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C H APT ER

1 Reporting and Analyzing Receivables

Study Objectives

Explain how accounts receivable are recognized and valued in the accounts.

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3.

Explain how notes receivable are recognized and valued in the accounts.
Explain the statement presentation of receivables.

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Types of Receivables
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Amounts due to a business from its customers or other entities Expected to be collected in cash Frequently classified as
Accounts receivable amounts owed by customers due to the sale of goods and services
Notes receivable formal credit instrument (written promise to pay)

Other receivables such as interest receivable, loans and advances to employees, recoverable sales and income tax, etc.
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Accounts Receivables
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A receivable is recorded when service is provided on account or at point of sale of merchandise on account A receivable is reduced when cash is collected, a sales discount is taken, or the product is returned by the customer

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Accounts Receivable Subsidiary Ledger

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Subsidiary ledger is a group of accounts that share a common characteristic (i.e. they are all receivable accounts) The subsidiary ledger for accounts receivable provides the details that support the total balance for accounts receivable in the general ledger
The single accounts receivable account in the general ledger is the control account

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Interest Revenue
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If a customer does not pay in full within a specified period of time (usually 30 days), an interest (financing) charge may be added to the balance due
Seller recognizes interest revenue and increases the account receivable balance owed by the customer

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Recording Estimated Uncollectible Accounts

Some accounts receivable become uncollectible

Losses from these uncollectible accounts are debited to an account called Bad Debts Expense Bad debts expense is recognized in the same period that the related sales revenue is generated

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Allowance Method
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This method estimates the uncollectible accounts at the end of each period The amount estimated is shown in the Allowance for Doubtful Accounts
A contra asset account (with credit balance); shown below Accounts Receivable

Note that the allowance is an estimate it does not show specific customer accounts

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Three Features of the Allowance Method

1. Recording estimated uncollectible accounts

Any increase to the allowance is recorded as bad debts expense

2. Recording the write-off of an uncollectible account

Actual accounts are written off when they are determined to be uncollectible This write-off reduces the allowance

3. Recording the recovery of an uncollectible account

If a written-off account is later collected, the write-off is reversed and the collection recorded
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Recording Estimated Uncollectible Accounts

The balance in the Allowance for Doubtful Accounts is deducted from Accounts Receivable in the current assets section of the statement of financial position:

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Estimating the Allowance

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Most companies use the percentage of receivables basis to determine the allowance
Estimate what percentage of receivables are likely to be uncollectible Apply this percentage to total receivables, or Apply this percentage to receivables classified according to the length of time they have been outstanding (called Aging the accounts receivable)
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Estimating the Allowance (Continued)

Once the appropriate estimate for uncollectible accounts is determined, an adjusting entry can be recorded The amount of the adjusting entry is the difference between the required balance and the existing balance in the allowance account

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Recording the Write-Off of an Uncollectible Account

The vice president of finance authorizes a write-off of $2,500 owed by T. Ebbet:

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Recording the Recovery of an Uncollectible Account

Record in two separate entries:

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Discussion Question
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Why is it important that bad debt expense is recorded in the same period as the related revenue?

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Summary of Allowance Method

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Using the Abrams Furniture Ltd (from the textbook) lets review all the entries required to record bad debts using the allowance method:

Step 1 Record estimated uncollectibles

Step 2 Record any write-off of uncollectibles Step 3 Record any recovery of uncollectibles

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Summary of Allowance Method

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Step 1 Record estimated uncollectibles
Dec. 31 Bad Debts Expense 10,000 10,000 Allowance for Doubtful Accounts (AFDA)

(To record estimate of uncollectible accounts ($11,000 - $1,000))

At year-end, the current assets section of Abrams Furnitures statement of financial position would report receivables as follows: Accounts receivable Less: AFDA Net realizable value $200,000 11,000 $189,000

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Summary of Allowance Method

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Step 2 Record any write-offs
Mar. 1 Allowance for Doubtful Accounts Accounts Receivable T. Ebbet (To write-off the T. Ebbet customer account) On March 1, the current assets section of Abrams Furnitures statement of financial position would report receivables as follows before and after this write-off: Before Write-off Accounts receivable $227,500 After Write-off $225,000 2,500 2,500

Allowance for doubtful accounts

Net realizable value

11,000
$216,500

8,500
$216,500

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Summary of Allowance Method

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Step 3 Record any uncollectible recovery
July 1 Accounts ReceivableT. Ebbet Allowance for Doubtful Accounts (To reverse write-off of T. Ebbet account) Cash 2,500 2,500 2,500 2,500

Accounts ReceivableT. Ebbet (To record collection from T. Ebbet)

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Notes Receivable
Stronger legal claim to assets than accounts receivable; written promise (promissory note) to repay A credit instrument that normally:
Requires the payment of interest Extends for time periods greater than 30 days

Often accepted from customers who need to extend payment of an account receivable Often required from high risk customers
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Formula for Calculating Interest

The basic formula for calculating interest on an interest-bearing note is:
Face Value of Note

Annual Interest Rate

Time in Terms of One Year

Interest

The interest rate specified on the note is an annual rate of interest.

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Honoring and Dishonoring Notes Receivable

Honoured
Paid in full at maturity date Collection recorded

Dishonoured
Not paid at maturity date; note no longer negotiable
Balance transferred to Accounts Receivable if eventual collection expected Balance transferred to Allowance for Doubtful Account if eventual collection not expected
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Valuing Notes Receivable

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Notes receivable are reported at their net realizable value. Each note must be analyzed to determine its probability of collection.

If the collection is in doubt, bad debts expense and an allowance for doubtful accounts (notes) must be recorded. Allowance method applied same as for Accounts Receivable
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Statement Presentation
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Statement of Financial Position
Reported in the current assets section
Following cash and short-term investments Only required to disclose net realizable value, but helpful to disclose gross receivables and the allowance for doubtful accounts

Income Statement
Bad debts expense is reported as an operating expense Interest revenue is non-operating
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Comparing IFRS and ASPE

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