Accounts Receivable

Receivables are claims held against customers and others for money, goods,
or services. For financial statement purposes, companies classify receivables
as either current or noncurrent. Companies expect to collect current
receivables within a year or during the current operating cycle, whichever is
longer.
Customers often owe a company amounts for goods bought or services
rendered. A company may sub classify these trade receivables, usually the
most significant item it possesses, into accounts receivable and notes
receivable. Accounts receivable are oral promises of the purchaser to pay for
goods and services sold. They represent open accounts resulting from
short-term extensions of credit.
Notes receivable are written promises to pay a certain sum of money on a
specified future date.
In most receivables transactions, the amount to be recognized is the
exchange price between the two parties. The exchange price is the amount
due form the debtor. Some type of business document, often an invoice,
services as evidence of the exchange price.
Prices may be subject to a trade or quantity discount. Companies use such
trade discounts to avoid frequent changes in catalogs, to alter prices for
different quantities purchased, or to hide the true invoice price from
competitors. Companies offer cash discounts to induce prompt payment.
Companies usually record sales and related sales discounts transactions by
entering the receivable and sale at the gross amount. Under this method,
companies recognize sales discounts only when they receive payment within
the discount period.
Some contend that sales discounts not taken reflect penalties added to an
established price to encourage prompt payment, that is the seller offers sales
on account at a slightly higher price than if selling for cash.
Ideally, a company should measure receivables in terms of their present
value, that is, the discounted value of the cash to be received in the future.
When expected cash receipts require a waiting period, the receivable face
amount is not worth the amount that the company ultimately receives.
Reporting receivables involves classification valuation on the balance sheet.
Classification involves determining the length of time each receivable will be
outstanding.
Determining net realizable value requires estimating both uncollectible
receivables and any returns or allowances to be granted.
Under the direct write-off method, when a company determines a particular
account to be uncollectible, it charges the loss to bad debt expense. Bad debt
expense will show only actual losses from uncollectible. The company will
report accounts receivable at its gross amount.

Supporters of this method contend that it records facts, not estimates. It

assumes that a good account receivable resulted form each sale, and that
later events revealed certain accounts to be uncollectible and worthless.
As a result, using the direct write-off method is not considered appropriate,
except when the amount uncollectible is immaterial.
The allowance method of accounting for bad debts involves estimating
uncollectible accounts at the end of each period. This ensures that companies
state receivables on the balance sheet at their net realizable value.
Is appropriate in situations where it is probable that an asset been impaired
and that the amount of the loss can be reasonably estimated.
Allowance for doubtful accounts shows the estimated amount of claims on
customers that the company expects will become uncollectible in the future.
Companies use a contra account instead of a direct credit to accounts
receivable because they do not know which customers will not pay.
Companies do not close allowance for doubtful accounts at the end of the
fiscal year.
Under the allowance method, companies debit every bad debt write-off to the
allowance account rather than to bad debt expense. A debit to bad debt
expense would be incorrect because the company has already recognized the
expense when it made the adjusting entry for estimated bad debts.
Instead, the entry to record the write-off of an uncollectible account reduces
both accounts receivable and allowance for doubtful accounts.
The percentage of sales basis results in a better matching of expenses with
revenues an income statement viewpoint. The percentage of receivables
basis produces the better estimate of net realizable value a balance sheet
viewpoint, under both bases, the company must determine its past experience
with bad debt losses.
The amount of bad debt expense and related credit to the allowance account
are unaffected by any balance currently existing in the allowance account.
Because the bad debt expense estimate is related to a nominal account, any
balance in the allowance is ignored. Therefore, the percentage of sales
method achieves a proper matching of cost and revenues. This method is
frequently referred to as the income statement approach.