FINANCIAL ACCOUNTING

Tools for Business Decision-Making

KIMMEL  WEYGANDT  KIESO  TRENHOLM  IRVINE

CHAPTER 8:
Reporting and Analyzing Receivables
 September 22

Agenda:
Synchronous (1hr – 1.5hr)

• Brief Review – Finish Chapter 7 Reporting Cash

• Chapter 8 - Receivables
• Overview
• Types of Receivables
• Subsidiary Ledger
• Estimating/Recording Uncollectible Accounts
• Recording Known Uncollectibles
• Recovery of Uncollectibles
• Notes Receivable
• Other

Asynchronous (Remainder of Class Time)

• Follow-up questions from synchronous class

• Quiz (available @ 3pm (until midnight) following synchronous class – 20 minutes to complete)
 Accounts Receivable
1- Estimating Allowance
2- Recording Bad Debt Expense (Estimate)
3- Write-Off (of Actual Known Uncollectibles)
4- Recovery of uncollectibles
 Review!

Describe the REVENUE RECOGNITION principle??

Describe the EXPENSE RECOGNITION principle??

Chapter From 30,000 feet!

Timeline

2019 2020 2021

Chapter From 30,000 feet!

Timeline

2019 2020 2021

Revenue Recognition:
- Sell on credit (common business model)
- Credit terms (N90)
Expense Recognition
Chapter From 30,000 feet!

Timeline
Revenue 2020
Income Statement

Customer Bankruptcy Occurs in 2021 –

should be matched to related revenue

2019 2020 2021

Revenue Recognition:
- Sell on credit (common business model
- Credit terms (N90)
Expense Recognition
- What about customers who don’t pay
- Why? (CCAA/bankruptcy/receivership)
Chapter From 30,000 feet!

Much of this chapter is devoted to…

2019 2020 2021

ensuring bad debt

expenses are matched to
related revenues.
 Types of Receivables

Start detailed discussion with types of

receivables.
 Types of Receivables

• Amounts due to a business from its customers or

other entities expected to be collected in cash
• Frequently classified as
– Accounts receivable – (trade receivables) from sale of
goods and services
– Notes receivable – formal credit instrument (written
promise to pay)
– Other receivables – interest, loans and advances to
employees, taxes
 Practice – Types of Receivables

BE-1 Page 439

 Practice – Types of Receivables

BE-1 Page 439

BRIEF EXERCISE 8-1

(a) Notes receivable
(b) Accounts receivable
(c) Other receivables
(d) Other receivables
(e) Notes receivable
(f) Other receivables
Accounts Receivable Subsidiary Ledger
 Accounts Receivable Subsidiary Ledger

• Subsidiary ledger accounts that share a

common characteristic
• The subsidiary ledger for accounts receivable
provides the details that support the total
balance for accounts receivable in the general
ledger (control account).
 Accounts Receivable Subsidiary Ledger
General
Ledger

Accounts Receivable
(Control Account)
$12,000
Subledger - $12,000

ABC Company Tri Company Hal Company

(Customer) (Customer) (Customer)
$2,000 $6,000 $4,000
 Recording Estimated
Uncollectible Accounts
 Recording Estimated
Uncollectible Accounts
• Some accounts receivable become
uncollectible
• Losses from these uncollectible accounts are
debited to an account called Bad Debts
Expense
• Bad debts expense is recognized in the same
period that the related sales revenue is
generated
 Allowance Method

• This method estimates the uncollectible

accounts at the end of each period
• The amount estimated is shown in the
Allowance for Doubtful Accounts
– A contra asset account that is shown below
Accounts Receivable
• Note that the allowance is an estimate – it
does not show specific customer accounts
 Estimating the Allowance

• Most companies use the percentage of

receivables basis to determine the allowance
– Estimate what percentage of receivables are likely
to be uncollectible
– Apply this percentage to total receivables, or
– Apply this percentage to receivables classified
according to the length of time they have been
outstanding (called aging the accounts receivable)
 Estimating the Allowance
# of days Accounts Rec. Estimated % Est’d Amount
0-30 $111,500 2% $2,230
31-60 41,400 5% 2,070
61-90 38,000 10% 3,800
91-120 6,600 25% 1,650
Over 120 2,500 50% 1,250
Total $200,000 $11,000

Example: Allowance for Doubtful

Bad Debt Expense Accounts
(AFDA) Accounts Receivable
$11,000 $11,000 $200,000
 Estimating the Allowance
# of days Accounts Rec. Estimated % Est’d Amount
0-30 $111,500 2% $2,230
31-60 41,400 5% 2,070
61-90 38,000 10% 3,800
91-120 6,600 25% 1,650
Over 120 2,500 50% 1,250
Total $200,000 $11,000

Example – Balance Sheet:

Current Assets:
Accounts Receivable $200,000
Less: Allow. For Doubtful Acct. 11,000
Net Receivables $189,000
 Estimating the Allowance

Note:
• Previous example assumed first year of
business (i.e. $0 Unadjusted Balance in AFDA account)
Allowance for Doubtful
Bad Debt Expense Accounts
(AFDA)

$11,000 $0 Unadjusted Balance

11,000
$11,000 Adjusted Balance
(Equals Estimate)
 Estimating the Allowance

• Assume 2’nd year ($1,000 Unadjusted Balance in AFDA

account)

Allowance for Doubtful

Bad Debt Expense Accounts
(AFDA)

$10,000 $1,000 Unadjusted Balance

10,000
$11,000 Adjusted Balance
(Equals Estimate)

Current Assets:
Now adjusting entry is $10,000 (not $11,000), Accounts Receivable $200,000
Less: Allow. For Doubtful Acct. 11,000
but net receivables is still $189,000 as estimated Net Receivables $189,000
 Recording and Reporting Estimated
Uncollectible Accounts

The balance in the Allowance for Doubtful Accounts is

deducted from Accounts Receivable in the current assets
section of the statement of financial position:

See page 420 example –Illus.8-3

(note unadjusted balance – cr $1,000 – so Bad Debt
Recording the Write-Off of an Uncollectible
Account
Recording the Write-Off of an Uncollectible
Account
• The vice president of finance authorizes a
write-off of $2,500 owed by T. Ebbet:
 Practice

E8-3, Page 442

E8-4, Page 442
 Practice

• E8-3, Page 442EXERCISE 8-3

(a) Dec. 31 Bad Debts Expense ($36,000 – $4,400) 31,600
Allowance for Doubtful Accounts
31,600

(b) Dec. 31 Bad Debts Expense ($36,000 + $2,400) 38,400

Allowance for Doubtful Accounts
8,400
 Practice

E8-4, Page 442

EXERCISE 8-4
(a) Age of Accounts Amount % Estimated Uncollectible
0-30 days $260,000 2 $ 5,200
31-60 days 50,400 10 5,040
61-90 days 34,000 30 10,200
Over 90 days 25,600 50 12,800
$33,240
(b) Mar. 31 Bad Debts Expense 24,440
Allowance for Doubtful Accounts 24,440
($33,240 – $8,800)
(c) The carrying amount of the accounts receivable at March 31 is as follows:
Accounts receivable $370,000
Less: Allowance for doubtful accounts 33,240
$336,760
Recording the Recovery of an Uncollectible
Account

Record in two separate entries:

 Practice

E8-5, Page 442

(a)
2017
Dec. 31Bad Debts Expense 18,800
Allowance for Doubtful Accounts 18,800
($16,800 + $2,000)
2018
May 11 Allowance for Doubtful Accounts 1,900
Accounts Receivable 1,900
Nov. 12 Accounts Receivable 1,900
Allowance for Doubtful Accounts 1,900
Cash 1,900
Accounts Receivable 1,900
 Practice

E8-5, Page 442

Dec. 31 May 11 Nov.12

2017 2018 (b) 2018

Accounts receivable $300,000 $298,100 $298,100

Less: Allowance for doubtful accounts 16,800 14,900 16,800
Carrying amount $283,200 $283,200 $281,300
 Summary of the
Allowance Method
1. Recording estimated uncollectible accounts
– Any increase to the allowance is recorded as bad
debts expense
2. Recording the write-off of an uncollectible
account
– Actual accounts are written off when they are
determined to be uncollectible
– This write-off reduces the allowance
3. Recording the recovery of an uncollectible
account
– If a written-off account is later collected, the write-off
is reversed and the collection recorded
Notes Receivable
 Notes Receivable

• Stronger legal claim to assets than accounts

receivable; written promise (promissory note)
to repay
• A credit instrument that normally
– Requires the payment of interest
– Extends for time periods greater than 30 days
• Often accepted from
– Customers who need to extend payment of an
account receivable
– High-risk customers
 Formula for Calculating Interest

• The basic formula for calculating interest on an

interest-bearing note is
•
Annual Time in
Face Value
X Interest X Terms of = Interest
of Note
Rate One Year

• The interest rate specified on the note is an

annual rate of interest
 Revenue Recognition

• Year end adjustments:

• Face Value Annual Time in
X Interest X Terms of = Interest
of Note
Rate One Year

1 year note – e.g. $1,000/4%

2019 2020 2021

6 months 6 months
= $1,000 x 4%/2
= $40/2
=$20

Dec. 31/2020 Interest Rec. $20

Interest Revenue $20
 Derecognizing Notes Receivable

• Honoured
– Paid in full at maturity date
– Collection recorded
• Dishonoured
– Not paid at maturity date; note no longer
negotiable
– Balance transferred to Accounts Receivable if
eventual collection expected
– Balance transferred to Allowance for Doubtful
Notes if eventual collection not expected
 Practice

E8-7, Page 443

Assume:
• perpetual inventory system
• time measured in months (not days)
• Unadjusted AFDA = $0 on Feb. 28
• nearest ½ month means,
– 1 month if: =or> ½ month
– 0 month if: < ½ month
 Practice

E8-7, Page 443 Solution:

Nov. 1 Notes Receivable 116,000

Cash 116,000
Dec. 1 Notes Receivable 22,600
Sales 22,600
Cost of Goods Sold 13,200
Inventory 13,200
15 Notes Receivable 24,000
Accounts Receivable 24,000
 Practice

E8-7, Page 443 Solution:

Feb. 1 Cash 22,826
Notes Receivable 22,600
Interest Revenue ($22,600 × 6% × 2/12) 226
28 Interest Receivable 3,780
Interest Revenue 3,780

Calculation of interest revenue on February 28:

Bouchard note: $116,000 × 9% × 4/12
= $3,480
Aquilina note: $24,000 × 6% × 2.5/12=. 300
Total accrued interest $3,780

28 Bad Debt Expense 18,200

Allowance for Doubtful Notes 18,200
Statement Presentation
 Statement Presentation

• Statement of Financial Position

– Receivables reported in the current assets section
– Following cash and short-term investments
– Only required to disclose net realizable value, but
helpful to disclose gross receivables and the
allowance for doubtful accounts
• Income Statement
– Bad debts expense is reported as an operating
expense
– Interest revenue is non-operating
 Managing Receivables
Note: this will be covered in much more depth in Financial Management (FIN 2500)
 Managing Receivables

• Determine to whom to extend credit

• Establish a payment period
• Monitor collections
– Prepare and update an accounts receivable aging
schedule
• Evaluate the liquidity of receivables
 Evaluating the Liquidity of Receivables

• Liquidity is measured by how quickly certain

assets can be converted into cash
– Receivables turnover
– Average collection period
 Receivables Turnover

• Is a measure of the liquidity of receivables

Receivables Turnover = Net Credit Sales

Average Gross Receivables

Higher is better
 Average Collection Period

• Is the average amount of time that a

receivable is outstanding

Average Collection Period = 365 days

Receivables Turnover

Lower is better