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Accounting

Principles
Second Canadian Edition
Weygandt Kieso Kimmel
Trenholm

Prepared by:
Carole Bowman, Sheridan College
CHAPTER

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 Account Titles and Explanation Debit Credit
July 1 Accounts Receivable - Adorable Junior 1,000
Sales 1,000
To record sales on account.

When a business sells merchandise to a


customer on credit, Accounts Receivable is
debited and Sales is credited.
RECOGNIZING ACCOUNTS
RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 5 Sales Returns and Allowances 100
Accounts Receivable - Adorable 100
To record merchandise returned.

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 Account Titles and Explanation Debit Credit
July 31 Cash ($1,000 - $100) 900
Accounts Receivable - Adorable 900
To record collection of account.

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 Account Titles and Explanation Debit Credit
July 31 Accounts Receivable - Adorable 13.50
Interest Revenue 13.50
To record interest on amount due.

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 Account Titles and Explanation Debit Credit
Jan. 12 Bad Debts Expense 200

Accounts Receivable E. Schaefer 200


For write-off of E. Schaefer account.

Periera Company writes off E. Schaefers $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 Debit Credit
Dec. 31 Bad Debts Expense 24,000
Allowance for Doubtful Accounts 24,000
To record estimate of uncollectible accounts.

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 $ 14,800
Accounts receivable $200,000
Less: Allowance for doubtful accounts 24,000 188,000

Net Realizable Value


THE ALLOWANCE METHOD

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
Mar. 1 Allowance for Doubtful Accounts 500

Accounts Receivable Nadeau 500

Write-off of Nadeau account.

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 Account Titles and Explanation Debit Credit
July 1 Accounts Receivable Nadeau 500

Allowance for Doubtful Accounts 500

To reverse write-off of Nadeau


account.

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 Account Titles and Explanation Debit Credit
July 1 Cash 500

Accounts Receivable Nadeau 500

To record collection from Nadeau.

2. Record the collection in the usual manner.


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 Percentage of Receivables


Net Realizable Value
Allowance
Accounts for
Receivable Doubtful
Accounts

Emphasis on Income Emphasis on Balance


Statement Relationships 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
sellers bank balance.
BANK CARD SALES

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
July 31 Cash 965

Credit Card Expense ($1,000 x 3.5%) 35

Sales 1,000
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.
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 Account Titles and Explanation Debit Credit
July 31 Accounts Receivable 475

Credit Card Expense ($500 x 5%) 25

Sales 500
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.
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:

Annual Time
Face Value X X = Interest
Interest in Terms of
of Note
Rate One Year
RECOGNIZING NOTES RECEIVABLE

GENERAL JOURNAL
Date Account Titles and Explanation Debit Credit
1,000
May 1 Notes Receivable
Accounts Receivable Brent Company 1,000

To record acceptance of Brent


Company note.

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 Debit Credit
Sept. 30 Cash 10,150
Notes Receivable - Higly 10,000
Interest Revenue 150
To record collection of Higly note.

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 Debit Credit
Sept. 30 Accounts Receivable - Higly 10,150
Notes Receivable - Higly 10,000
Interest Revenue 150
To record the dishonour of Higly note.

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 companys
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 companys 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 Receivables Collection


=
(365) Turnover Period in Days
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