Accounting for Receivables Chapter 8 Receivables Includes all money claims against other entities including people business firms and other organization Are usually a significant portion of the total current assets Types of Receivables 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 Types of Receivable 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 When allowing customers to purchase on credit we run the risk of nonpayment Many retail businesses may shift the risk of uncollectible to other companies Allow only VISA or Mastercard Companies may also sell their receivables to other companies Usually companies issue their own credit cards Regardless of the care used in granting credit and the collection procedures used a part of the credit sales will not be collectible Bad debts expenses operating expense recorded from the uncollectible receivables Two methods 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 Direct write off method No estimate of uncollectible Write off as deemed uncollectible Allowance Method 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 Allowance method Allowance account Records the estimate uncollectible Credit to increase Bad Debts Expense Records the annual estimated uncollectible Uncollectible account expense Adjusting Entry Suppose that accounts receivable have a Balance of 105 000 and it is estimated that 4 000 will go bad Record the adjusting entry under the allowance method Account Bad Debts Expense Allowance for Bad Debts Debit Credit 4 000 4 000 Net Realizable Value Net Realizable Value Accounts receivable balance Allowance for bad debts What is really expected to be collected Write offs to the Allowance Account Once that we determine that a particular customer will be not collectible we write off the account 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 Account Allowance for Bad Debts Accounts Receivable Debit Credit 1 200 1 200 Estimating Uncollectibles The allowance method estimates bad debts expense at the end of the period Estimate of uncollectibles at the end of a fiscal period is based on past experience and forecasts of the future Two methods are used Estimated based on percentage of sales Analysis of accounts receivable Estimated Based on Sales We assume that a percentage of credit sales will go bad and record that as the adjusting entry 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 Bad Debts Expense Allowance for Bad Debts 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 Example 4 Credit sales are Estimate is 1 000 000 x 55 550 000 x 3 550 000 16 500 Allowance for Bad Debts Debit Credit 2 000 balance 16 500 should be balance Example 4 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 Account Bad Debts Expenses Allowance for bad debts Debit Credit 14 500 14 500 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 Example 5 Credit sales are Estimate is 1 000 000 x 55 550 000 x 3 550 000 16 500 Allowance for Bad Debts Debit Credit 2 000 balance 16 500 should be balance Example 4 As a result of the credit balance in the Allowance account We will record the entry not for 16 500 but 18 500 16 500 2 000 Account Bad Debts Expense Allowance for bad debts Debit Credit 18 500 18 500 Rule 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 Notes on Allowance method If allowance account has prior balance then at end of year should equal estimated uncollectible Analysis of Receivables Actually looking at each individual account and determining probability of collect ability Aging of receivables Aging Schedule Age Interval Balance Not past due 1 30 31 60 61 90 91 180 181 365 Over 365 Total 75 000 4 000 3 100 1 900 1 200 800 300 86 300 Percent Amount 2 5 10 20 30 50 80 1 500 200 310 380 360 400 240 3 390 Entry Date Account May Bad debts Expense 21 Allowance account Debit Credit 3 390 3 390 Direct write off Method There is no estimated uncollectible No allowance account Only when specific customer goes bad will it be written off to the expense account Direct Write off Example 5 Suppose that Haby s account goes bad with a balance of 8 000 Date Account May 21 Bad debts Expense Accounts receivable Debit Credit 8 000 8 000 Reinstatement of write offs Allowance method Example 6 Suppose Habys pays the amount due Date Account May 21 Accounts receivable Allowance account Debit Credit 8 000 8 000 Reinstatement of write offs Direct Write off method Date Account May 21 Accounts receivable Bad Debts expense Debit Credit 8 000 8 000 Notes Receivable Characteristics 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 Sample Note I Chris owe Odalys 10 000 payable in 60 days plus 12 interest Signed Chris May 1 2007 Principal Maker Payee Interest rate Time Computation of Due Date The length of time that the note is open is usually stated in days or months Use 360 day year for