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Accounting for receivables

The Operating Cycle 2

of a Business
Assume that Acme Manufacturing sold merchandise to
Harper Company on account.
When the inventory is sold on account:
Accounts Receivable 1,000
Sales 1,000
Sold merchandise to Harper
Company on account.
When the collection takes place:
Cash 1,000
Accounts Receivable 1,000
Payment received on account.
The Operating Cycle 3

of a Business
Receivables are all claims against other
entities. They are usually settled in cash.
Trade receivables: Receivables arising from
normal operating activities.
Notes receivable: Trade receivables evidenced
by a formal written promise to pay.
Nontrade receivables: All receivables arising
from activities other than normal operations.
The Operating Cycle 4

of a Business
Nontrade receivables arise from a variety
of transactions, such as
(1) The sale of securities or property other
than inventory
(2) Deposits to guarantee contract
performance or expense payments
(3) Claims for rebates and tax refunds
(4) Dividends and interest receivable
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5

Accounting for
Receivable
Recognizing accounts receivable
Valuing accounts receivable
Disposing of account receivable
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Valuing Accounts Receivable


Occur when customers do not pay for items
or services purchased on credit.
Bad debts are uncollectible accounts
receivable.
Bad Debt Expense is reported as a selling
or general and administrative expense.
Accounts receivable are reported on the
balance sheet at their net realizable value.
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Uncollectible A/R

The direct write-off method


The allowance method
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Accounting for Uncollectible
Receivables (Direct Method)
Write Off:
Bad Debts Expense 400
Accounts Receivable 400
To write off an
uncollectible account.

Since
This
Thisthis
Since entry
this determination
entry isis made
made when
determination when was
the
wasthemade
account
made after
account has
after the
hasthe
been
period
been determined
period in
in which
whichuncollectible.
determined the
the sale
sale takes
uncollectible.takes place,
The
The direct
place, the
direct
the
matching
write-off
write-offprinciple
matching method
method isis
principle isisused
violated.
used by
by small
violated. This
small
This
method
businesses
method isis not
businesses because
not accepted
because
acceptedofof its
under
its simplicity.
under GAAP.
simplicity.
GAAP.
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The Allowance Method

Uncollectible A/R are estimated and matched


against sales in the same accounting period in
which the sales occurred.
Estimated uncollectible is debited to Bad Debt
Expense and credited to Allowance for Bad Debts
through an adjusting entry at the end of each
period.
Actual uncollectible is debited to Allowance for
Bad Debts and credited to A/R at the time the
specific account is written off.
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Accounting for Uncollectible
Receivables (Allowance Method)
In this method, an estimate of the total uncollectible
accounts is made at the end of the period, and an expense
is recognized.
Bad Debts Expense 2,000
Allowance for Bad Debts 2,000
To record estimated
uncollectible accounts.

GAAP
GAAPrequires
requires the
the use
use of
of the
the
allowance
allowance method.
method.
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Accounting for Uncollectible
Receivables (Allowance Method)
When the account is then determined to be
uncollectible, the write-off entry is:
Allowance for Bad Debts 400
Accounts Receivable 400
To write off an uncollectible
account.

Note:
Note: Bad
Bad Debt
Debt Expense
Expense isis not
not debited.
debited.
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Accounting for Uncollectible
Receivables (Allowance Method)
What happens if the written off receivable is
later collected? Assume that the customer from
Slide 22 pays the $400 written-off debt a month
after the write-off.
Accounts Receivable 400
Allowance for Bad Debts 400
To reverse the entry made to
write off the account.

Note:
Note: Before
Before the
the payment
payment entry,
entry, the
the debt
debt
must
must be
be restored.
restored.
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Accounting for Uncollectible
Receivables (Allowance Method)
What happens if the written off receivable is
later collected? Assume that the customer from
Slide 22 pays the $400 written-off debt a month
after the write-off.
Cash 400
Accounts Receivable 400
To record collection of the
account.
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Accounting for Uncollectible
Receivables (Allowance Method)
(1) Allowance for Bad Debt is a
contra-asset account which is subtracted from
Accounts Receivable on the balance sheet.
2)The actual write-off entry for $400 does not reduce
net receivables, as shown below:

Accts. Receivable $100,000 Accts. Receivable $99,600


Less Allowance for Less Allowance for
Doubtful Accounts 2,000 Doubtful Accounts 1,600
Net Receivables $ 98,000 Net Receivables $98,000
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Estimating the Allowance for
Uncollectible Accounts

Percentage of credit
sales
Percentage of accounts
receivable
Aging receivables
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Percentage
Example: of Credit
Doubtful Sales
Accounts Expense

The
The ABC
ABC company
company had had credit
credit sales
sales of
of
$100,000.
$100,000. The
The current
current accounts
accounts
receivable
receivable balance
balance isis $30,500.
$30,500. TheThe
allowance
allowance for
for doubtful
doubtful accounts
accounts balance
balance isis
$350.
$350. Historically,
Historically,22 percent
percent of
of the
the credit
credit
sales
sales are
are not
not collected.
collected.

What
What isis the
the entry
entry to
to record
record estimated
estimated bad
bad debts?
debts?
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Percentage
Example: of Credit
Doubtful Sales
Accounts Expense

The
The ABC
ABC company
company had had credit
credit sales
sales of
of
$100,000.
$100,000. The
The current
current accounts
accounts
receivable
receivable balance
balance isis $30,500.
$30,500. TheThe
allowance
allowance for
for doubtful
doubtful accounts
accounts balance
balance isis
$350.
$350. Historically,
Historically,22 percent
percent of
of the
the credit
credit
sales
sales are
are not
not collected.
collected.

Bad Debt Expense 2,000


Allowance for Doubtful Accounts 2,000
To record estimated uncollectible
accounts for the year.
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Percentage of Credit Sales

Allowance for Doubtful Accounts


Balance 350
Adjusting 2,000
Dec. 31, Bal. 2,350
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Percentage of Accounts
Example: Doubtful Receivable
Accounts Expense

The
The XYZ
XYZ company
company had had credit
credit sales
sales of
of
$693,000.
$693,000. The
The current
current accounts
accounts
receivable
receivable balance
balance isis $50,000.
$50,000. TheThe
allowance
allowance account
account balance
balance isis $600.
$600.
Historically,
Historically, 33 percent
percent of
of accounts
accounts
receivable
receivable are
are not
not collectible.
collectible.
What
What isis the
the required
required adjusting
adjusting entry
entry to
to
record
record estimated
estimated bad
bad debts?
debts?
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Percentage of Accounts Receivable

Bad Debt Expense 900


Allowance for Doubtful Accounts 900
To record estimated uncollectible
accounts for the year. ($50,000 x .03) $600
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Percentage of Accounts Receivable

Allowance for Doubtful Accounts


Balance 600
Adjusting 900
Thats
Thats the
the desired
desired Dec. 31, Bal. 1,500
ending
ending balance.
balance.
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Percentage of Accounts Receivable

Allowance
IIWhat
see!
see! if
What The
if
Thethefor
the Doubtful
ending
allowance
ending Accounts
balance
allowance
balance
Balancemust
account
must be
be forced
account had
350aa debit
forced
had to
to be
debitbe the
Adjustingthe 1,850
balance
calculated
balance
calculated of
of $350?
amount.
$350?
amount.
Dec. 31, Bal. 1,500
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Aging Receivables
The
The ABC
ABC company
company had had credit
credit sales
sales of
of
$100,000.
$100,000. The The current
current accounts
accounts
receivable
receivable balance
balance isis $47,550.
$47,550. TheThe
allowance
allowance forfor doubtful
doubtful accounts
accounts balance
balance isis
$620.
$620. The
The firm
firm ages
ages the
the accounts
accounts toto
determine
determine
Remember, the
the expected
expected
because uncollectibles.
uncollectibles.
receivables
Remember, because receivables are
are
involved,
involved, the
the amount
amount derived
derived from
from
aging
aging provides
provides thethe desired
desired balance
balance ofof
the
the allowance
allowance account.
account.
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Aging Receivables
Uncollectible Estimated
Accounts Amount of
Classification Experience Uncollectible
(in days) Balance Percentage Accounts
Not yet due $40,000 2% $ 800
1-30 past due 3,000 5 150
31-60 past due 1,200 10 120
61-90 past due 650 20 130
91-180 past due 500 30 150
181-365 past due 800 50 400
+365 past due 1,400 1,120
$47,550 $2,870
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Aging Receivables

Bad Debt Expense 2,250


Allowance for Doubtful Accounts 2,250
To record estimated uncollectible
accounts for the year.
Required
Required balance
balance $2,870
$2,870
Current
Current balance
balance (620)
(620)
Adjusting
Adjusting entry
entry $2,250
$2,250
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Aging Receivables

Allowance for Doubtful Accounts


Balance 620
Adjusting 2,250
Dec. 31, Bal. 2,870
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Presentation of Sales and Receivables in
the Financial Statements

Receivables qualifying as current items


may be grouped for presentation on the
balance sheet in the following classes:
1) Notes receivabletrade debtors
2) Accounts receivabletrade debtors
3) Other receivables
Accounts Receivable as a 28

Source of Cash

As
As aa sale
sale (either
(either with
with or
or
without
without recourse.
recourse.
As
As aa secured
secured borrowing.
borrowing.
Accounts Receivable as a 29

Source of Cash
SFAS 140 specified conditions that must be met if a
transfer of receivables is to be accounted for as a sale:
1. The transferred assets have been isolated from the
transferor and its creditors cannot access the assets.
2. The transferee has the right to pledge or exchange the
transferred assets.
3. The transferor does not maintain effective control
over the assets through either (a) an agreement to
repurchase them before their maturity or (b) the
ability to cause the transferee to return specific assets.
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Factoring Accounts Receivable

Accounts Receivable
from Factoring
Payment of Accounts

Factor
Factor

Sale of Accounts
Receivable

Receivable
Cash
Goods and
Services Provided
Customers Company
Accounts
Receivable
Established
Accounting for Factoring 31

Accounts Receivable
Close sold receivables
Close accompanying Allowance for Bad
Debts
Expense any factoring charges
Establish a receivable for any sales price
withheld by the factor
Debit Cash for net proceeds of the sale
Recognize a gain or loss from factoring
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Example: Factoring
Accounts Receivable
Assume that Hendredon Furniture factors $600 of receivables
to Federal Factors, Inc. Federal Factors assesses a service
charge of 2% of the amount of receivables sold.

Cash 588,000
Service Charge 12,000
A/R 600,000
(To record the sale of A/R)
Example: Factoring 33

Accounts Receivable
Assume:
Factored Receivables $10,000
Allowance for Bad Debts 300
Factor Withholding 5%
Sales Price $ 8,500

Lets
Lets journalize
journalize this
this
transaction
transaction
Example: Factoring 34

Accounts Receivable
Cash 8,075
Receivable from Factor 425
Allowance for Bad Debts 300
Loss from Factoring Receivables 1,200
Accounts Receivable 10,000
Computations
Cash: $8,500 425 = $8,075
Factor Receivable: $8,500 x 5% = $425
Factoring Loss: ($10,000 300) $8,500 =
$1,200
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Secured Borrowing
Assignment of Accounts Receivable
There are no special accounting problems
involved.
Simply record the loan.
Specific Assignment:
Specified accounts receivable pledged.
Accounts receivable reclassified on balance
sheet.
Footnote disclosure of loan provisions required.
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Notes Receivable
A
Apromissory
promissory note
note isis an
an
unconditional
unconditional written
written
promise
promise to
to pay
pay aa certain
certain
sum
sum of
of money
money at at aa
specified
specified time.
time.
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Notes Receivable

Initially recorded at present value.


Two types:
Interest-bearing: Interest rate is stated on
the note.
Noninterest-bearing: Interest is implied
in the face amount of the note.
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Example: Notes Receivable

Assume:
Note Receivable $1,000
Interest Rate 10%
Time to Maturity 2 years
Journalize this note as:
1. An interest-bearing note.
2. A noninterest-bearing note.
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Example: Notes Receivable


Interest-Bearing Note:
Notes Receivable 1,000
Sales 1,000

Noninterest-Bearing Note:
Notes Receivable 1,210
Sales 1,000
Discount on Notes Receivable 210
(PV of $1,000 @ 10% for
2 years = $1,210)
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Determining the Maturity 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, the date the note is issued is
omitted but the due date is included.

For example, the maturity date of a 60-day note


dated July 17 is:
Term of note 60
July (31 17) 14
August 31 45
Maturity date, September 15
==
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Computing Interest

Face Annual
value interest time interest
of note rate
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Disposing of N/R
Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4-
month, 9% interest note. On October 1, the maturity date, the
entry by Wolder to record the collection is:
Oct. 1. Cash 10,300
Notes Receivable 10,000
Interest Revenue 300

If Wolder Co. prepares financial statements as of September


30, it would be necessary to accrue interest. In this case, the
adjusting entry by Wolder would be for 4 months, or $300, as
shown below:
Sept. 30. Interest Receivable 300
Interest Revenue 300
And at the maturity date, the entry would be:
Oct. 1. Cash 10,300
Notes Receivable 10,000
Interest Receivable
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Dishonor of N/R

Oct. 1. A/R 10,300


N/R 10,000
Interest Revenue 300
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Discounting Notes Receivables

Discount Rate: The interest rate charged


by the financial institution for buying a
note receivable.
Discount Period: The time between the
date a note is sold to a financial institution
and its maturity date.
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Formulas for Discounting Notes

Interest = Face amount x Interest


rate x Interest period
Maturity value = Face amount + Interest
Discount = Maturity value x Discount
period x Discount rate
Proceeds = Maturity value - Discount
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Assume that a 90-day, 12%, $1,800 note receivable
from Prior & Co., dated April 8, is discounted at the
payees bank on May 3 at the rate of 14%. The data
used in determining the effect of the transaction are as
follows:
Face value of note dated April 8 1,800
Interest on note (90 days at 12%) 54
Maturity value on note due July 7 1,854
Discount on maturity value (65 days
from May 3 to July 7, at 14%)
46.87
Proceeds 1,807.13
======
The endorser records as interest revenue the excess of
the proceeds from discounting the note, $1,807.13, over
the face value, $1,800, as follows:
May 3. Cash 1,807.13
N/R 1,800
Interest Revenue 7.13
If the proceeds from discounting a note receivable less
than the face value, the endorser records the excess of
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Without a statement limiting responsibility, the endorser of a


note is committed to paying the note if the maker defaults.
This potential liability is called a contingent liability.
If the maker pays the promised amount at maturity, the
contingent liability is removed without any action on the part
of the endorser.
If, on the other hand, the maker dishonors the note and the
endorser is notified according to legal requirement, the
endorsers liability becomes an actual one.
In some cases, the bank may charge a protest fee for
notifying the endorser that a note has been dishonored.
Assume that the $1,800, 90-day, 12% note discounted on May
3 is dishonored at maturity by the maker. The bank charges
a protest fee of $12. The entry would be:

May 7. A/R 1,866


Cash 1,866
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The End