Bank Reconciliation and Entries

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Financial & Managerial Accounting

Fifteenth Edition

Chapter 8

Receivables

Learning Objectives (1 of 2)

Obj. 1: Describe the common classes of receivables.

Obj. 2: Describe the accounting for uncollectible receivables.

Obj. 3: Describe the direct write-off method of accounting for uncollectible receivables.

Obj. 4: Describe the allowance method of accounting for uncollectible receivables.

Obj. 5: Compare the direct write-off and allowance methods of accounting for uncollectible accounts.

Obj. 6: Describe the accounting for notes receivable.

Learning Objectives (2 of 2)

Obj. 7: Describe the reporting of receivables on the balance sheet.

Obj. 8: Describe and illustrate the use of accounts receivable turnover and number of days’ sales in receivables to evaluate a company’s efficiency in collecting its receivables.

Classification of Receivables

The receivables that result from sales on account are normally accounts receivable or notes receivable.

The term receivables includes all money claims against other entities, including people, companies, and other organizations.

Notes and accounts receivable that result from sales transactions are sometimes called trade receivables.

Accounts Receivables

The most common transaction creating a receivable is selling merchandise or services on account (on credit).

The receivable is recorded as a debit to Accounts Receivable.

Such accounts receivable are normally collected within a short period, such as 30 or 60 days.

They are classified on the balance sheet as a current asset.

Notes Receivables

Notes receivable are amounts that customers owe for which a formal, written instrument of credit has been issued.

If notes receivable are expected to be collected within a year, they are classified on the balance sheet as a current asset.

Notes are often used for credit periods of more than 60 days.

Notes may also be used to settle a customer’s accounts receivable.

Other Receivables

Other receivables include:

Interest receivable

Taxes receivable

Receivables from officers or employees

Other receivables are normally reported separately on the balance sheet.

If they are expected to be collected within one year, they are classified as current assets.

If collection is expected beyond one year, these receivables are classified as noncurrent assets and reported under the caption Investments.

Uncollectible Receivables (1 of 5)

A major issue of selling merchandise or services on account (on credit) is that some customers will not pay their accounts. That is, some accounts receivable will be uncollectible.

Uncollectible Receivables (2 of 5)

Companies may shift the risk of uncollectible receivables to other companies by not accepting sales on account and only accepting cash or credit cards.

Companies may also sell their receivables.

Selling receivables is called factoring the receivables.

The buyer of the receivables is called a factor.

An advantage of factoring is that the company selling its receivables immediately receives cash for operating and other needs.

Uncollectible Receivables (3 of 5)

Regardless of how careful a company is in granting credit, some credit sales will be uncollectible.

The operating expense recorded from uncollectible receivables is called bad debt expense, uncollectible accounts expense, or doubtful accounts expense.

Uncollectible Receivables (4 of 5)

Some indications that an account may be uncollectible include the following:

The receivable is past due.

The customer does not respond to the company’s attempts to collect.

The customer files for bankruptcy.

The customer closes its business.

The company cannot locate the customer.

Uncollectible Receivables (5 of 5)

The two methods of accounting for uncollectible receivables are as follows:

The direct write-off method records bad debt expense only when an account is determined to be worthless.

The direct write-off method is often used by small companies and companies with few receivables.

The allowance method records bad debt expense by estimating uncollectible accounts at the end of the accounting period.

Generally accepted accounting principles (GAAP) require companies with a large amount of receivables to use the allowance method.

Direct Write-Off Method for Uncollectible Accounts (1 of 3)

Assume that a $4,200 account receivable from D. L. Ross has been determined to be uncollectible. The entry to write off the account is as follows:

Direct Write-Off Method for Uncollectible Accounts (2 of 3)

An account receivable that has been written off may be collected later.

In such cases, the account is reinstated by an entry that reverses the write-off entry.

The cash received in payment is then recorded as a receipt on account.

Direct Write-Off Method for Uncollectible Accounts (3 of 3)

Assume that the D. L. Ross account written off on May 10 is later collected on November 21. The reinstatement and receipt of cash are recorded as follows:

Allowance Method for Uncollectible Accounts (1 of 3)

As of the end of its accounting period on December 31, ExTone Company has an accounts receivable balance of $200,000. ExTone estimates that a total of $30,000 of the December 31, 20Y1, accounts receivable will be uncollectible. The following adjusting entry is made on December 31:

Allowance Method for Uncollectible Accounts (2 of 3)

Since ExTone doesn’t know which customer accounts will be uncollectible, specific customer accounts cannot be decreased or credited. Instead, a contra asset account, Allowance for Doubtful Accounts, is credited for the estimated bad debts.

Allowance Method for Uncollectible Accounts (3 of 3)

The preceding adjusting entry affects the income statement and the balance sheet.

On the income statement, the $30,000 of Bad Debt Expense will be matched against the related revenues of the period.

On the balance sheet, the value of the receivables is reduced to the amount that is expected to be collected or realized.

This amount, $170,000 ($200,000 − $30,000), is called the net realizable value of the receivables.

Write-Offs to the Allowance Account (1 of 8)

When a customer’s account is identified as uncollectible, it is written off against the allowance account.

This requires the company to remove the specific accounts receivable and an equal amount from the allowance account.

Write-Offs to the Allowance Account (2 of 8)

On January 21, 20Y2, of the following year, John Parker’s account of $6,000 with ExTone Company is written off as follows:

Write-Offs to the Allowance Account (3 of 8)

Because Allowance for Doubtful Accounts is based on an estimate, it will normally have a balance at the end of a period. As a result, the total write-offs to the allowance account during the period will rarely equal the balance of the account at the beginning of the period.

The allowance account will have a credit balance at the end of the period if the write-offs during the period are less than the beginning balance.

The allowance account will have a debit balance at the end of the period if the write-offs during the period exceed the beginning balance.

The Allowance Method

Write-Offs to the Allowance Account (4 of 8)

During the second year of operations, ExTone Company writes off $26,750 of uncollectible accounts, including the $6,000 account of John Parker recorded on January 21, 20Y2. Allowance for Doubtful Accounts will have a credit balance of $3,250 ($30,000 – $26,750), computed as follows:

Write-Offs to the Allowance Account (5 of 8)

If ExTone Company had written off $32,100 in accounts receivable during the second year, Allowance for Doubtful Accounts would have a debit balance of $2,100, computed as follows:

Write-Offs to the Allowance Account (6 of 8)

The allowance account balances (credit balance of $3,250 and debit balance of $2,100) in the preceding illustrations are before the end-of-period adjusting entry.

After the end-of-period adjusting entry is recorded, Allowance for Doubtful Accounts should always have a credit balance.

Write-Offs to the Allowance Account (7 of 8)

An account receivable that has been written off against the allowance account may be collected later.

Like the direct write-off method, the account is reinstated by an entry that reverses the write-off entry. The cash received in payment is then recorded as a receipt on account.

Write-Offs to the Allowance Account (8 of 8)

Assume that Nancy Smith’s account of $5,000, which was written off on April 2, 20Y2, is later collected on June 10. ExTone Company records the reinstatement and collection as follows:

Estimating Uncollectibles

The allowance method requires an estimate of uncollectible accounts at the end of the period.

This estimate is normally based on past experience, industry averages, and forecasts of the future.

The two methods used to estimate uncollectible accounts are as follows:

Percent of sales method.

Analysis of receivables method.

Percent of Sales Method (1 of 5)

Since accounts receivable are created by credit sales, uncollectible accounts can be estimated as a percent of credit sales.

Percent of Sales Method (2 of 5)

Assume the following data for ExTone Company on December 31, 20Y2, before any adjustments:

Bad Debt Expense of $22,500 is estimated as follows:

Percent of Sales Method (3 of 5)

The adjusting entry for uncollectible accounts on December 31, 20Y2, is as follows:

Percent of Sales Method (4 of 5)

After the adjusting entry is posted to the ledger, Bad Debt Expense will have an adjusted balance of $22,500, and Allowance for Doubtful Accounts will have an adjusted balance of $25,750 ($3,250 + $22,500). Both T accounts follow:

Percent of Sales Method (5 of 5)

The amount of the adjusting entry is the amount estimated for Bad Debt Expense.

This estimate is credited to whatever the unadjusted balance is for Allowance for Doubtful Accounts.

Check Up Corner: Percent of Sales Method (1 of 3)

At the end of the current year, ARS Industries has the following account balances before making an adjusting entry for uncollectible accounts:

Check Up Corner: Percent of Sales Method (2 of 3)

The company recorded $3,500,000 of credit sales during the year. The company uses the percent of sales method and estimates that ½ of 1% of credit sales for the year will be uncollectible.

Determine the bad debt expense for the period, and journalize the adjusting entry.

Determine the adjusted balances of Allowance for Doubtful Accounts and Accounts Receivable.

Determine the net realizable value of accounts receivable at the end of the period.

Check Up Corner Percent of Sales Method (3 of 3)

Analysis of Receivables Method (1 of 6)

The analysis of receivables method is based on the assumption that the longer an account receivable is outstanding, the less likely it is that it will be collected.

Analysis of Receivables Method (2 of 6)

The analysis of receivables method is applied as follows:

Step 1: The due date of each account receivable is determined.

Step 2: The number of days each account is past due is determined. This is the number of days between the due date of the account and the date of the analysis.

Step 3: Each account is placed in an aged class according to its days past due (1–30 days past due, 31–60 days past due, 61–90 days past due, and so on).

Step 4: The totals for each aged class are determined.

Analysis of Receivables Method (3 of 6)

Step 5: The total for each aged class is multiplied by an estimated percentage of uncollectible accounts for that class.

Step 6: The estimated total of uncollectible accounts is determined as the sum of the uncollectible accounts for each aged class.

The preceding steps are then summarized in an aging schedule, and this overall process is called aging the receivables.

Aging of Receivables Schedule, December 31

Analysis of Receivables Method (4 of 6)

The sum of the estimated uncollectible accounts for each aged class is the estimated uncollectible accounts on December 31.

This is the desired adjusted balance for Allowance for Doubtful Accounts.

Comparing the sum of the estimated uncollectible accounts in the aging schedule with the unadjusted balance of the allowance account determines the amount of the adjustment for Bad Debt Expense.

Analysis of Receivables Method (5 of 6)

For ExTone Company, the unadjusted balance of the allowance account is a credit balance of $3,250. The amount to be added to this balance is therefore $23,240 ($26,490 – $3,250). The adjusting entry is as follows:

Analysis of Receivables Method (6 of 6)

After the preceding adjusting entry is posted to the ledger, Bad Debt Expense will have an adjusted balance of $23,240, and Allowance for Doubtful Accounts will have an adjusted balance of $26,490.

The amount of the adjusting entry is the amount that will yield an adjusted balance for Allowance for Doubtful Accounts equal to that estimated by the aging schedule.

Check Up Corner: Analysis of Receivables Method (1 of 3)

At the end of the current year, ARS Industries has the following account balances before making an adjusting entry for uncollectible accounts:

The company recorded $3,500,000 of credit sales during the year. An aging of the company’s accounts receivable on December 31 and a historical analysis of the percentage of uncollectible accounts in each age class follow:

Check Up Corner: Analysis of Receivables Method (2 of 3)

The company estimates the allowance for doubtful accounts based on the analysis of receivables method.

Determine the bad debt expense for the period, and journalize the adjusting entry.

Determine the adjusted balances of Allowance for Doubtful Accounts and Accounts Receivable.

Determine the net realizable value of accounts receivable at the end of the period.

Check Up Corner: Analysis of Receivables Method (3 of 3)

Difference Between Estimation Methods

Comparing Direct Write-Off and Allowance Methods (1 of 2)

The following transactions are taken from the records of Hobbs Company for the year ending December 31, 20Y6:

Comparing Direct Write-Off and Allowance Methods (2 of 2)

Direct Write-Off and Allowance Methods

	Direct Write-Off Method	Allowance Method
Bad debt expense is recorded	When the specific customer accounts are determined to be uncollectible.	Using an estimate based on: (1) a percent of sales or (2) an analysis of receivables.