Chapter 9

Report
Accounting
Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel · Trenholm
Prepared by:
Carole Bowman, Sheridan College
CHAPTER
9
ACCOUNTING FOR
RECEIVABLES
RECEIVABLES
• The term receivables refers to amounts due from
individuals and other companies; they are claims
expected to be collected in cash.
• Three major classes of receivables are:
1. Accounts Receivable
2. Notes Receivable
3. Other Receivables
ACCOUNTS RECEIVABLE
The three primary accounting problems
associated with accounts receivable are:
1. Recognizing accounts receivable.
2. Valuing accounts receivable.
3. Disposing of accounts receivable.
RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 1
Account Titles and Explanation
Accounts Receivable - Adorable Junior
Sales
To record sales on account.
Debit
Credit
1,000
When a business sells merchandise to a
customer on credit, Accounts Receivable is
debited and Sales is credited.
1,000
RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 5
Account Titles and Explanation
Sales Returns and Allowances
Accounts Receivable - Adorable
To record merchandise returned.
Debit
Credit
100
100
When a business receives returned merchandise
previously sold to a customer on credit, Sales
Returns and Allowances is debited and
Accounts Receivable is credited.
RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 31
Account Titles and Explanation
Cash ($1,000 - $100)
Accounts Receivable - Adorable
To record collection of account.
Debit
Credit
900
900
When a business collects cash from a customer
for merchandise previously sold on credit, Cash
is debited and Accounts Receivable is credited.
RECOGNIZING
ACCOUNTS RECEIVABLE
GENERAL JOURNAL
Date
July 31
Account Titles and Explanation
Accounts Receivable - Adorable
Interest Revenue
To record interest on amount due.
Debit
Credit
13.50
13.50
When financing charges are added to a balance
owing, Accounts Receivable is debited and
Interest Revenue is credited.
VALUING
ACCOUNTS RECEIVABLE
• To ensure that receivables are not
overstated on the balance sheet, they are
stated at their net realizable value.
• Net realizable value is the net amount
expected to be received in cash and
excludes amounts that the company
estimates it will not be able to collect.
VALUING
ACCOUNTS RECEIVABLE
• Two methods of accounting for
uncollectible accounts are:
1. Allowance method
2. Direct write-off method
DIRECT WRITE-OFF METHOD
• Under the direct write-off method, no entries
are made for bad debts until an account is
determined to be uncollectible at which time
the loss is charged to Bad Debts Expense.
• No attempt is made to match bad debts to
sales revenues or to show the net realizable
value of accounts receivable on the balance
sheet.
DIRECT WRITE-OFF METHOD
GENERAL JOURNAL
Date
Jan. 12
Account Titles and Explanation
Debit
Bad Debts Expense
200
Accounts Receivable — E. Schaefer
For write-off of E. Schaefer account.
Credit
200
Periera Company writes off E. Schaefer’s $200
balance as uncollectible on January 12. When
this method is used, Bad Debts Expense will
show only actual losses from uncollectibles.
THE ALLOWANCE METHOD
• The allowance method is required when
bad debts are deemed to be material in
amount.
• Uncollectible accounts are estimated and
the expense for the uncollectible accounts is
matched against sales in the same
accounting period in which the sales
occurred.
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Account Title and Explanation
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
To record estimate of uncollectible accounts.
Debit
Credit
24,000
24,000
Estimated uncollectible amounts are debited to
Bad Debts Expense and credited to Allowance
for Doubtful Accounts (a contra asset account) at
the end of each period.
ADORABLE JUNIOR GARMET
Balance Sheet (partial)
Current assets
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 14,800
$200,000
24,000
Net Realizable Value
188,000
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
Mar. 1
Account Titles and Explanation
Allowance for Doubtful Accounts
Accounts Receivable — Nadeau
Write-off of Nadeau account.
Debit
Credit
500
500
Actual uncollectible accounts are debited to
Allowance for Doubtful Accounts and credited to
Accounts Receivable at the time the specific
account is written off.
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
July 1
Account Titles and Explanation
Accounts Receivable — Nadeau
Allowance for Doubtful Accounts
To reverse write-off of Nadeau
account.
Debit
Credit
500
500
When there is recovery of an account that has
been written off:
1. reverse the entry made to write off the account
and ...
THE ALLOWANCE METHOD
GENERAL JOURNAL
Date
July 1
Account Titles and Explanation
Cash
Accounts Receivable —Nadeau
To record collection from Nadeau.
Debit
Credit
500
2. Record the collection in the usual manner.
500
BASES USED FOR THE
ALLOWANCE METHOD
• Companies use either of two methods in
the estimation of uncollectible accounts:
1. Percentage of sales
2. Percentage of receivables
• Both bases are GAAP; the choice is a
management decision.
ILLUSTRATION 9-4
COMPARISON OF BASES OF
ESTIMATING UNCOLLECTIBLES
Percentage of Sales
Matching
Sales
Percentage of Receivables
Net Realizable Value
Bad Debts
Expense
Emphasis on
Income Statement
Relationships
Accounts
Receivable
Allowance
for
Doubtful
Accounts
Emphasis on
Balance Sheet
Relationships
PERCENTAGE OF SALES BASIS
• In the percentage of sales basis, management
establishes a percentage relationship between
the amount of credit sales and expected losses
from uncollectible accounts.
• Expected bad debt losses are
determined by applying the
percentage to the sales base
of the current period.
• This basis better matches expenses
with revenues.
PERCENTAGE OF
RECEIVABLES BASIS
• Under the percentage of receivables
basis, management establishes a
percentage relationship between the
amount of accounts receivable and the
required balance in the allowance
account.
• This percentage can be applied to
the total accounts receivable balance,
or to individual accounts receivable
balances stratified by age.
PERCENTAGE OF
RECEIVABLES BASIS
• The required balance in the allowance account
is determined by applying the percentage to
the accounts receivable balance at the end of
the current period.
• The amount of the adjusting entry to record
expected bad debt losses for the current period
is the difference between the required balance
and the existing balance in the allowance
account.
• This basis produces the better estimate of net
realizable value of receivables.
DISPOSING OF
ACCOUNTS RECEIVABLE
To accelerate the receipt of cash from
receivables, owners frequently:
1. sell to a factor, such as a finance company
or a bank, and
2. make credit card sales.
DISPOSING OF
ACCOUNTS RECEIVABLE
• A factor buys receivables from businesses
for a fee and collects the payments
directly from customers.
• Credit cards are frequently used by retailers
who wish to avoid the paperwork of issuing
credit.
• Retailers can receive cash more quickly
from the credit card issuer.
CREDIT CARD SALES
• Three parties are involved when credit cards are
used in making retail sales:
1. the credit card issuer,
2. the retailer, and
3. the customer.
• The retailer pays the credit card issuer a
percentage fee of the invoice price for its services.
• From an accounting standpoint, sales from bank
cards (e.g., Visa and MasterCard) are treated
differently than sales from non-bank cars (e.g.,
American Express).
BANK CARD SALES
• Sales resulting from the use of VISA and
MasterCard are considered cash sales by the
retailer.
• These cards are issued by banks.
• Upon receipt of credit card sales slips from a
retailer, the bank immediately
adds the amount to the
seller’s bank balance.
BANK CARD SALES
GENERAL JOURNAL
Date
July 31
Account Titles and Explanation
Cash
Credit Card Expense ($1,000 x 3.5%)
Sales
To record VISA credit card sales.
Anita Ferreri purchases a number
of compact discs for her restaurant
from Karen Kerr Music Co. for
$1,000 using her Royal Bank VISA
card. The service fee that the Royal
charges is 3.5 percent.
Debit
Credit
965
35
1,000
NON-BANK CARD SALES
• Sales using American Express and other
non-bank cards are reported as credit sales,
not cash sales.
• Conversion into cash does not occur until
American Express remits the net amount
to the seller.
NON-BANK CARD SALES
GENERAL JOURNAL
Date
July 31
Account Titles and Explanation
Accounts Receivable
Credit Card Expense ($500 x 5%)
Sales
To record American Express
credit card sales.
Kerr Music Co. accepts an
AMERICAN EXPRESS card
for a $500 sale. The service fee
that AMERICAN EXPRESS
charges is 5 percent.
Debit
Credit
475
25
500
NOTES RECEIVABLE
• A promissory note is a written promise to pay
a specified amount of money on demand or at
a definite time.
• The party making the promise is the maker.
• The party to whom
payment is made is
called the payee.
ILLUSTRATION 9-8
FORMULA FOR
CALCULATING INTEREST
The basic formula for calculating interest on an
interest-bearing note is:
Face Value
of Note
X
Annual
Interest
Rate
X
Time
in Terms of
One Year
=
The interest rate specified on the note is
an annual rate of interest.
Interest
RECOGNIZING NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Titles and Explanation
May 1 Notes Receivable
Accounts Receivable — Brent Company
To record acceptance of Brent
Company note.
Debit
Credit
1,000
1,000
Wilma Company receives a $1,000, 6%
promissory note, due in two months (July 31)
from Brent Company to settle an open account.
VALUING NOTES RECEIVABLE
• Like accounts receivable, short-term notes
receivable are reported at their net
realizable value.
• The notes receivable
allowance account is
Allowance for
Doubtful Notes.
HONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Sept. 30 Cash
Notes Receivable - Higly
Interest Revenue
To record collection of Higly note.
Debit
Credit
10,150
10,000
150
• A note is honoured when it is paid in full at its maturity date.
• Wolder Co. lends Higly Inc. $10,000 on June 1, accepting a 4.5%
interest-bearing note, due in 4 months, on September 30.
• Wolder collects the maturity value of the note from Higley on
September 30.
DISHONOUR OF NOTES RECEIVABLE
GENERAL JOURNAL
Date
Account Title and Explanation
Sept. 30 Accounts Receivable - Higly
Notes Receivable - Higly
Interest Revenue
To record the dishonour of Higly note.
Debit
Credit
10,150
10,000
150
• A dishonoured note is a note that is not paid in full at
maturity.
• A dishonoured note receivable is no longer negotiable.
• Since the payee still has a claim against the maker
of the note, the balance in Notes Receivable is
usually transferred to Accounts Receivable.
BALANCE SHEET PRESENTATION
OF RECEIVABLES
• Each of the major types of receivables
should be identified in the balance sheet or
in the notes to the financial statements.
• In the balance sheet, short-term
receivables are reported within the current
assets section below cash and temporary
investments.
• Both the gross amount of receivables and
the allowance for doubtful accounts should
be reported.
USING THE INFORMATION IN THE
FINANCIAL STATEMENTS
• Financial ratios are calculated to evaluate the
short-term liquidity of a company.
• These ratios include the
1. current ratio,
2. acid test (quick) ratio,
3. receivables turnover ratio, and the
4. collection period ratio.
CURRENT RATIO
• The current ratio (working capital ratio) is a
widely used measure for evaluating a company’s
liquidity and short-term debt-paying ability.
CURRENT ASSETS
CURRENT RATIO = —— —————————
CURRENT LIABILITIES
ACID TEST RATIO
• The acid test ratio (quick ratio) is a
measure of a company’s short-term
liquidity.
CASH + TEMPORARY INVESTMENTS + RECEIVABLES (NET)
ACID TEST RATIO = ————————————————————————————
CURRENT LIABILITIES
ACCOUNTS RECEIVABLE
TURNOVER RATIO
• The ratio used to assess the liquidity of the
receivables is the receivables turnover ratio.
Net Credit
Sales

Average Net
Receivables
=
Receivables
Turnover
COLLECTION PERIOD
• The collection period in days is a variant of the
receivables turnover ratio and makes liquidity
even more evident.
• The general rule is that the collection period
should not exceed the credit term period.
Days in Year
(365)

Receivables
Turnover
Collection
=
Period in Days
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