Chapter 8

Slide 1

Reporting and Analyzing ReceivablesStudy ObjectivesExplain how accounts receivable are recognized and valued in the accounts.Explain how notes receivable are recognized and valued in the accounts.Explain the statement presentation of receivables.8Copyright John Wiley & Sons Canada, Ltd.18CHAPTER1CHAPTERCHAPTERWe are NOT covering the following Study Objectives:SO4 Apply the principles of sound accounts receivables management SO5 Demonstrate analysis of accounts and notes receivable SO6 Explain how bad debts are accounted for using the allowance methodSO7 Explain the presentation of accounts and notes receivable

Readings in the textbook pertaining to the above topics will not be covered in this course.

1Types of ReceivablesAmounts due to a business from its customers or other entitiesExpected to be collected in cashFrequently classified asAccounts receivable amounts owed by customers due to the sale of goods and servicesNotes 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.Copyright John Wiley & Sons Canada, Ltd.28CHAPTER1CHAPTERReceivables are frequently classified as:

Accounts receivableAmounts owed by customers on account.Result from the sale of goods and services.Expected to be collected within 30.Usually the most significant type of claim held by a company.Notes receivableFormal instruments of credit issued as evidence of debt.Normally require payment of interest and extend for 30 days or longer.May be current or non-current assets depending on their due dates.Notes and accounts receivable resulting from sales are called trade receivables.Other receivablesInclude interest receivable, loans to company officers, advances to employees, and recoverable sales taxes and income taxes.2Accounts ReceivablesA receivable is recorded when service is provided on account or at point of sale of merchandise on accountA receivable is reduced when cash is collected, a sales discount is taken, or the product is returned by the customerCopyright John Wiley & Sons Canada, Ltd.38CHAPTER1CHAPTERAccounts Receivable Subsidiary LedgerSubsidiary 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 ledgerThe single accounts receivable account in the general ledger is the control account

8Copyright John Wiley & Sons Canada, Ltd.4CHAPTER1CHAPTERAccounts Receivable Subsidiary LedgerA subsidiary ledger is a group of accounts with a common characteristic.Individual customer balances are organized and tracked.All transactions are posted twice, once to the general ledger and once to the subsidiary ledger.Transactions are usually posted daily to the accounts receivable subsidiary ledger.In computerized systems, the entries to the two ledgerssubsidiary and generalare simultaneous.

4Interest RevenueIf 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 dueSeller recognizes interest revenue and increases the account receivable balance owed by the customerCopyright John Wiley & Sons Canada, Ltd.58CHAPTER1CHAPTERRecording EstimatedUncollectible AccountsSome accounts receivable become uncollectibleLosses from these uncollectible accounts are debited to an account called Bad Debts ExpenseBad debts expense is recognized in the same period that the related sales revenue is generatedCopyright John Wiley & Sons Canada, Ltd.68CHAPTER1CHAPTERLosses arising from uncollectible amounts are considered a normal and necessary risk of having credit sales.

6Allowance MethodThis method estimates the uncollectible accounts at the end of each periodThe amount estimated is shown in the Allowance for Doubtful Accounts A contra asset account (with credit balance); shown below Accounts ReceivableNote that the allowance is an estimate it does not show specific customer accountsCopyright John Wiley & Sons Canada, Ltd.78CHAPTER1CHAPTERWhat is the purpose of the Allowance?The allowance is an estimate of the amount of receivables that are expected to become uncollectible in the future.Using the allowance method ensures that receivables are stated at their net realizable value. Net realizable value is the net amount expected to be received in cash; it excludes amounts that the company estimates it will not collect.

7Three Features of theAllowance MethodRecording estimated uncollectible accountsAny increase to the allowance is recorded as bad debts expenseRecording the write-off of an uncollectible accountActual accounts are written off when they are determined to be uncollectibleThis write-off reduces the allowanceRecording the recovery of an uncollectible accountIf a written-off account is later collected, the write-off is reversed and the collection recorded

8Copyright John Wiley & Sons Canada, Ltd.8CHAPTER1CHAPTER8The balance in the Allowance for Doubtful Accounts is deducted from Accounts Receivable in the current assets section of the statement of financial position:

Recording Estimated Uncollectible AccountsCopyright John Wiley & Sons Canada, Ltd.98

CHAPTERUsing the Abrams Furniture Ltd. example from the text, a company has net credit sales of $1.2 million in 2012. Of this amount, $200,000 remains uncollected at year end. Bad debt expense is estimated at $10,000. The required adjusting entry is:Dec. 31Bad Debts Expense (1)10,000Allowance for Doubtful Accounts (2) 10,000

(To record estimate of uncollectible accounts)Bad Debt Expense is reported in the income statement as an operating expense.Allowance for Doubtful Accounts is a contra asset account that shows the receivables that are expected to become uncollectible.Using a contra account helps separate estimates (Allowance for Doubtful Accounts) from actual amounts (Accounts Receivable).

Assuming an opening balance of $1,000 in Allowance for Doubtful Accounts, the ending balance of $11,000 would be reported as:Accounts Receivable$200,000Less Allowance for Doubtful Accounts 11,000Net realizable value$189,000The $189,000 represents the expected Net Realizable Value of the Accounts Receivable.

9Estimating the AllowanceMost companies use the percentage of receivables basis to determine the allowanceEstimate what percentage of receivables are likely to be uncollectibleApply this percentage to total receivables, orApply this percentage to receivables classified according to the length of time they have been outstanding (called Aging the accounts receivable)8Copyright John Wiley & Sons Canada, Ltd.10CHAPTER1CHAPTEREstimating the AllowanceWhile there are several acceptable methods, most companies use a percentage of receivables basis to determine the balance of Allowance for Doubtful Accounts.

% of Receivables Basis Management estimates the percentage of outstanding receivables that will result in losses from uncollectible accounts.The percentages can be applied to the receivables in total, or the receivables may be divided (stratified) based on the age of the receivable.Aging the accounts receivable classifies the outstanding accounts by age and applies percentages to these categories based on past experience.

10Estimating the Allowance(Continued)Once the appropriate estimate for uncollectible accounts is determined, an adjusting entry can be recordedThe amount of the adjusting entry is the difference between the required balance and the existing balance in the allowance account8Copyright John Wiley & Sons Canada, Ltd.11CHAPTER1CHAPTERRefer to the aging schedule for Abrams Furniture Ltd. in Illustration 8-3. Note the increasing uncollectible percentages from 2% to 50% over the different categories.The aging schedule estimates the balance in Allowance for Doubtful Accounts at $11,000. Assuming Allowance for Doubtful Accounts has an existing credit balance of $1,000, the required adjusting entry is:Dec. 31Bad Debts Expense10,000Allowance for Doubtful Accounts10,000Occasionally the allowance account will have a debit balance before the adjustment. If the Allowance for Doubtful Accounts had a debit balance of $1,000, then the adjusting entry would have been for $12,000 to arrive at the credit balance of $11,000.

11The vice president of finance authorizes a write-off of $2,500 owed by T. Ebbet:

Recording the Write-Off of an Uncollectible AccountCopyright John Wiley & Sons Canada, Ltd.128

CHAPTERRecording the Write-off of an Uncollectible AccountWrite-offs should be formally approved in writing by authorized management personnel. To adhere to the appropriate internal control activity, authorization to write off accounts should not be given to someone who also has daily responsibilities related to cash or receivables. Actual uncollectible amounts are Dr to Allowance for Doubtful Accounts and Cr to Accounts Receivable at the time the specific account is written off as uncollectible.Under the allowance method, every bad debt write-off is debited to the allowance account and not to Bad Debts Expense.

Continuing with the Abrams Furniture Ltd. example, assume the vice-president of finance authorizes a write-off of a $2,500 balance owed by T. Ebbet. The required entry is:Dr Allowance for Doubtful Accounts2,500Cr Accounts Receivable T. Ebbet2,500Note that this entry does not change the net receivables balance, as both Accounts Receivable and Allowance for Doubtful Accounts have been decreased by the same amount.

12Recording the Recovery of an Uncollectible AccountCopyright John Wiley & Sons Canada, Ltd.138

Record in two separate entries:CHAPTERRecovery of an Uncollectible Account

When a bad debt is recovered, two entries are required:The entry made in writing off the account is reversed to reinstate the customers account. If a partial payment is received, only that amount is reinstated.The collection is recorded in the usual manner.

Assuming Ebbet later pays the $2,500 balance that has been written off, the resulting entries are:(To reverse the write-off of T. Ebbet account)

Accounts Receivable T. Ebbet2,500Allowance for Doubtful Accounts2,500(To record cash collection from customer)Cash2,500Accounts Receivable T. Ebbet2,500

13Discussion QuestionWhy is it important that bad debt expense is recorded in the same period as the related revenue?

8Copyright John Wiley & Sons Canada, Ltd.14CHAPTER1CHAPTER14Summary of Allowance MethodUsing 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 uncollectiblesStep 2 Record any write-off of uncollectibles Step 3 Record any recovery of uncollectibles 8Copyright John Wiley & Sons Canada, Ltd.15CHAPTER1CHAPTER15Summary of Allowance MethodStep 1 Record estimated uncollectiblesDec. 31Bad Debts Expense 10,000Allowance for Doubtful Accounts (AFDA)10,000(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$200,000Less: AFDA 11,000Net realizable value $189,000

Copyright John Wiley & Sons Canada, Ltd.16CHAPTER1CHAPTERSummary of Allowance MethodStep 2 Record any write-offs Mar. 1Allowance for Doubtful Accounts 2,500Accounts Receivable T. Ebbet 2,500(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-offAfter Write-offAccounts receivable $227,500$225,000Allowance for doubtful accounts 11,000 8,500Net realizable value$216,500$216,500

Copyright John Wiley & Sons Canada, Ltd.17CHAPTER1CHAPTER17Summary of Allowance MethodStep 3 Record any uncollectible recovery

July 1Accounts ReceivableT. Ebbet 2,500Allowance for Doubtful Accounts 2,500(To reverse write-off of T. Ebbet account)

Cash2,500Accounts ReceivableT. Ebbet2,500(To record collection from T. Ebbet)

Copyright John Wiley & Sons Canada, Ltd.18CHAPTER1CHAPTER18Notes ReceivableStronger legal claim to assets than accounts receivable; written promise (promissory note) to repayA credit instrument that normally:Requires the payment of interest Extends for time periods greater than 30 daysOften accepted from customers who need to extend payment of an account receivableOften required from high risk customers8Copyright John Wiley & Sons Canada, Ltd.19CHAPTER1CHAPTERNotes Receivable defined:A promissory note is a written promise to pay a specified amount of money on demand or at a definite time.

Promissory notes may be used when: Individuals and companies lend or borrow moneyWhen the amount of the transaction and the credit period exceed normal limitsIn settlement of accounts receivableThe party making the promise to pay is the maker; the party to whom payment is to be made is called the payee.Recognizing Notes ReceivableAt the time a note is received, it is recorded at the principal value or face value with no interest added.

Using the example from the text, on May 1, Tabusintac Ltd. accepts a note receivable in exchange for an account receivable from Raja Ltd. The note is for $10,000 with 6% interest due in four months. The entry to record this transaction is:May 1 Notes Receivable Raja Ltd. 10,000 Accounts Receivable Raja Ltd. 10,000

(To record acceptance of Raja notes)If the note had been exchanged for cash, the credit would have been to Cash. 19The basic formula for calculating interest on an interest-bearing note is:

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

Formula for Calculating InterestCopyright John Wiley & Sons Canada, Ltd.20 Face Valueof NoteAnnual InterestRateTime in Terms of One YearInterestXX=8CHAPTERWhen is interest recorded on the note receivable?As time passes, interest revenue accrues on the note. Note that interest rates are always stated as an annual rate and must be adjusted for partial periods.In the Raja example the interest is calculated for the 4 months of the note as: $10,000 x 6% x 4/12 = $200If Tabusintacs year end is May 31, the following adjusting entry would accrue one months interest.May 31 Interest Receivable 50 Interest Revenue 50 (To accrue interest on Raja note receivable) $10,000 x 6% x 1/12 = $50

Note while interest on an overdue account receivable is debited to Accounts Receivable, interest on a note receivable is NOT debited to the Notes Receivable account. Since the note is a formal credit instrument, its recorded principal must remain unchanged.

20Honoring and Dishonoring Notes Receivable8Copyright John Wiley & Sons Canada, Ltd.21HonouredPaid in full at maturity dateCollection recordedDishonouredNot paid at maturity date; note no longer negotiableBalance transferred to Accounts Receivable if eventual collection expectedBalance transferred to Allowance for Doubtful Account if eventual collection not expectedCHAPTER1CHAPTERExample Honouring Notes Receivable

The entry to record the receipt of the $10,000 principal and $200 interest would be:Sept 1 Cash 10,200 Notes Receivable Raja Ltd. 10,000 Interest Receivable 50 Interest Revenue 150 (To record collection of Raja note and interest)

Example Dishonouring Notes Receivable

The entry to record the dishonored note would be:Sept 1 Accounts Receivable 10,200 Notes Receivable Raja Ltd. 10,000 Interest Receivable 50 Interest Revenue 150 (To record dishonored Raja note; eventual collection expected)If there is no hope of collection, the principal and any accrued interest should be written off. No interest revenue would be recorded, because collection will not occur.Sept 1 Allowance for Doubtful Accounts (Notes) 10,050 Notes Receivable Raja Ltd. 10,000 Interest Receivable 50

21Valuing Notes ReceivableNotes 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 8Copyright John Wiley & Sons Canada, Ltd.22CHAPTER1CHAPTER22Statement PresentationStatement of Financial PositionReported in the current assets sectionFollowing cash and short-term investmentsOnly required to disclose net realizable value, but helpful to disclose gross receivables and the allowance for doubtful accountsIncome StatementBad debts expense is reported as an operating expenseInterest revenue is non-operatingCopyright John Wiley & Sons Canada, Ltd.238CHAPTER1CHAPTERStatement of Financial Position: Each of the major types of receivables should be identified in the statement of financial position or in the notes to the financial statements.Short-term receivables are reported in the current assets section of the statement of financial position following cash and short-term investments.Disclosure of gross amounts of receivables and the Allowance for Doubtful Accounts is appropriate in the statement or in the notes to F/S. Review the Shaw Communications Inc.s Statement of Financial Position for Presentation of Receivables shown in Illustration 8-4.

23Comparing IFRS and ASPECopyright John Wiley & Sons Canada, Ltd.248

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