Accounts Receivable • Arise from credit sales to customers. • Often referred to as Trade Receivables. • Other receivables include interest receivable, rent receivable, tax refund receivable.
Journalize the following transactions for Kimmel Company (assume a
perpetual inventory system):
1.On March 1, Kimmel Company sold $40,000 of merchandise costing
$32,000 on credit terms of n/30 to JP Holdings.
2.On March 27, JP Holdings paid its account in full.
Credit Risk Analysis Accounts Receivable
1. Employing credit – scoring models.
2. Using the latest technology to make informed credit granting decisions. 3. Adopting technology to improve the collection process. 4. Monitoring the macroeconomics environment such as: debt levels / interest rates, employment and profit levels.
Valuing Accounts Receivable • Some customers who are granted credit do not pay what they promised. • The accounts of these customers are called uncollectible accounts or bad debts.
Valuing Accounts Receivable Methods for accounting for uncollectible accounts: 1. Direct method (does not satisfy GAAP) 2. Allowance method (satisfies GAAP) a) Income statement approach (percent of sales) b) Balance sheet approach (calculates the required balance in AFDA)
Allowance Method • The matching principle requires that bad debts expense be matched and reported in the same period as the sale that generated the receivable. • The allowance method satisfies the matching principle by matching expected bad debts losses (expenses) with revenues that produced the losses.
Recording Estimated Bad Debt Expense • Adjustments for bad debts are made at the end of the accounting period. • Adjustments use a contra-asset account called Allowance for Doubtful Accounts.
Recording Estimated Bad Debt Expense - Allowance Method Example: The estimated bad debts for TechCom is $1,500. The period end entry to record bad debts is: Bad Debts Expense 1,500 Allowance for Doubtful Accounts 1,500
Writing Off a Bad Debt - Allowance Method Example: A specific customer’s account (Jack Kent) is considered uncollectible. The entry to record the write-off is: Allowance for Doubtful Accounts 520 Accounts Receivable - Jack Kent 520
Note that there is no expense recorded when the
account is written off. The estimated expense was previously recorded.
General Ledger Balances Bad Debts Expense 1,500 Allowance for Doubtful Accounts 1,500 To record estimated bad debts Allowance for Doubtful Accounts 520 Accounts Receivable - Jack Kent 520 To write off an uncollectible account
Foster Company uses the allowance method to account for uncollectibles. On
October 31, it wrote off a $1,200 account of a customer, Gwen Rowe. On December 9, it received an $800 payment from Rowe.
1.Make the appropriate entry or entries for October 31.
2.Make the appropriate entry or entries for December 9.
Direct Write-off Method • Sometimes used as an alternative to the Allowance method when uncollectible accounts are not material. • The loss from an uncollectible account is recorded when it is determined to be uncollectible. • This method does not satisfy the principles of prudence and matching.
Writing Off a Bad Debt - Direct Write-off Method Example: A specific customer’s account (Jack Kent) is considered uncollectible. The entry to record the write-off is: Bad Debts Expense 520 Accounts Receivable—Jack Kent 520
Winston Abbott operates Abbott Small Engine Repair on his cattle farm, greatly supplementing his farm income. Most of his customers pay cash, so he uses the direct write-off method to account for uncollectible accounts receivable. On March 28, 2017, he determined that the $1,100 account for Jim Patterson is uncollectible. Record the write-off. Estimating Bad Debts Expense Acceptable Methods: 1. Percent of Sales Approach 2. Accounts Receivable Approach
Approach. • Based on idea that a percentage of a company’s credit sales are uncollectible. • The primary focus is on matching bad debts expense with credit sales.
Percent of Sales Approach Example: MusicLand has credit sales of $400,000 and estimates 0.6% of those sales will not be collectible. Estimated Bad Debts Expense is calculated as $2,400 ($400,000 x .6%). The period end adjusting entry would be: Bad Debts Expense 2,400 Allowance for Doubtful Accounts 2,400 To record estimated bad debts
QS 8-5: Adjusting entry to estimate bad debts—percent of sales:
Lexton Company uses the allowance method to account for uncollectible
accounts receivable. At year-end, October 31, it was estimated that 0.6% of net credit sales were uncollectible based on past experience. Net sales were $690,000, of which 2/3 were on credit. Record the entry at year-end to estimate uncollectible receivables. Percent of Accounts Receivable Approach • This method assumes that a percentage of Accounts Receivable is uncollectible. • Using this method, we compute the estimate of the Allowance for Doubtful Accounts as:
Estimated adjusted balance in Allowance for Doubtful Accounts - Unadjusted year-end balance in Allowance for Doubtful Accounts = Estimated Bad Debts Expense
The objective for the entry is to make the Allowance account
balance equal to the portion of outstanding Accounts Receivable estimated to be uncollectible.
QS 8-7: Adjusting entry to estimate bad debts—percent of receivables:
Foster Company uses the allowance method to account for uncollectible
accounts receivable. At year-end, December 31, the unadjusted balance in the Allowance for Doubtful Accounts was $450 credit. Based on past experience, it was estimated that 2.5% of the Accounts Receivable balance of $640,000 was uncollectible. Record the adjusting entry to estimate bad debts at December 31. Aging of Accounts Receivable Approach Assumes that the older the Account Receivable the more likely it will become uncollectible. Steps: 1. Group accounts based on how much time has passed since they were created. 2. Estimate rates of uncollectibility for each group. 3. Apply rate to each group to get the required balance for the Allowance account.
Aging of Accounts Receivable Example: At December 31, the receivables for DeCor were classified as follows:
DeCor Schedule of Accounts Receivable by Age 31-Dec-14 Accounts Receivable Days Past Due Balance Current $ 37,000 1 - 30 6,500 31 - 60 3,500 61 - 90 1,900 Over 90 1,000 $ 49,900
Aging of Accounts Receivable Using estimated bad debt percentages, DeCor would calculate the estimated uncollectible amount as follows: DeCor Schedule of Accounts Receivable by Age 31-Dec-14 Accounts Estimated Estimated Receivable Bad Debts Uncollectible Days Past Due Balance Percent Amount Current $ 37,000 2% $ 740 1 - 30 31 - 60 6,500 3,500 5% 10% 325 350 61 - 90 1,900 25% 475 Over 90 1,000 40% 400 $ 49,900 $ 2,290
Limited. Aging of Accounts Receivable DeCor’s unadjusted balance in the allowance account is a debit Allowance for Doubtful Accounts Unadj. bal. 200 of $200. The previous computation shows the desired Adj. bal. 2,290 balance is $2,290.
Aging of Accounts Receivable DeCor’s unadjusted balance in the allowance account is a debit Allowance for Doubtful Accounts Unadj. bal. 200 of $200. The previous Adj. 2,490 computation shows the desired Adj. bal. 2,290 balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490.
Aging of Accounts Receivable DeCor’s unadjusted balance in the allowance account is a debit Allowance for Doubtful Accounts Unadj. bal. 200 of $200. The previous 2,490 computation shows the desired Adj. bal. 2,290 balance is $2,290. Therefore, the adjusting entry is for: $2,290 + 200 = $2,490.
Bad Debts Expense 2,490
Allowance for Doubtful Accounts 2,490 To record estimated bad debts
Delcom had total accounts receivable on December 31, 2017, of $160,000 aged as follows:
Prepare the December 31, 2017, adjusting entry to estimate uncollectible accounts receivable assuming an unadjusted credit balance in Allowance for Doubtful Accounts of $800. QS 8-8: Accounts receivable allowance method of accounting for bad debts:
Duncan Company's year-end trial balance shows accounts receivable of
$89,000, allowance for doubtful accounts of $500 (credit), and net credit sales of $270,000. Uncollectibles are estimated to be 1.5% of outstanding accounts receivable.
a. Prepare the December 31 year-end adjustment.
b. What amount would have been used in the year-end adjustment had the allowance account had a year-end debit balance of $200?
c. Assume the same facts, except that Duncan estimates uncollectibles as 1% of
net credit sales. What amount would be used in the adjustment? Mini-Quiz On October 29, 2017, TC Co. concluded that a customer's $4,400 account receivable was uncollectible and that the account should be written off. What effect will this write-off have on TC Co.’s 2017 profit and balance sheet totals assuming the allowance method is used to account for bad debts?
A)Decrease in profit; no effect on total assets.
B)No effect on profit or on total assets. C)Decrease in profit; decrease in total assets. D)Increase in profit; no effect on total assets. E)No effect on profit; decrease in total assets.
Short-Term Notes Receivable Promissory Note A written promise to pay a specified amount of money either on demand or at a definite future date. Short-Term Note Receivable A promissory note that becomes due within 12 months or within the firm’s operating cycle.
Short-Term Notes Receivable Example: TechCom receives a $1,000, 90-day, 6% promissory note at the time of a sale. The entry to record the transaction would be:
Short-Term Notes Receivable Example: On December 16, TechCom receives a $3,000, 60-day, 6% promissory note and $1,000 cash to settle a $4,000 past due account. The entry to record the transaction would be: Cash 1,000 Notes Receivable 3,000 Accounts Receivable 4,000
Short-Term Notes Receivable On December 31, 15 days after the note is issued, an accrual for interest earned on the note is made. The entry to record the accrual would be: Interest Receivable 7.40 Interest Revenue 7.40 (3,000 x 6% x 15/365)
On February 14, the 60-day note matures.
The entry to record the honouring of the note would be: Cash 3,029.59 Interest Revenue 22.19 Interest Receivable 7.40 Notes Receivable 3,000.00 (3,000 x 6% x 60/365)= 29.59
Short-Term Notes Receivable • Sometimes the maker of a note does not pay the note at maturity. This is known as dishonouring the note. • The payee should use every legitimate means to collect. • If the note was made to replace an AR then it should be removed from Notes Receivable and reinstated as an Account Receivable.
On August 2, 2017, SLM Company received a $5,500, 90-day, 5% note from
customer Will Carr as payment on his account. Determine the maturity date and prepare the August 2 and maturity date entries, assuming the note is honoured by Carr. QS 8-13: Dishonouring of a note receivable:
Ajax Company had a $17,000, 7%, 30-day note of Beatrice Inc. At maturity, April 4, Beatrice dishonoured the note. Record the entry on April 4. Financial Statement Analysis
The quality (likelihood of collection) and liquidity
(speed of collection) of a company’s receivables may be assessed by calculating: 1. Accounts Receivable Turnover ratio
Exercise 8-18: Accounts receivable turnover and days’ sales uncollected:
The following information was taken from the December 31, 2017, annual report of WestCon Developments.
1.Required Calculate accounts receivable turnover and days' sales uncollected for the year 2017.*
2.Compare your calculations in (1) to the industry average and comment on WestCon's relative performance as F (Favourable) or U (Unfavourable).*
*Round the answer to two decimal places.
Review Explain why the allowance method satisfies the generally accepted principles of prudence and matching. • The allowance method ensures that the asset, accounts receivable, and the reported net income are not overstated. In this way it accomplishes the requirements of the prudence principle. • The allowance method recognizes the bad debts expense in the same period in which the related credit sales were recognized. In this way it accomplishes the required matching of expenses with the period in which the revenue was recognized.
receivable. • A note is recorded by entering the total amount borrowed (principal) as a debit to Notes Receivable and as a credit to the account representing the asset or service exchanged for the note.
