Chapter 8

3 types of receivables:

1. Accounts Receivable: amounts customers owe on account. They result from the sale of goods and services.
2. Notes Receivable: written promise (as evidenced by a formal instrument) for amounts to be received. The note
normally requires the collection of interest and extends for time periods of 60–90 days or longer. Notes and accounts
receivable that result from sales transactions are often called trade receivables.
3. Other Receivables: include non-trade receivables such as interest receivable, loans to company officers, advances to
employees, and income taxes refundable. These do not generally result from the operations of the business.

Three accounting issues associated with accounts receivable are:

1. Recognizing accounts receivable.

2. Valuing accounts receivable.
3. Disposing of accounts receivable.

Recognizing Accounts Receivable:

Y on July 1, 2014, sells merchandise on account to X for $1,000, terms 2/10, n/30. On July 5, X returns merchandise worth $100
to Y. On July 11, Y receives payment from X for the balance due.

July 1:

1. Debit accounts receivable 1,000

2. Credit sales revenue 1,000 (To record sales on account)

July 5:

1. Debit sales returns and allowances 100

2. Credit accounts receivable 100 (To record merchandise returned)

July 11:

1. Debit sales discounts 18 (900 x .02)

2. Debit cash 882 (900 – 18)
3. Credit accounts receivable 900 (To record collection of accounts receivable)

Assuming that you owe $300 at the end of the month, and Y charges 1.5% per month on the balance due, the adjusting entry
that Y makes to record interest revenue of $4.50 ($300 x 1.5%) on June 30 is as follows.

June 30:

1. Debit Accounts receivable 4.50

2. Credit Interest revenue 4.50 (To record interest on amount due)

Valuing Accounts Receivable:

Companies record credit losses as debits to Bad Debt Expense.

Two methods are used in accounting for uncollectible accounts: (1) the direct write-off method and (2) the allowance method.

Allowance method for uncollectible accounts:

The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period.

Cash (net) realizable value is the net amount the company expects to receive in cash.

Thus, this method reduces receivables in the statement of financial position by the amount of estimated uncollectible
receivables.
 1. Companies estimate uncollectible accounts receivable. They match this estimated expense against revenues in the
same accounting period in which they record the revenues.
2. Companies debit estimated uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts
through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts
Receivable.
3. When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and
credit that amount to Accounts Receivable.

Recording estimated uncollectibles

Y has credit sales of €1,200,000 in 2014. Of this amount, €200,000 remains uncollected at December 31. The credit manager
estimates that €12,000 of these sales will be uncollectible.

December 31:

1. Debit Bad Debt Expense 12,000

2. Credit Allowance for Doubtful Accounts 12,000 (To record estimate of uncollectible accounts)

The amount of €188,000 represents the expected cash realizable value of the accounts receivable at the statement date.

Recording the write-off of an uncollectible account

When companies have exhausted all means of collecting a past-due account and collection appears impossible, the company
should write off the account.

the financial vice president of Y authorizes a write-off of the €500 balance owed by X on March 1, 2015.

March 1:

1. Debit Allowance for Doubtful Accounts 500

2. Credit Accounts receivable 500

Bad Debt Expense does not increase when the write-off occurs. Under the allowance method, companies debit every bad debt
write-off to the allowance account rather than to Bad Debt Expense.

A write-off affects only statement of financial position accounts.

Recovery of an uncollectible account

Occasionally, a company collects from a customer after it has written off the account as uncollectible. The company makes two
entries to record the recovery of a bad debt: (1) It reverses the entry made in writing off the account. This reinstates the
customer’s account. (2) It journalizes the collection in the usual manner.
On July 1, X pays the €500 amount that Y had written off on March 1.

July 1:

1. Debit accounts receivable 500

2. Credit Allowance for Doubtful accounts 500

1. Debit cash 500

2. Credit accounts receivable 500

Note that the recovery of a bad debt, like the write-off of a bad debt, affects only statement of financial position accounts.

Estimating the allowance

Two bases are used to determine this amount: (1) percentage of sales and (2) percentage of receivables.

Percentage of Sales

In the percentage-of-sales basis, management estimates what percentage of credit sales will be uncollectible. This percentage
is based on past experience and anticipated credit policy.

Y elects to use the percentage-of-sales basis. It concludes that 1% of net credit sales will become uncollectible. If net credit
sales for 2014 are €800,000, the estimated bad debt expense is €8,000 (1% x €800,000).

December 1:

1. Debit Bad debt expense 8,000

2. Credit allowance for doubtful accounts 8,000

Percentage-of-Receivables

Under the percentage-of-receivables basis, management estimates what percentage of receivables will result in losses from
uncollectible accounts.