expected to be collected in cash.
 The 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.

 For many companies, receivables are also one of the

largest assets.
 Cont’d

Amounts due from individuals and companies that are

expected to be collected in cash.

Illustration 8-1
Receivables as a Percentage of Assets
 5.2. Types of Receivables

Classifications of Receivables

Amounts customers Written promise Nontrade receivables

owe on account (formal instrument) such as interest, loans
that result from the for amount to be to officers, advances
sale of goods and received. Also called to employees, and
income taxes
services. trade receivables.
refundable.
Accounts Notes Other
Receivable Receivable Receivables
1. Accounts Receivable
• A/Rs are amounts owed by customers on account.
They result from the sale of goods and services on
account.
• They represent the most significant type of claims
held by a company.
• They represent credit granted on open account as
they arise from oral agreement.

• Companies generally expect to collect accounts

receivable within 30 to 60 days.
• They are usually the most significant type of claim
held by a company.
 2. Notes Receivable
 N/R represent claims that are evidenced by
formal instruments of credit such as promissory
notes.
 The credit instrument normally requires the
debtor to pay interest.
• Notes and Accounts receivable that result from
sales transaction are often called trade
receivables.
• The note normally requires the collection of
interest and extends for time periods of 60–90
days or longer.
 3. Other Receivables

• These do not generally result from the operations of

the business.
• Therefore, they are generally classified and reported
as separate items in the statement of financial
position. include non trade receivables such as:
• interest receivable
• loans to company officers
• advances to employees and
• income tax refundable

• These are unusual and therefore, generally classified

and reported separately on the balance sheet.
 Cont..

• All receivables that are expected to be realized in

cash within one year are presented in the
current asset section of the balance sheet.

• Those that are not currently collectible such as

long-term loans are listed under the investment
section next to current assets.
 Cont’d
Question #7
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.
 5.3. Accounts Receivable
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 receivables.
Recognizing Accounts Receivable
Illustration: Assume that Hennes & Mauritz (SWE) Co. on
July 1, 2014, sells merchandise on account to Polo Company
for $1,000 terms 2/10, n/30. Prepare the journal entry to
record this transaction on the books of Hennes & Mauritz.

Jul. 1 Accounts Receivable 1,000

Sales Revenue 1,000
Recognizing Accounts Receivable
Illustration: On July 5, Polo returns merchandise worth
$100 to Hennes & Mauritz.

Jul. 5 Sales Returns and Allowances 100

Accounts Receivable 100

Illustration: On July 11, Hennes & Mauritz receives payment

from Polo Company for the balance due.

Jul. 11 Cash ($900 - $18) 882

Sales Discounts ($900 x .02) 18
Accounts Receivable 900
 > DO IT!
On May 1, Wilton sold merchandise on account to Bates for €50,000
terms 3/15, net 45. On May 4, Bates returns merchandise with a
sales price of €2,000. On May 16, Wilton receives payment from
Bates for the balance due. Prepare journal entries to record the
May transactions on Wilton’s books. (Ignore CGS Entries.)

May 1 Accounts Receivable—Bates 50,000

Sales Revenue 50,000

4 Sales Returns and Allowances 2,000

Accounts Receivable—Bates 2,000

16 Cash (€48,000 - €1,440) 46,560

Sales Discounts (€48,000 x .03) 1,440
Accounts Receivable—Bates 48,000
Valuing Accounts Receivable
 Current asset.

 Valuation (net realizable value).

Uncollectible Accounts Receivable

 Sales on account raise the possibility of accounts not

being collected.
 Seller records losses that result from extending
credit as Bad Debt Expense.
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 cash
amount expect to be (net) realizable value.
received.  Required by IFRS.
 Not acceptable for
financial reporting.
Direct Write-off Method for Uncollectible Accounts

Illustration: Assume that Warden Ltd. writes off M. E.

Doran’s HK$1,600 balance as uncollectible on December 12.
Warden’s entry is:

Bad Debt Expense 1,600

Accounts Receivable—M. E. Doran 1,600

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

This method estimating uncollectible accounts at the end

of each period. This provides better matching on the
income statement. It also ensures that companies state
receivables on the statement of financial position at their
cash (net) realizable value. Cash (net) realizable value is
the net amount the company expects to receive in cash. It
excludes amounts that the company estimates it will not
collect. Thus, this method reduces receivables in the
statement of financial position by the amount of
estimated uncollectible receivables. IFRS requires the
allowance method for financial reporting purposes when
bad debts are material in amount.
1.Companies estimate uncollectible accounts
receivable.

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.
Allowance Method
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 Bad Debt Expense 12,000

Allowance for Doubtful Accounts 12,000
 Cont’d

Illustration 8-3
Presentation of Allowance for Doubtful Accounts
 Cont’d
WRITE-OFF 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:

Mar. 1 Allowance for Doubtful Accounts 500

Accounts Receivable—R. A. Ware 500

Illustration 8-4
General Ledger Balances after Write-off
 Cont’d
WRITE-OFF 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:

Mar. 1 Allowance for Doubtful Accounts 500

Accounts Receivable—R. A. Ware 500

Illustration 8-5
Cash Realizable Value Comparison
 Cont’d
RECOVERY OF AN UNCOLLECTIBLE ACCOUNT
Illustration: On July 1, R. A. Ware pays the €500 amount that
Hampson Furniture had written off on March 1. Hampson
makes these entries: (1st reverse the write-off account)

July 1 Accounts Receivable—R. A. Ware 500

Allowance for Doubtful Accounts 500

1 Cash 500
Accounts Receivable—R. A. Ware 500
(collection from R. A. Ware)
• Note that the recovery of a bad debt, like the write-off of
a bad debt, affects only statement of financial position
accounts.
The amount of the expected uncollectible was given.
• However, in “real life,” companies must estimate that
amount when they use the allowance method.

One of two bases is used to determine this amount:

(1) percentage of sales or
(2) percentage of receivables.
Both bases are generally accepted. The choice is a
management decision.
 Cont’d
Illustration 8-6
ESTIMATING THE ALLOWANCE Comparison of Bases for
Estimating Uncollectibles

Emphasis on Income Statement Emphasis on Statement of

Relationships Financial Position Relationships
 1. Percentage-of-Sales
ESTIMATING THE ALLOWANCE Illustration 8-6

In percentage sales bases,

Mgt estimates
what percentage of credit
sales will be uncollectible.

This percentage is based on

past experience &
Emphasis on Income Statement
Relationships anticipated credit policy.
 Cont…
In the percentage-of-sales basis, management estimates what
percentage of credit sales will be uncollectible. This percentage is
based on past experience and anticipated credit policy.

The company applies this percentage to either total

credit sales or net credit sales of the current year.

Illustration: Assume that Gonzalez SA elects to use the percentage-

of-sales basis. It concludes that 1% of net credit sales will become
uncollectible. If net credit sales for 2017 are €800,000, the* adjusting
entry is:
Dec. 31 Bad Debt Expense 8,000
Allowance for Doubtful Accounts 8,000
* €800,000 x 1%
 Cont’d
Percentage-of-Sales
 Emphasizes matching of expenses with revenues.

 Adjusting entry to record bad debts disregards the

existing balance in Allowance for Doubtful Accounts.

Illustration 8-7
Bad Debt Accounts after Posting
 2. Percentage-of-Receivables
ESTIMATING THE ALLOWANCE
Illustration 8-6

Management establishes
a percentage relationship
between the amount of
receivables and expected
losses from uncollectible
accounts.
Emphasis on Statement of
Financial Position Relationships
 Cont..
• Under the percentage-of-receivables basis,
management estimates what percentage of
receivables will result in losses from
uncollectible accounts. The company prepares
an aging schedule, in which it classifies
customer balances by the length of time they
have been unpaid. Because of its emphasis on
time, the analysis is often called aging the
accounts receivable.
 > DO IT!
Brule Co. has been in business five years. The ledger at the
end of the current year shows:
Accounts Receivable $30,000 Dr.
Sales Revenue $180,000 Cr.
AFDA $2,000 Dr.
Bad debts are estimated to be 10% of receivables. Prepare
the entry to adjust Allowance for Doubtful Accounts.

Solution: *
Bad Debt Expense 5,000
Allowance for Doubtful Accounts 5,000

* [(0.1 x $30,000) + $2,000]

 Cont’d
Question #8
Which of the following approaches for bad debts is best
described as a statement of financial position method?

a. Percentage-of-receivables basis.

b. Direct write-off method.

c. Percentage-of-sales basis.

d. Both A & B.
 Cont’d
How are these accounts presented on the Statement of
Financial Position?

Allowance for
Accounts Receivable Doubtful Accounts

Beg. 500 25 Beg.

End. 500 25 End.

 Cont’d
ABC Corporation
Statement of Financial Position (partial)
Current Assets:
Supplies € 40
Inventory 812
Accounts receivable 500
Less: Allowance for doubtful accounts (25) 475
Cash 330
Total current assets 1,657
 Cont’d
Alternate
ABC Corporation Presentation
Statement of Financial Position (partial)
Current Assets:
Supplies € 40
Inventory 812
Accounts receivable, net of €25 allowance 475
Cash 330
Total current assets 1,657
 Cont’d
Journal entry for credit sale of €100.
Accounts Receivable 100
Sales 100

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.

End. 500 25 End.

 Cont’d
Journal entry for credit sale of €100.
Accounts Receivable 100
Sales 100

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

End. 600 25 End.

 Cont’d
Collected €333 on account.
Cash 333
Accounts Receivable 333

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

End. 600 25 End.

 Cont’d
Collected €333 on account.
Cash 333
Accounts Receivable 333

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

End. 267 25 End.

 Cont’d
Adjustment of €15 for estimated bad debts.
Bad Debt Expense 15
Allowance for Doubtful Accounts 15

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

End. 267 25 End.

 Cont’d
Adjustment of €15 for estimated bad debts.
Bad Debt Expense 15
Allowance for Doubtful Accounts 15

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.

End. 267 40 End.

 Cont’d
Write-off of uncollectible accounts for €10.
Allowance for Doubtful Accounts 10
Accounts Receivable 10

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.

End. 267 40 End.

 Cont’d
Write-off of uncollectible accounts for €10.
Allowance for Doubtful Accounts 10
Accounts Receivable 10

Allowance for
Accounts Receivable Doubtful Accounts
Beg. 500 25 Beg.
Sale 100 333 Coll. 15 Est.
10 W/O W/O 10

End. 257 30 End.

 Cont’d
ABC Corporation
Statement of Financial Position (partial)
Current Assets:
Supplies € 40
Inventory 812
Accounts receivable 257
Less: Allowance for doubtful accounts (30) 227
Cash 330
Total current assets 1,409
 Disposing of Accounts Receivables
• Companies now frequently sell their receivables to
another company for cash. Companies sell

receivables for two major reasons.

• 1st they may be the only reasonable source of cash. When
money is tight, companies may not be able to borrow money
in the usual credit markets. Or, if money is available, the cost of
borrowing may be prohibitive/ high-priced.
• A 2nd reason for selling receivables is that billing and collection
are often time-consuming and costly.
 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 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.
SALE OF RECEIVABLES
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 to record the sale by
Tsai Furniture is as follows.
(NT$600,000 x 2% = NT$12,000)

Cash 588,000
Service Charge Expense 12,000
Accounts Receivable 600,000
CREDIT CARD SALES
 Retailer pays card issuer a fee of 2 to 6% of the
invoice price for its services.

 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.
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 transaction by Yang Music is as follows.

Cash 5,820
Service Charge Expense 180
Sales Revenue 6,000
 > DO IT!
Mehl Wholesalers NV needs to raise €120,000 in cash to safely
cover next Friday’s employee payroll. Mehl has reached its debt
ceiling. Mehl’s balance of outstanding receivables totals €750,000.
Mehl decides to factor €125,000 of its receivables on September 7,
2017, to alleviate this cash crunch. Record the entry that Mehl
would make when it raises the needed cash. (Assume a 1% service
charge.)
Solution
Cash 123,750
Service Charge Expense 1,250
*
Accounts Receivable 125,000
* (1% x €125,000)
 5.4. Notes Receivable
Companies may grant credit in exchange for a promissory
note.

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 amount of transaction and credit period exceed

normal limits, or

3. in settlement of accounts receivable.

 Cont’d
To the payee, the promissory note is a note receivable.
To the maker, the promissory note is a note payable.
Illustration 8-11 Promissory Note
Determining the Maturity Date
Maturity date of a promissory note may be stated in one
of three ways:
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

When counting days, omit the date the note is issued, but
include the due date.
Computing Interest

Illustration 8-14
Formula for Computing Interest

Illustration 8-15
Computation of Interest
 Determining Due date
The period of time between the issuance date and the maturity date of a
short-term note may be stated in either days or month. When the term of a
note is stated in terms of days, the due date is the specified number of days
after its issuance.

Example: the due date of a 90- day note dated June 20 may be determined as follows:

• Term of note ----------------------------------- 90 days

• June days --------------------- 30
• Date of note ------------------ 20 10
• Number of days remaining ----------------- 80
• July days-----------------------------------------31
• Days remaining ------------------------------- 49
• August days ------------------------------------ 31
• Due date September ------------------------- 18
• Example: the maturity date of a 60-day note
dated July 17 is September 15, computed as
follows.
 Notes Receivable and Interest Income
sales are made on account with a normal credit terms of 30 to 90 days.

But the account of a customer may become delinquent in which case the

seller may require the account of the customer be converted in to a note.

In this way the buyer will be given more time. If the seller needs cash

immediately, the note may be endorsed and transferred to a bank or

other financial agency and converted in to cash accelerating the process.

When a note is received from a credit customer on account, an entry is

recorded by debiting notes receivable account and crediting the accounts

receivable account of the customer. If the note is interest bearing, interest is

also to be computed and recorded as appropriate.

 Recognizing Notes Receivable

Eg: assume that Beza Company received a Br.

30,000, 14%, 60 days promissory note dated
December 1,1995 from Zebra Company on account.
The following entries will be made in relation to the
note:1995 Dec. 31:
Notes Receivable ----------------30,000
Accounts Receivable -----------------30,000
Interest Receivable-------------- 700
Interest Income ---------------------- 700
If entry is made, the collection is recorded up on
maturity as follows:
Jan.30: Cash ---------------------------- 30,700
Notes receivable ------------------ 30,000
Interest income --------------------700
(To record collection of note and interest)
Recognizing Notes Receivable
Illustration: Calhoun Company wrote a ₤1,000, two-month,
12% promissory note dated May 1, to settle an open
account. Prepare entry would Wilma Company makes for
the receipt of the note.

May 1 Notes Receivable 1,000

Accounts Receivable—Calhoun Co. 1,000
Valuing Notes Receivable
 Report short-term notes receivable at their cash
(net) realizable value.
 Estimation of cash realizable value and recording
bad debt expense and related allowance are similar
to accounts receivable.
 Allowance for Doubtful Accounts is used.
Disposing of Notes Receivable
1. Notes may be held to their maturity date.

2. Maker may default and payee must make an

adjustment to the account.

3. Holder speeds up conversion to cash by selling the

note receivable.
 Cont’d
HONOR OF NOTES RECEIVABLE
A note is honored when its maker pays it in full at
its maturity date.

DISHONOR OF NOTES RECEIVABLE

A dishonored note is not paid in full at maturity.
Dishonored note receivable is no longer negotiable.
HONOR OF NOTES RECEIVABLE
Illustration: Wolder Co. lends Higley Inc. €10,000 on
June 1, accepting a five-month, 9% interest note. If
Wolder presents the note to Higley Inc. on November 1,
the maturity date, Wolder’s entry to record the collection
is:
Nov. 1 Cash 10,375
Notes Receivable 10,000
Interest Revenue 375

(€10,000 x 9% x 5/12 = €375)

Accrual of Interest Receivable
Illustration: Suppose instead that Wolder Co. prepares financial
statements as of September 30. The adjusting entry by Wolder
is for four months ending Sept. 30. Illustration 8-16
Timeline of Interest Earned

Sept. 30 Interest Receivable 300

Interest Revenue 300
(€10,000 x 9% x 4/12 = € 300)
 Cont’d
Illustration: Prepare the entry Wolder’s would make to
record the honoring of the Higley note on November 1.

Nov. 1 Cash 10,375

Notes Receivable 10,000
Interest Receivable 300
Interest Revenue (€10,000 × 9% × 1/12) 75
DISHONOR OF NOTES RECEIVABLE
Illustration: Assume that Higley Co. on November 1
indicates that it cannot pay at the present time. 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).

Nov. 1 Accounts Receivable 10,375

Notes Receivable 10,000
Interest Revenue 375
 > DO IT!
Gambit Stores accepts from Leonard Co. €3,400, 90-day,
6% note dated May 10 in settlement of Leonard’s overdue
open account. The note matures on August 8. What entry
does Gambit make at the maturity date, assuming Leonard
pays the note and interest in full at that time?

Solution

Interest payable at maturity date = €3,400 × 6% × 90/360 = €51

Cash 3,451
Notes Receivable 3,400
Interest Revenue 51
 Cont’d
Question #9
One of the following statements about promissory notes is
incorrect. The incorrect statement is:
a. The party making the promise to pay is called the maker.

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.
1. January ------------------ 31
2. February------------------28
3. March----------------------31
4. April------------------------30
5. May-------------------------31
6. June---------------------------30
7. July ------------------------------------31
8. August---------------------------------31
9. September ----------------30
10.October---------------------31
11.November------------------30
12.December-------------------31
The End of Chapter 5
Thank You!!!