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Learning Objective 1
Topic 4 Explain How Companies Recognize
Accounts Receivable
Accounting for Receivables

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Chapter Outline: Recognition of Accounts Receivables (1 of 2)

Learning Objectives • The term receivables refers to amounts due from
LO 1 Explain how companies recognize accounts receivable. individuals and companies
LO 2 Describe how companies value accounts receivable and • Receivables are claims that are expected to be
record their disposition. collected in cash
LO 3 Explain how companies recognize, value, and dispose of • Management of receivables is a very important
notes receivable (honored and dishonored). activity for any company that sells goods or services
LO 4 Describe the statement presentation and analysis of on credit
receivables.
• Receivables are important because they represent
VAS highlights
one of a company’s most liquid assets

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Recognition of Accounts Receivables (2 of 2) Recognizing Accounts Receivable (1 of 5)

Amounts due from individuals and companies that are expected to
• Service organization records a receivable when it
be collected in cash. performs service on account
• Merchandiser records accounts receivable at point of
Receivables as a Company sale of merchandise on account
Company Percentage of Total Assets
Adidas (DEU) 16% • Seller may offer a discount to encourage early
Hyundai (KOR) 5 payment
Samsung (KOR) 13 • Buyer might return goods found to be unacceptable
Nestlé (CHE) 41
▪ Sales returns reduce receivables
China Mobile Limited (HKG) 2

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Types of Receivables (1 of 2) Recognizing Accounts Receivable (2 of 5)

Illustration: Assume that Zhang Ltd. on July 1, 2020, sells
Amounts due from individuals and companies that are expected to
be collected in cash. merchandise on account to Li Stores for ¥1,000, terms 2/10,
n/30 (amounts in thousands). On July 5, Li returns
merchandise with a sales price of ¥100 to Zhang. Prepare the
Amounts customers Written promise Nontrade receivables
owe on account that (formal instrument) such as interest, journal entries to record these transactions.
result from the sale for amount to be loans to officers,
Jul. 1 Accounts Receivable 1,000
of goods and received. Normally advances to
services. requires the employees, and Sales Revenue 1,000
collection of income taxes
interest. refundable. Jul. 5 Sales Returns and Allowances 100
Accounts Notes Other Accounts Receivable 100
Receivable Receivable Receivables

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Recognizing Accounts Receivable (3 of 5) Recognizing Accounts Receivable (5 of 5)

Illustration: On July 11, Zhang receives payment from Li for Illustration: Assuming that you owe €300 at the end of the
the balance due. Prepare the journal entry to record this month and IKEA charges 1.5% per month on the balance due,
transaction. the adjusting entry that IKEA makes to record interest revenue
of €4.50 (€300 × 1.5%) on June 30 is as follows.
Jul. 11 Cash (¥900 − ¥18) 882
Sales Discounts (¥900 x .02) 18 June 30 Accounts Receivable 4.50
Accounts Receivable 900 Interest Revenue 4.50

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Recognizing Accounts Receivable (4 of 5) Do It! 1: Recognizing Accounts

Illustration: Some retailers issue their own credit cards. When Receivable (1 of 3)
you use a retailer’s credit card (IKEA, for example), the retailer On May 1, Wilton sold merchandise on account to Bates for
charges interest on the balance due if not paid within a £50,000, terms 3/15, net 45. On May 4, Bates returns merchandise
specified period (usually 25–30 days). with a sales price of £2,000. On May 16, Wilton receives payment
Illustration: Assume you use your IKEA credit card to purchase from Bates for the balance due. Prepare journal entries to record
the May transactions on Wilton’s books. (Ignore cost of goods sold
clothing with a sales price of €300 on June 1, 2020. The entry
entries.)
is recorded as follows.
May 1 Accounts Receivable 50,000
Jun. 1 Accounts Receivable 300
Sales Revenue 50,000
Sales Revenue 300

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Do It! 1: Recognizing Accounts

Receivable (2 of 3)
On May 1, Wilton sold merchandise on account to Bates for Learning Objective 2
£50,000, terms 3/15, net 45. On May 4, Bates returns merchandise
with a sales price of £2,000. On May 16, Wilton receives payment Describe How Companies Value
from Bates for the balance due. Prepare journal entries to record
the May transactions on Wilton’s books. (Ignore cost of goods sold
Accounts Receivable and Record Their
entries.) Disposition
May 4 Sales Returns and Allowances 2,000
Accounts Receivable 2,000

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Do It! 1: Recognizing Accounts Valuation of Accounts Receivable

Receivable (3 of 3) Valuing Accounts Receivable
On May 1, Wilton sold merchandise on account to Bates for • Current asset
£50,000, terms 3/15, net 45. On May 4, Bates returns merchandise
with a sales price of £2,000. On May 16, Wilton receives payment • Valuation (net realizable value)
from Bates for the balance due. Prepare journal entries to record
the May transactions on Wilton’s books. (Ignore cost of goods sold Uncollectible Accounts Receivable
entries.) • Sales on account raise possibility of accounts not
May 16 Cash (£48,000 − £1,440) 46,560 being collected
Sales Discounts (£48,000 × .03) 1,440 • Seller records losses that result from extending
Accounts Receivable 48,000 credit as Bad Debt Expense

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Accounting for Uncollectible Accounts Valuing Accounts Receivable

Direct Write-Off Method
Hampson Furniture
• No matching of expenses with revenues Statement of Financial Position (partial)
• Receivable not stated at net realizable value Current Assets
Supplies € 25,000
• Not acceptable for financial reporting purposes
Inventory 310,000
Allowance Method Accounts receivable €200,000
• Better matching of expenses with revenues Less: Allowance for doubtful accounts 12,000 188,000
Cash 14,800
• Receivable stated at cash (net) realizable value Total current assets €537,800
• Required for financial reporting purposes Gross presentation of account receivables

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Valuing Accounts Receivable Valuing Accounts Receivable

How are these accounts presented on the Balance Sheet?
Hampson Furniture
Statement of Financial Position (partial)
Current Assets
Supplies € 25,000
Allowance for Inventory 310,000
Accounts Receivable Doubtful Accounts Accounts receivable, net of €12,000 allowance 188,000
Bal. 200,000 12,000 Bal. Cash 14,800
Total current assets €537,800

Bal. Bal. Net presentation of account receivables (one line approach)

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Valuing Accounts Receivable Valuing Accounts Receivable

Journal entry for credit sale of €100 Adjustment of €15 for estimated bad debts?
Accounts Receivable 100 Bad Debt Expense 15
Sales Revenue 100 Allowance for Doubtful Accounts 15

Allowance for Allowance for

Accounts Receivable Doubtful Accounts Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal. Bal. 500 25 Bal.
Sale 100 Sale 100 333 Coll. 15 Exp.

Bal. 600 25 Bal. Bal. 267 40 Bal.

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Valuing Accounts Receivable Valuing Accounts Receivable

Collect €333 on account? Write-off of uncollectible accounts of €10?
Cash 333 Allowance for Doubtful Accounts 10
Accounts Receivable 333 Accounts Receivable 10

Allowance for Allowance for

Accounts Receivable Doubtful Accounts Accounts Receivable Doubtful Accounts
Bal. 500 25 Bal. Bal. 500 25 Bal.
Sale 100 333 Coll. Sale 100 333 Coll. 15 Exp.
10 w/o w/o 10
Bal. 267 25 Bal. Bal. 257 30 Bal.

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Valuing Accounts Receivable Allowance Method for Uncollectible

Accounts
ABC Supplies
Statement of Financial Position (partial) 1. Companies estimate uncollectible accounts
Current Assets receivable.
Prepaid expense € 40 2. Debit Bad Debt Expense and credit Allowance for
Inventory 812 Doubtful Accounts (a contra-asset account).
Accounts receivable €257
Less: Allowance for doubtful accounts 30 227 3. Companies debit Allowance for Doubtful Accounts
Cash 330 and credit Accounts Receivable at the time the
Total current assets €1,409 specific account is written off as uncollectible.

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Direct Write-Off Method for Allowance Method for Uncollectibles

(1 of 5)
Uncollectible Accounts
Illustration: Assume that Warden Co. writes off M. E. Doran’s
Recording Estimated Uncollectibles
NT$1600 balance as uncollectible on December 12. Warden’s Illustration: Hampson Furniture has credit sales of €1,200,000
entry is as follows. in 2020, of which €200,000 remains uncollected at December
31. The credit manager estimates that €12,000 of these sales
Bad Debt Expense 1,600 will be uncollectible.
Accounts Receivable 1,600
Dec. 31 Bad Debt Expense 12,000
Unless bad debt losses are insignificant, the direct write-off Allowance for Doubtful Accounts 12,000
method is not acceptable for financial reporting purposes.

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Allowance Method for Uncollectibles Allowance Method for Uncollectibles

(2 of 5) (4 of 5)

Hampson Furniture Recovery of an Uncollectible Account

Statement of Financial Position (partial)
Illustration: On July 1, R. A. Ware pays the €500 amount that
Current Assets Blank Blank
Hampson had written off on March 1. Hampson makes the
Supplies Blank € 25,000 following entries.
Inventory Blank 310,000
Accounts receivable €200,000 188,000 July 1 Accounts Receivable 500
Allowance for doubtful accounts 12,000 Blank Allowance for Doubtful Accounts 500
Cash Blank 14,800
July 1 Cash 500
Total current assets Blank €537,800
Accounts Receivable 500

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Allowance Method for Uncollectibles Estimating the Allowance (1 of 4)

(3 of 5)
Frequently, companies estimate the allowance as a
Illustration: The financial vice president of Hampson Furniture percentage of the outstanding receivables.
authorizes a write-off of the €500 balance owed by R. A. Ware
on March 1, 2021. The entry to record the write-off is as Percentage-of-Receivables Basis
follows. • Management establishes a percentage relationship
Mar. 1 Allowance for Doubtful Accounts 500 between amount of receivables and expected losses
Accounts Receivable 500 from uncollectible accounts
• Amount of bad debt expense that should be recorded
Accounts Receivable Allowance for Doubtful Accounts is difference between required balance and existing
Jan. 1 Bal. 200,000 Mar. 1 500 Mar. 1 500 Jan. 1 Bal. 12,000
Mar. 1 Bal. 199,500 Mar. 1 Bal. 11,500 balance in allowance account

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Estimating the Allowance (2 of 4) Estimating the Allowance (4 of 4)

Accounts Receivable Aging Schedule
Illustration: Assume the unadjusted trial balance shows
Number of Days Past Due Allowance for Doubtful Accounts with a debit balance of
Not yet
Customer Total Due 1-30 31-60 61-90 Over 90
¥500. Prepare the adjusting entry assuming ¥2,228 is the
T.E. Adert ¥ 600 ¥ 300 ¥ 200 ¥ 100 estimate of uncollectible receivables.
R.C. Bortz 300 ¥ 300
B.A. Carl 450 200 ¥ 250 Dec. 31 Bad Debt Expense 2,728
O.L. Diker 700 500 200
Allowance for Doubtful Accounts 2,728
T.O. Ebbet 600 300 300
Others 36,950 26,200 5,200 2,450 1,600 1,500
¥39,600 ¥27,000 ¥5,700 ¥3,000 ¥2,000 ¥1,900 Bad Debt Expense Allowance for Doubtful Accounts
Estimated % Dec. 31 Adj. 2,728 Dec. 31 Bal. 500
uncollectible 2% 4% 10% 20% 40% Dec. 31 Adj. 2,728
Total estimated Dec. 31 Bal. 2,228
uncollectible ¥2,228 ¥540 ¥228 ¥300 ¥400 ¥760
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Estimating the Allowance (3 of 4) Do It! 2a: Bad Debt Expense

Illustration: The unadjusted trial balance shows Allowance Brule Group has been in business for 5 years. The unadjusted
for Doubtful Accounts with a credit balance of ¥528. Prepare trial balance at the end of the current year shows Accounts
the adjusting entry assuming ¥2,228 is the estimate of Receivable $30,000, Sales Revenue $180,000, and Allowance
uncollectible receivables from the aging schedule. for Doubtful Accounts with a debit balance of $2,000. Brule
estimates bad debts to be 10% of accounts receivable.
Dec. 31 Bad Debt Expense 1,700 Prepare the entry necessary to adjust Allowance for Doubtful
Allowance for Doubtful Accounts 1,700 Accounts.

Bad Debt Expense 5,000*

Bad Debt Expense Allowance for Doubtful Accounts
Dec. 31 Adj. 1,700 Dec.31 Bal. 528 Allowance for Doubtful Accounts 5,000
Dec. 31 Adj. 1,700
Dec. 31 Bal. 2,228
* [(10% × $30,000) + $2,000]

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Notes Receivable (2 of 2)
To the payee, the promissory note is a note receivable.
Learning Objective 3 To the maker, the promissory note is a note payable.
Explain How Companies Recognize,
Value, and Dispose of Notes Receivable

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Notes Receivable (1 of 2) Determining the Maturity Date

Companies may grant credit in exchange for a promissory Maturity date of a promissory note may be stated in one
note. A promissory note is a written promise to pay a of three ways:
specified amount of money on demand or at a definite
1. On demand.
time.
Promissory notes may be used 2. On a stated date.

1. when individuals and companies lend or borrow 3. At the end of a stated period of time.
money, Note terms are expressed in:
2. when amount of transaction and credit period • Months
exceed normal limits, or
• Days
3. in settlement of accounts receivable.
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Computing Interest Valuing Notes Receivable

Face Value of Note × Annual Interest Rate × Time in • Report short-term notes receivable at their cash (net)
Terms of One Year = Interest realizable value
When counting days, omit date note is issued, but • Estimation of cash realizable value and recording bad
include due date debt expense and related allowance are similar to
accounts receivable
Terms of Note Interest Computation
Face x Rate x Time = Interest
₺ 730, 12%, 120 days ₺ 730 x 12% x 120/360 = ₺ 29.20
₺1,000, 9%, 6 months ₺1,000 x 9% x 6/12 = ₺ 45.00
₺2,000, 6%, 1 year ₺2,000 x 6% x 1/1 = ₺120.00

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Recognizing Notes Receivable Disposing of Notes Receivable (for your reference only)
Illustration: Calhoun plc wrote a £1,000, two-month, 12% 1. Notes may be held to their maturity date
promissory note dated May 1, to settle an open account.
Prepare an entry Wilma Ltd. would make for the receipt of the
2. Maker may default and payee must make an
note. adjustment to the account
3. Holder speeds up conversion to cash by selling the
May 1 Notes Receivable 1,000 note receivable
Accounts Receivable 1,000

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Disposing of Notes Receivable (2 of 2) Accrual of Interest Receivable (1 of 2)

Honor of Notes Receivable Illustration: Suppose instead that Wolder Co. prepares
financial statements as of September 30. The adjusting entry
• Maker pays it in full at its maturity date by Wolder is for four months ending Sept. 30.
Dishonor of Notes Receivable
• Not paid in full at maturity
• No longer negotiable

Sept. 30 Interest Receivable (€10,000 × 9% x 4/12) 300

Interest Revenue 300

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Honor of Notes Receivable Accrual of Interest Receivable (2 of 2)

Illustration: Wolder Co. lends Higley Co. €10,000 on June 1, Illustration: Prepare the entry Wolder’s would make to record
accepting a five-month, 9% interest note. To obtain payment, the honoring of the Higley note on November 1.
Wolder (the payee) must present the note either to Higley Co.
(the maker) or to the maker’s agent, such as a bank. If Wolder Nov. 1 Cash 10,375
presents the note to Higley Co. on November 1, the maturity Notes Receivable 10,000
date, Wolder’s entry to record the collection is as follows. Interest Receivable 300
Nov. 1 Cash 10,375 Interest Revenue (€10,000 × 9% x 1/12) 75
Notes Receivable 10,000
Interest Revenue (€10,000 × 9% x 5/12) 375

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Presentation and Analysis

Presentation
Learning Objective 4 Income Statement
Describe the Statement Presentation • Report bad debt expense and service charge expense
and Analysis of Receivables in operating expenses section
• Report interest revenue under “Other income and
expense” in non-operating section

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Presentation and Analysis Analysis (read by your self)

Presentation Illustration: Cisco Lenovo Group (CHN) (which reported in U.S.
dollars) had net sales of $38,707 million for the year. It had a
Statement of Financial Position beginning accounts receivable (net) balance of $2,885 million
• Identify on statement or in the notes each major type and an ending accounts receivable (net) balance of $3,171
of receivable million. Assuming that Lenovo’s sales were all on credit, its
accounts receivable turnover is computed as follows.
• Report short-term receivables as current assets
Net Credit Average Net Accounts Receivable
• Report both gross amount of receivables and ÷ =
Sales Accounts Receivable Turnover
allowance for doubtful account
$2,885 + $3,171
$38,707 ÷ = 12.8 times
2

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Analysis VAS highlights

Illustration: A variant of the accounts receivable turnover ratio
is average collection period in terms of days.

Net Credit Average Net Accounts Receivable

÷ =
Sales Accounts Receivable Turnover
$2,885 + $3,171
$38,707 ÷ = 12.8 times
2

Days in Accounts Receivable Average Collection

÷ =
Year Turnover Period in Days
365 days ÷ 12.8 times = 28.5 days

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DO IT! 4: Analysis of Receivables VAS highlights

Illustration: In 2020, Nadal Racquets has net credit sales of €923,795 for • VAS doesn’t mention direct write off
the year. It had a beginning accounts receivable (net) balance of €38,275
and an ending accounts receivable (net) balance of €35,988. Compute
ILLUSTRATION 9.21
• Allowance is based on very detailed regulations applied for
Nadal’s (a) accounts receivable turnover and (b) average collection period companies with specific level of allowance (30%, 50%, 70%, 100%)
in days. ❑What are the pros and cons of this?
Net Credit Average Net Accounts Accounts Receivable • Recognize trade receivables (from customers) in same account
÷ = with advance from customer on the Ledger (company cannot add
Sales Receivable Turnover
more accounts due to fixed account ledgers, but they can create
€38,275 + €35,988
€923,795 ÷ = 24.9 times the sub accounts)
2
• Report Trade Receivables in Current and NCA section
Accounts Receivable Average Collection
Days in Year ÷
Turnover
=
Period in Days • There are almost no notes between buyer and seller, but between
buyer and the banks/loan company, if any: use loan contracts
365 days ÷ 24.9 times = 14.7 days
instead of notes.
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