Dr Winston Kwok

Learning Objectives
1. Describe accounts receivable and how they
occur and are recorded
2. Apply the direct write-off method to account
for accounts receivable
3. Apply the allowance method and estimate
uncollectibles based on accounts receivable
4. Account for interest receivable on a note
Describe accounts receivable and
how they occur and are recorded
Receivables

Accounts receivable Notes receivable

Other receivables
(miscellaneous)
Accounts Receivable
Arise from sales or services provided to customer
on account (also called trade debtor or debtor).
Informal promise by customer to pay for goods or
services.
Generally converted to cash (collected from
customer) within a few months (less than a year so
short-term or current asset).
Very liquid asset, after cash and short-term
investments (liquidity means how fast an asset can
be converted into cash).
Notes Receivable
Written, formalized promise by debtors to pay
specific sum at future date.
Typically interest-bearing.
Generally arise from sales or services provided to
customers on purchase agreement, or used to
extend AR payment terms.
Can be noncurrent or long-term if not receivable
within the year.
Accounts Receivable

On July 1, TechCom had a credit sale of $950 to

CompStore and a collection of $720 from RDA
Electronics from a prior credit sale.
Accounts Receivable
 Accounts Receivable Ledger

After all items are posted, the balance in the accounts receivable controlling account is
equal to the sum of the balances in the accounts receivable subsidiary ledger.
Nestls Receivables

Trade and other receivables

largest current asset.
Accounts Receivable:
Good or Bad?
Good:
Some customers cannot pay cash or
prefer to buy on credit: Increase
revenue.
Bad
Some credit customers may not pay later:
Need to record expense.
 Accounts Receivable
Some customers may not pay their account.
Uncollectible amounts are referred to as bad debts
expense and recognized as a cost of doing
business, so classified as an operating expense.

There are two methods of

accounting for bad debts:
Direct Write-Off Method
Allowance Method
Apply the direct write-off method to
account for accounts receivable
Direct Write-Off Method
Company waits until it is clear that a customer cannot pay,
which may be after the accounting period that the
receivable was recorded:
TechCom determines on January 23 that it cannot
collect $520 owed to it by its customer J. Kent
which credit sale was recorded in the previous
period.
Matching Principle

The matching (expense recognition)

principle requires expenses to be reported
in the same accounting period as the sales
they helped produce.

The direct write-off method usually does not best

match sales and expenses.
Apply the allowance method and estimate
uncollectibles based on accounts
receivable
 Allowance Method
Based on idea of impairment: company's asset that is worth
less than the amount listed on the company's statement of
financial position.
IAS 39 Financial Instruments: A receivable is considered
impaired if there is objective evidence that the entire amount
or a portion of it may ultimately be uncollectible as a result of a
loss event.
Loss events include:
Significant financial difficulty of debtor.
Payment defaults on principal or interest.
Probable bankruptcy of debtor.
Data indicating decreased repayment ability of a group e.g.
poor economic conditions.
 Allowance Method
At the end of each period, estimate total bad debts
expected from that periods sales.
There are two advantages to the allowance method:
1. It records estimated bad debts expense in the period
when the related sales are recorded.
2. It reports accounts receivable on the statement of
financial position at the estimated amount of cash to
be collected.
Results in:
More relevant asset amounts.
Better match between revenues and expenses.
Improved information for decision making.
 Recording Bad Debts Expense
TechCom had credit sales of $300,000 during its first year of
operations. At the end of the first year, $20,000 of credit
sales remained uncollected. Based on the experience of
similar businesses, TechCom estimated that $1,500 of its
accounts receivable would be uncollectible.
Some examples of alternative names:
Bad Debts Expense can be called Uncollectible Accounts Expense.
Allowance for Doubtful Accounts can be called Allowance for
Uncollectible Accounts or Allowance for Impairment of Receivables.

Contra asset account

This contra account allows readers to know both the gross amount of
the AR and allowance to date.
Allowance for doubtful accounts
is a Contra Asset Account
Accounts Receivable
An account linked with
another account.
Balance is opposite to the
other accounts balance. + -
Normal
An asset is debit, so the
contra asset is credit. Allowance for
Doubtful Accounts

- +
Normal
 Presentation in
Statement of Financial Position
TechCom had credit sales of $300,000 during its first year of
operations. At the end of the first year, $20,000 of credit
sales remained uncollected. Based on the experience of
similar businesses, TechCom estimated that $1,500 of its
accounts receivable would be uncollectible.

The company can also show the accounts receivable amount

as $18,500 (carrying amount or net amount) and show
details about the allowance in notes to financial statements.
Writing Off a Bad Debt
TechCom decides that J. Kents $520 account is
uncollectible.
Writing Off a Bad Debt

The write-off does NOT affect the realizable or

carrying amount of accounts receivable.
Recovering a Bad Debt
To help restore credit standing, a customer sometimes
volunteers to pay all or part of the amount owed on an
account even after it has been written off.

On March 11, Kent pays in full his $520 account

previously written off.
 Estimating Bad Debts Expense

How does a company come up with the estimate for

the entry at the end of the year?
1. Percent of Receivables
2. Aging of Receivables

Remember that we are estimating because of the allowance

method.
Percent of Receivables Method
1. Compute the estimate of the Allowance for
Doubtful Accounts.
Year-end Accounts Receivable Bad Debt %
2. Bad Debts Expense is computed as:
Total Estimated Bad Debts Expense
Previous Balance in Allowance Account
= Current Bad Debts Expense
Percent of Receivables Method
Musicland has $50,000 in accounts receivable and a $200 credit
balance in Allowance for Doubtful Accounts on December 31, 2011.
Past experience suggests that 5% of receivables are uncollectible.

Desired balance in Allowance for

Doubtful Accounts.
$ 50,000
5%
= $ 2,500
Aging of Receivables Method
Classify each receivable by how
long it is past due.

Each age group is multiplied by its

estimated bad debts percentage.

Estimated bad debts for each group

are totaled.
Aging of Receivables

Longer past due, higher percents

 Aging of Receivables
Musicland has an unadjusted Allowance for Doubtful
credit balance in the allowance Accounts
account is $200. 200
2,070
We estimated the proper 2,270

balance to be $2,270.
Summary of Methods
 Nestls receivables
Carrying or net amount is
CHF 13,459 million
Note 7

Gross amount of trade and other receivables

(CHF millions) as at 31 Dec 2014 =
13,459 + 352 = 13,811
Individual and Group estimation of
bad debts
IAS 39:
a) Assessment at individual asset level for all
individually significant items.
b) For individually non-significant items, the entity
has a choice either to assess it individually or
collectively for a group of assets with similar
credit risk features.
c) Collective assessment for items where no
individual impairment exists but forms part of a
group of assets with similar credit characteristics.
Individual and Group estimation of
bad debts
At the beginning of the period, GlobeCom has a credit balance of $1,700 in
its allowance for doubtful accounts. At the end of the period, GlobeCom has
accounts receivable of $71,200. There was objective evidence that 10% of
a $6,000 debt owed by a debtor, IslandCom, would most probably be
uncollectible. The rest of the accounts receivables were reviewed
collectively and the results indicated that an estimated 2% of these accounts
would not be collectible.

Required ending balance in the allowance for doubtful accounts is:

10% X $6,000 + 2% X ($71,200 - $6,000) = $1,904.
Beginning balance is $1,700, we need to credit another $204.
When Estimates Differ from Write-Offs

Accounts receivable written off during a period will rarely

equal the estimated uncollectible amount.

Allowance for Doubtful Accounts

Shows a debit balance Shows a credit balance
when the total amount of when the total amount of
accounts receivable accounts receivable
written off is greater written off is less than
than the estimated the estimated allowance.
allowance. Needs to be This is the normal
adjusted to become a balance for this account.
credit balance before
preparing the financial
statements.
Account for interest receivable on a note
 Notes Receivable
A promissory note is a written promise to pay a specified
amount of money, usually with interest, either on
demand or at a definite future date.
Computing Maturity and Interest
The maturity date of a note is the day the note
(principal and interest) must be repaid.

On July 10, 2011, TechCom received a $1,000, 90-day,

12% promissory note as a result of a sale to Julia Browne.

The note is due and payable on October 8, 2011.

Interest Computation

Even for If the note is

maturities less expressed in
than one year, days, base a
the rate is year on 360
annualized. days.
Recording End-of-Period
Interest Adjustments
On December 16, TechCom accepts a $3,000, 60-day,
12% note from a customer in granting an extension
on a past-due account. When TechComs accounting
period ends on December 31, $15 of interest has
accrued on the note.

$3,000 x 12% x 15/360 = $15

Recording End-of-Period
Interest Adjustments
Days in December 31
Minus the date of the note 16
Day remaining in December 15
Days in January 31
Days in February 14
Period of the note in days 60

Recording collection on note at maturity.

$3,000 x 12% x 60/360 = $60