Chapter 8 Receivables Classification of Receivables Receivables o Includes all money claims against other entities including people business firms and other organization o Are usually a significant portion of the total current assets o Types of Receivables o Accounts receivable Results from the sale of merchandise on credit and expected to be collected within a relatively short period such as 30 or 60 days o Notes receivable Are amounts that customer owe for which a formal written instrument of credit has been issued Are usually used for credit periods of more than sixty days May be used to settle a customer s accounts receivable Uncollectible receivables o When allowing customers to purchase on credit we run the risk of nonpayment o Many retail businesses may shift the risk of uncollectible to other companies Allow only VISA or Mastercard o Companies may also sell their receivables to other companies Usually companies issue their own credit cards o Regardless of the care used in granting credit and the collection procedures used a part of the credit sales will not be collectible o Bad debts expenses operating expense recorded from the uncollectible receivables Created by M Mari Fall 2007 Page 1 of 10 Chapter 8 Receivables Two methods of accounting for receivables 1 Allowance method 2 Direct write off method Remember from Chapter 1 Allowance method Required by generally accepted accounting principles GAAP Estimates the accounts receivable that will not be collected and records bad debt expense for this estimate at the end of each accounting period We create a CONTRA ASSET ACCOUNT called Allowance for Bad Debts It increases with a credit Record the total estimate that has not been written off Entry is considered an adjusting entry Example 1 Suppose that accounts receivable have a balance of 105 000 and it is estimated that 4 000 will go bad in the next period Date Account May Uncollectible account 21 expense Allowance for bad debts Pr Debit 4 000 Credit 4 000 Net Realizable Value Accounts receivable balance Allowance for bad debts What is really expected to be collected Created by M Mari Fall 2007 Page 2 of 10 Why Matching principle Chapter 8 Receivables Write offs to the Allowance Account o Once that we determine that a particular customer will be not collectible we write off the account o The write off consists of reducing the allowance account by the amount of the write off and removing the uncollectible account from accounts receivable Example 2 Suppose that J Mays account with a balance of 1 200 is uncollectible Date Account May Allowance account 31 Accounts receivable Pr Debit 1 200 Credit 1 200 Estimating Uncollectibles o The allowance method estimates bad debts expense at the end of the period o Estimate of uncollectibles at the end of a fiscal period is based on past experience and forecasts of the future o Two methods are used o Estimated based on percentage of sales o Analysis of accounts receivable Estimate Based on Sales o We assume that a percentage of credit sales will go bad and record that as the adjusting entry Created by M Mari Fall 2007 Page 3 of 10 Chapter 8 Receivables Example 3 Suppose that credit sales for the period were 800 000 of which 1 is expected to be uncollectible Record the entry 800 000 x 1 8 000 Account May 21 Pr Uncollectible account expense Allowance account Debit Credit 8 000 8 000 Example 4 Suppose that the company expects 3 of credit sales to go uncollected A review of the trial balance shows Sales 1 000 000 of which 45 are cash sales Accounts receivable has a balance of 70 000 Allowance for bad debts has credit balance of 2 000 Credit sales are 1 000 000 x 55 550 000 Estimate is 550 000 x 3 16 500 Allowance for Bad Debts DEBIT CREDIT 2 000 balance 16 500 should be balance As a result of the credit balance in the Allowance account we will record the entry not for 16 500 but 14 500 16 500 2 000 Date Account May Uncollectible account 21 expense Allowance account Created by M Mari Fall 2007 Page 4 of 10 Pr Debit 14 500 Credit 14 500 Chapter 8 Receivables Example 5 Suppose that the company expects 3 of credit sales to go uncollected A review of the trial balance shows Sales 1 000 000 of which 45 are cash sales Accounts receivable has a balance of 70 000 Allowance for bad debts has debit balance of 2 000 Credit sales are 1 000 000 x 55 550 000 Estimate is 550 000 x 3 16 500 Allowance for Bad Debts DEBIT CREDIT 2 000 balance 16 500 should be balance As a result of the debit balance in the Allowance account we will record the entry not for 16 500 but 18 500 16 500 2 000 Date Account May Uncollectible account 21 expense Allowance account Pr Debit 18 500 Credit 18 500 When the Allowance Account at the end of the year Has a debit balance we underestimated the bad debts last period Has a credit balance we overestimated the bad debts last period Created by M Mari Fall 2007 Page 5 of 10 Chapter 8 Receivables Estimate Based on Analysis of Receivables This is done through an aging of accounts receivables Age Interval Not past due 1 30 31 60 61 90 91 180 181 365 Over 365 Total Balance 75 000 4 000 3 100 1 900 1 200 800 300 86 300 Percent 2 5 10 20 30 50 80 Amount 1 500 200 310 380 360 400 240 3 390 The aging is done by multiplying the balance times the percent to get the amount Date Account May Uncollectible account 21 expense Allowance account Pr Debit 3 390 Credit 3 390 Direct Write off Method There is no estimated uncollectibles There is no allowance account Only when a specific customer goes bad will it be written off to the expense account Suppose that Haby s account goes bad with a balance of 8 000 Date Account May Uncollectible account 21 expense Accounts receivable Created by M Mari Fall 2007 Page 6 of 10 Pr Debit 8 000 Credit 8 000 Chapter 8 Receivables Reinstatements of Write offs Allowance method Date Account May 21 Accounts receivable Debit Credit 8 000 Allowance account 8 000 For the amount originally written off then record the collection of funds Direct Write off Method Date Account May 21 Accounts receivable Debit Credit 8 000 Bad Debts expense 8 000 For the amount originally written off then record the collection of funds Characteristics of Notes Receivable Promissory note is a written promise to pay a sum of money on demand or at a definite time Payee the person to whom the note is payable to Maker one making the note and owing the money Due date when the note is due Maturity value principal interest Created by M Mari Fall 2007 Page 7 of