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Accounting for Receivables: Definitions, Valuation, and Bad Debt Expense - Prof. C. Denste, Study notes of Financial Accounting

Louisiana State University (LSU) - System OfficeFinancial Accounting
Prof. C. Denstel

Various types of receivables, including accounts receivable, notes receivable, and trade receivables. It also covers methods for accounting for bad debts, such as the direct write-off method and the allowance method. Examples of journal entries and discusses financial statement presentation of receivables.

Typology: Study notes

2014/2015

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Chapter 8: Reporting and Analyzing Receivables
(Note: This worksheet is intended as an optional study guide. Do not submit to the instructor.)
Learning Objectives:
1. Identify the different types of receivables.
2. Explain how accounts receivable are recognized in the accounts.
3. Describe the methods used to account for bad debts.
4. Compute the interest on notes receivable.
5. Describe the entries to record the disposition of notes receivable.
6. Explain the statement presentation of receivables.
7. Describe the principles of sound accounts receivables management.
8. Identify ratios to analyze a company’s receivables.
9. Describe methods to accelerate the receipt of cash from receivables.
NOTE: “Accelerating cash receipts” on pages 417-418 may be omitted.
1. Types of Receivables:
Receivables are important because they represent one of a company’s most
_liquid_ assets.
Define the following:
Concept Definition
Receivables Amounts due from individuals and companies that are
expected to be collected in cash
Accounts Receivable Amounts customers owe on account
Notes Receivable Written promise (as evidenced by a formal
instrument) for amounts to be received
Trade Receivables Notes and accounts receivable that result from sales
transactions
Other Receivables Non trade receivables that generally do not result
from the operations of the business, such as interest
receivable, loans to company officers, advances to
employees, and income taxes refundable
2. Recognizing Accounts Receivable:
Two accounting issues associated with accounts receivable are:
1. _Recognizing_ accounts receivable
2. _Valuing_ accounts receivable
ACCT 2001: Ch. 08 Page 1 of 10
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Chapter 8: Reporting and Analyzing Receivables (Note: This worksheet is intended as an optional study guide. Do not submit to the instructor.) Learning Objectives:

  1. Identify the different types of receivables.
  2. Explain how accounts receivable are recognized in the accounts.
  3. Describe the methods used to account for bad debts.
  4. Compute the interest on notes receivable.
  5. Describe the entries to record the disposition of notes receivable.
  6. Explain the statement presentation of receivables.
  7. Describe the principles of sound accounts receivables management.
  8. Identify ratios to analyze a company’s receivables.
  9. Describe methods to accelerate the receipt of cash from receivables. NOTE: “Accelerating cash receipts” on pages 417-418 may be omitted.
  10. Types of Receivables: Receivables are important because they represent one of a company’s most liquid assets. Define the following: Concept Definition Receivables Amounts due from individuals and companies that are expected to be collected in cash Accounts Receivable Amounts customers owe on account Notes Receivable Written promise (as evidenced by a formal instrument) for amounts to be received Trade Receivables Notes and accounts receivable that result from sales transactions Other Receivables Non trade receivables that generally do not result from the operations of the business, such as interest receivable, loans to company officers, advances to employees, and income taxes refundable
  11. Recognizing Accounts Receivable: Two accounting issues associated with accounts receivable are:
    1. Recognizing accounts receivable
    2. Valuing accounts receivable

LO 1

LO 2

A service organization records a receivable when it performs service on account. A merchandiser records accounts receivable at the point of sale of merchandise on account. To review from Chapter 5:  When a merchandiser sells goods, it increases (debits) Accounts Receivable and increases (credits) Sales Revenue.  The seller may offer terms that encourage early payment by providing a discount. (This reduces accounts receivables)  The buyer might find some of the goods unacceptable and choose to return the unwanted goods. Sales returns also reduce receivables. Some retailers issue their own credit cards. When you use a retailer’s credit card (JCPenney, Macy’s, etc.) the retailer charges interest on the balance due if not paid within a specific period. Example entries: (Note that the cost of goods sold entry is omitted) Journal Entry Debit Credit Accounts Receivable xx Sales Revenue xx (To record sales on account) Journal Entry Debit Credit Accounts Receivable xx Interest Revenue xx (To record interest on amount due)

  1. Valuing Accounts Receivable: Companies report accounts receivable on the balance sheet as an asset. Determining the amount to report is sometimes difficult because some receivables will become uncollectible.

LO 3

a) Companies estimate uncollectible accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded. b) Companies record estimated uncollectibles as an increase (debit) to Bad Debt Expense and an increase (credit) to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable. c) Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivable at the time the specific account is written off as uncollectible.

  1. Recording estimated uncollectibles (step b): Journal Entry Debit Credit Bad Debt Expense xx Allowance for Doubtful Accounts xx (To record estimate of uncollectible accounts) Companies report Bad Debt Expense in the income statement as an operating expense. What does Allowance for Doubtful Accounts show? Why don’t companies just credit Accounts Receivable instead? Allowance for Doubtful Accounts shows the estimated amount of claims on customers that companies expect will become uncollectible in the future. Companies use a contra account instead of a direct credit to A/R because they do not know which customers will not pay. The credit balance in the allowance account will absorb the specific write-offs when they occur. Is Allowance for Doubtful Accounts closed at the end of the fiscal year? No.
  2. Recording the write-off of an uncollectible account (step c): To prevent premature or unauthorized write-offs, authorized management personnel should formally approve each write-off. To maintain segregation of duties, the employee authorized to write off accounts should not have daily responsibilities related to cash or receivables. Journal Entry Debit Credit Allowance for Doubtful Accounts xx Accounts Receivable xx

(Write-off of certain account) Under the allowance method, a company debits every bad debt write-off to the allowance account and not to Bad Debt Expense. A write-off affects only balance sheet accounts.

  1. Recovery of an uncollectible account: Occasionally, a company collects from a customer after the account has been written off as uncollectible. The company must make 2 entries to record the recovery of a bad debt: 1) It reverses the entry made in writing off the account. This reinstates the customer’s account: Journal Entry Debit Credit Accounts Receivable xx Allowance for Doubtful Accounts xx (To reverse write-off of customer account) 2) It journalizes the collection in the usual manner: Journal Entry Debit Credit Cash xx Accounts Receivable xx (To record collection from customer) Note that the recovery of a bad debt, like the write-off of a bad debt, affects only balance sheet accounts.
  2. Estimating the Allowance: Define percentage-of-receivables basis: A method of estimating the amount of bad debt expense whereby management establishes a percentage relationship between the amount of receivables and the expected losses from uncollectible accounts To more accurately estimate the ending balance in the allowance account, a company often prepares a schedule, called aging the accounts receivable. Define this concept: A schedule of customer balances classified by the length of time they have been unpaid The longer a receivable is past due, the less likely it is to be collected.

i) Determining the Maturity Date: The maturity date of a promissory note may be stated in one of three ways:  On demand  On a stated date  At the end of a stated period of time When the due date is stated in terms of days, you need to count the exact number of days, omitting the date the note is issued, to determine the maturity date. ii) Computing Interest: Give the basic formula for computing interest: Face Value of Note x Annual Interest Rate x Time in Terms of One Year = Interest iii) Recognizing Notes Receivable: Journal Entry Debit Credit Notes Receivable xx Accounts Receivable xx (To record acceptance of a note) The company records the note receivable at its face value, the value shown on the face of the note. No interest revenue is reported yet. Why? Because the revenue recognition principle does not recognize revenue until the performance obligation is satisfied. Interest is earned (accrued) as time passes. iv) Valuing Notes Receivable: Valuing short-term notes receivable is the same as valuing accounts receivable. v) Disposing of Notes Receivable: When is a note honored? A note is honored when its maker pays 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. Journal Entry Debit Credit Cash xx Notes Receivable xx Interest Revenue xx (To record collection of note and interest) To reflect interest earned, but not yet received, the company must accrue interest: Journal Entry

LO 5

Debit Credit Interest Receivable xx Interest Revenue xx (To accrue interest on note) At the note’s maturity, the company receives repayment of the note as well as the last installment of interest: Journal Entry Debit Credit Cash xx Notes Receivable xx Interest Receivable xx Interest Revenue xx (To record collection of note and interest) What is a dishonored (defaulted) note? What should the lender do if collection is eventually expected? What if there is no hope of collection? A dishonored (defaulted) note is a note that is not paid in full at maturity. If the lender expects that it eventually will be able to collect, the 2 parties negotiate new terms to make it easier for the borrower to repay the debt. If there is no hope of collection, the payee should write off the face value of the note.

  1. Financial Statement Presentation of Receivables: Companies should identify in the balance sheet or in the notes to the financial statements each of the major types of receivables. If a company has significant risk of uncollectible accounts or other problems with its receivables, it is required to discuss this possibility in the notes to the financial statements.
  2. Managing Receivables involves 5 steps:  Determine to whom to extend credit  Establish a payment period  Monitor collections  Evaluate the liquidity of receivables  Accelerate cash receipts from receivables when necessary Extending Credit: Many companies increase sales by being generous with their credit policy. However, they sometimes extend credit to risky customers who do not pay.

LO 6

LO 7

The credit card issuer, who is independent of the retailer; the retailer; and the customer A retailer’s acceptance of a national credit card is another form of selling – factoring – the receivable by the retailer. What are some of the major advantages of credit cards to the retailer? The retailer considers sales resulting from the use of Visa or MasterCard as cash sales. Journal Entry Debit Credit Cash xx Service Charge Expense xx Sales Revenue xx (To record credit card sales)

  1. Know all terms and definitions.