Chapter 7

Reporting and Analyzing Receivables

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Conceptual Learning Objectives

C1: Describe accounts receivable and
how they occur and are recorded
C2: Describe a note receivable and the
computation of its maturity date and
interest
C3: Explain how receivables can be
converted to cash before maturity
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Analytical Learning Objectives

A1: Compute accounts receivable
turnover and use it to help assess
financial condition

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Procedural Learning Objectives

P1: Apply the direct write-off and allowance
methods to account for accounts
receivable
P2: Estimate uncollectibles using methods
based on sales and accounts receivable
P3: Record the receipt of a note receivable
P4: Record the honoring and dishonoring of a
note and adjustments for interest

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C1

Accounts Receivable

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Amounts due from customers

for credit sales.
Credit sales require:
Maintaining a separate
account receivable for each
customer.
Accounting for bad debts
that result from credit sales.

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C1

Recognizing Accounts Receivable

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C1

Sales on Credit
On
On July
July 16,
16, Barton,
Barton, Co.
Co. sells
sells $950
$950 of
of
merchandise
merchandise on
on credit
credit to
to Webster,
Webster, Co.,
Co., and
and
$1,000
$1,000 of
of merchandise
merchandise on
on account
account to
to Matrix,
Matrix, Inc.
Inc.

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C1

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Sales on Credit

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C1

Sales on Credit

On
On July
July 31,
31, Barton,
Barton, Co.
Co. collects
collects $500
$500 from
from Webster,
Webster,
Co.,
Co., and
and $800
$800 from
from Matrix,
Matrix, Inc.
Inc. on
on account.
account.

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C1

Sales on Credit

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C1

Credit Card Sales

Advantages of allowing customers to use
credit cards:
Customers
Customers
credit
credit is
is
evaluated
evaluated by
by
the
the credit
credit
card
card issuer.
issuer.

Sales
Sales increase
increase by
by
providing
providing purchase
purchase
options
options to
to the
the
customer.
customer.

The
The risks
risks of
of extending
extending
credit
credit are
are transferred
transferred to
to
the
the credit
credit card
card issuer.
issuer.
McGraw-Hill/Irwin

Cash
Cash collections
collections
are
are quicker.
quicker.
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C1

Credit Card Sales

With
With bank
bank credit
credit cards,
cards, the
the seller
seller

deposits
deposits the
the credit
credit card
card sales
sales receipt
receipt
in
in the
the bank
bank just
just like
like itit deposits
deposits aa
customers
customers check.
check.

The
The bank
bank increases
increases the
the balance
balance in
in the
the
companys
companys checking
checking account.
account.

The
The company
company usually
usually pays
pays aa fee
fee of
of 1%
1%
to
to 5%
5% for
for the
the service.
service.

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C1

Credit Card Sales

On
On July
July 16,
16, 2010,
2010, Barton,
Barton, Co.
Co. has
has aa bank
bank credit
credit
card
card sale
sale of
of $500
$500 to
to aa customer.
customer. The
The bank
bank
charges
charges aa processing
processing fee
fee of
of 2%.
2%. The
The cash
cash is
is
received
received immediately.
immediately.

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C1

Credit Card Sales

On
On July
July 16,
16, 2010,
2010, Barton,
Barton, Co.
Co. has
has aa bank
bank credit
credit card
card
sale
sale of
of $500
$500 to
to aa customer.
customer. The
The bank
bank charges
charges aa
processing
processing fee
fee of
of 2%.
2%. Barton
Barton remits
remits the
the credit
credit card
card
sale
sale to
to the
the credit
credit card
card company
company and
and waits
waits for
for the
the
payment
payment that
that is
is received
received on
on July
July 28.
28.

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C1

Installment Accounts Receivable

Amounts owed by customers from credit sales for
which payment is required in periodic amounts over
an extended time period. The customer is usually
charged interest.

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P1

Valuing Accounts Receivable

Some
Some customers
customers may
may not
not pay
pay
their
their account.
account. Uncollectible
Uncollectible
amounts
amounts are
are referred
referred to
to as
as bad
bad
debts.
debts. There
There are
are two
two methods
methods
of
of accounting
accounting for
for bad
bad debts:
debts:

Direct
Direct Write-Off
Write-Off Method
Method

Allowance
Allowance Method
Method

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P1

Direct Write-Off Method

On
On August
August 4,
4, Barton
Barton determines
determines itit
cannot
cannot collect
collect $350
$350 from
from Martin,
Martin, Inc.,
Inc.,
aa credit
credit customer.
customer.

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P1

Direct Write-Off Method

On
On September
September 9,
9, Martin
Martin decides
decides to
to pay
pay
$200
$200 that
that was
was previously
previously written
written off.
off.

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P1

Matching vs. Materiality

Matching requires
expenses to be
reported in the same
accounting period as
the sales they help
produce.

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Materiality states
that an amount can
be ignored if its
effect on the
financial statements
is unimportant to
users business
decisions.
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P1

Allowance Method

At
At the
the end
end of
of each
each period,
period, estimate
estimate total
total bad
bad debts
debts
expected
expected to
to be
be realized
realized from
from that
that periods
periods sales.
sales.
There
There are
are two
two advantages
advantages to
to the
the allowance
allowance method:
method:
1.
1. It
It records
records estimated
estimated bad
bad debts
debts expense
expense in
in the
the
period
period when
when the
the related
related sales
sales are
are recorded.
recorded.
2.
2. It
It reports
reports accounts
accounts receivable
receivable on
on the
the balance
balance
sheet
sheet at
at the
the estimated
estimated amount
amount of
of cash
cash to
to be
be
collected.
collected.

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P1

Recording Bad Debts Expense

At the end of its first year of operations 2010, Barton Co.

estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2010, is $278,000.

Contra-asset account
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P1

Recording Bad Debts Expense

At the end of its first year of operations 2010, Barton Co.

estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2010, is $278,000.

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P1

Recording Bad Debts Expense

At the end of its first year of operations 2010, Barton Co.

estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2010, is $278,000.

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P2

Estimating Bad Debts Expense

1.
1.
2.
2.

Two
Two Methods
Methods
Percent
Percent of
of Sales
Sales Method
Method
Accounts
Accounts Receivable
Receivable Methods
Methods

Percent
Percent of
ofAccounts
Accounts
Receivable
Receivable

Aging
Aging of
ofAccounts
Accounts
Receivable
Receivable Method
Method

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P2

Percent of Sales Method

Bad debts expense is computed

as follows:

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P2

Percent of Sales Method

Barton has credit sales of

$1,400,000 in 2010.
Management estimates 0.5%
of credit sales will eventually
prove uncollectible.
What is Bad Debts Expense
for 2010?

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P2

Percent of Sales Method

Bartons accountant
computes estimated
Bad Debts Expense of
$7,000.

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Percent of Accounts Receivable

Method

P2

Compute the estimate of the Allowance for

Doubtful Accounts.

Bad Debts Expense is computed as:

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P2

Percent of Accounts Receivable

Barton
Barton has
has $100,000
$100,000 in
in
accounts
accounts receivable
receivable and
and aa $900
$900
credit
credit balance
balance in
in Allowance
Allowance for
for
Doubtful
Doubtful Accounts
Accounts on
on
December
December 31,
31, 2010.
2010. Past
Past
experience
experience suggests
suggests that
that 4%
4% of
of
receivables
receivables are
are uncollectible.
uncollectible.
What
What is
is Bartons
Bartons Bad
Bad Debts
Debts
Expense
Expense for
for 2010?
2010?
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P2

Percent of Accounts Receivable

Desired balance in Allowance for

Doubtful Accounts.

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Aging of Accounts Receivable

Method

P2

Each
Eachreceivable
receivable is
isgrouped
groupedby
by
how
how long
longititis
ispast
pastits
itsdue
duedate.
date.

Each age group is multiplied

by its estimated bad debts
percentage.

Estimated
Estimatedbad
baddebts
debtsfor
foreach
each
group
groupare
aretotaled.
totaled.
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P2

Aging of Accounts Receivable

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P2

Aging of Accounts Receivable

Bartons
Bartons unadjusted
unadjusted balance
balance
in
in the
the allowance
allowance account
account is
is
$900.
$900.
We
We estimated
estimated the
the proper
proper
balance
balance to
to be
be $5,320.
$5,320.

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P2

Writing Off a Bad Debt

With
With the
the allowance
allowance method,
method, when
when an
an
account
account is
is determined
determined to
to be
be uncollectible,
uncollectible,
the
the debit
debit goes
goes to
to Allowance
Allowance for
for Doubtful
Doubtful
Accounts.
Accounts.
Barton
Barton determines
determines that
that Martins
Martins $300
$300
account
account is
is uncollectible.
uncollectible.

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P2

Recovery of a Bad Debt

Subsequent
Subsequent collections
collections on
on accounts
accounts written
written
off
off require
require that
that the
the original
original write-off
write-off entry
entry be
be
reversed
reversed before
before the
the cash
cash collection
collection is
is
recorded.
recorded.

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P2

Summary
% of Sales

% of Receivables

Aging of
Receivables

Emphasis on
Matching

Emphasis on
Realizable Value

Emphasis on
Realizable Value

Accts.
Rec.

Accts.
Rec.

Sales

Bad
Debts
Exp.

Income
Income
Statement
Statement
Focus
Focus
McGraw-Hill/Irwin

All. for
Doubtful
Accts.

Balance
Balance
Sheet
SheetFocus
Focus

All. for
Doubtful
Accts.

Balance
Balance
Sheet
SheetFocus
Focus
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P3

Lets look at
notes receivable!

P3

Notes Receivable

A note is a
written
promise to
pay a specific
amount at a
specific future
date.
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P3

Notes Receivable
$1,000.00

Term

Ninety days

Payee

July 10, 2010

after date I promise to pay to

the order Barton Company, Los Angeles, CA

One
of thousand and no/100 --------------------------------- Dollars
Payable First National Bank of Los Angeles, CA
Maker
at
Value received with interest12%
at
per
annum
Oct. 8, 2010
No. 42
Due

Julia Browne

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P3

Notes Receivable
$1,000.00
Ninety days

July 10, 2010

after date I promise to pay to

thePrincipal
order Barton Company, Los Angeles, CA
One
of thousand and no/100 --------------------------------- Dollars
Payable First National
InterestBank
Rateof Los Angeles, CA
at
Value received with interest12%
at
per
annum
Oct. 8, 2010
No. 42
Due

Julia Browne

Due Date
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P3

Interest Computation

Even
Even for
for
maturities
maturities less
less
than
than one
one year,
year,
the
the rate
rate is
is
annualized.
annualized.
McGraw-Hill/Irwin

IfIf the
the note
note is
is
expressed
expressed in
in
days,
days, base
base aa
year
year on
on 360
360
days.
days.
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P3

Computing Maturity and Interest

On
On March
March 1,
1, 2010,
2010,
Matrix,
Matrix, Inc.
Inc. purchased
purchased aa
copier
copier for
for $12,000
$12,000 from
from
Office
Office Supplies,
Supplies, Inc.
Inc.
Matrix
Matrix gave
gave Office
Office
Supplies
Supplies aa 9%
9% note
note due
due
in
in 90
90 days
days in
in payment
payment
for
for the
the copier.
copier.
What
What is
is the
the maturity
maturity date
date
of
of the
the note?
note?

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P3

Computing Maturity and Interest

The note is due and payable on May 30, 2010.

How much interest will Matrix pay to Office
Supplies, Inc. on this note?
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P3

Computing Maturity and Interest

Total interest due

at May 30.
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P3

Recognizing Notes Receivable

Here
Here are
are the
the entries
entries to
to record
record the
the note
note on
on
March
March 1,
1, and
and the
the settlement
settlement on
on May
May 30,
30, 2010.
2010.

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P4

Recording a Dishonored Note

On
On May
May 30,
30, 2010,
2010, Matrix
Matrix informs
informs us
us that
that the
the
company
company is
is unable
unable to
to pay
pay the
the note
note or
or interest.
interest.

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P4

Recording End-of-Period Interest

Adjustments
When
When aa note
note receivable
receivable
is
is outstanding
outstanding at
at the
the
end
end of
of an
an accounting
accounting
period,
period, the
the company
company
must
must prepare
prepare an
an
adjusting
adjusting entry
entry to
to
accrue
accrue interest
interest income.
income.

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P4

Recording End-of-Period Interest

Adjustments
On
On December
December 1,
1, 2010,
2010, Matrix,
Matrix, Inc.
Inc. purchased
purchased aa
copier
copier for
for $12,000
$12,000 from
from Office
Office Supplies,
Supplies, Inc.
Inc. Matrix
Matrix
issued
issued aa 9%
9% note
note due
due in
in 90
90 days
days in
in payment
payment for
for the
the
copier.
copier. What
What adjusting
adjusting entry
entry is
is required
required on
on
December
December 31,
31, the
the end
end of
of the
the companys
companys accounting
accounting
period?
period?
$12,000 9% 30/360 = $90

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P4

Recording End-of-Period Interest

Adjustments
Recording collection on note at maturity.

Days in December
Minus the date of the note
Day remaining in December
Days in January
Days in February
Days in March until maturity
Period of the note in days

McGraw-Hill/Irwin

31
(1)
30
31
28
1
90

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C3

Disposing of Receivables

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Companies sometimes want to convert

receivables to cash before they are
due.
They can sell or factor receivables.
They may pledge receivables as
security for a loan.

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A1

Accounts Receivable Turnover

This ratio provides useful information for
evaluating how efficient management has
been in granting credit to produce revenue.
Net sales
Average accounts receivable

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End of Chapter 7

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