Accounts Receivable

Chapter 6
Accounts Receivable

Accounts receivable is a
current asset that arises
from sales on credit.

It is also the total amount

customers owe the firm.

They are sometimes called

“trade accounts receivable.”
Value Of Receivables

Receivables are reported at their

face value less an allowance for
accounts which are likely to be
uncollectible.
The amount which is actually
expected to be collected is called
the net realizable value (NRV).
GAAP requires that A/R be reported
at NRV.
 GAAP Not GAAP
Allowance Method Direct Write-Off
Method

Used only when bad

debts are a very small
A/R Sales item or when credit
Method Method sales are insignificant.
Direct Write-off
Direct Write-Off
No estimate of bad debts is made.
Only when a specific account is known to be
uncollectible (customer files bankruptcy, for
example) is bad debts expense recorded.
Method does not do a very good job of
matching the revenue (sale) with the expense
(bad debt), because a company often
discovers an account is uncollectible in a
period subsequent to the one in which the
sale was made.
Allowance Method
Estimates the bad debt expense for the accounting
period as an adjustment when it is time to prepare the
financial statements.

Records the amount as a deduction in accounts

receivable (A/R) , even though it is not known whose
accounts will be “bad.”

Create an account called :allowance for uncollectible

accounts” (a contra-asset account) to hold the
deductions in A/R until the firm can identify the specific
accounts that are bad and remove them form the books.
Allowance Method
The bad debts estimate is based upon:
Sales, or
Accounts Receivable

The allowance method attempts to match

the expense (bad debts) with the revenue
(sale) by recording the expense in the same
period as the sale even though the company
has not specifically identified which
accounts will go unpaid.
Sales Method
Percentage of Sales Method
Focuses on the income statement
and the amount of the current
period’s sales for which collection
will likely not be made.
Bad debts expense is recorded as
a percentage of sales and the
amount is an addition to the
allowance account.
Accounts Receivable Method
Focuses on the balance sheet and uses an aging
schedule to estimate the amount of accounts
receivable (A/R) that will not be collectible.
Analyzes A/R to determine how long each account
has been outstanding. The longer the account has
been outstanding, the greater the likelihood it will not
be collected.
The company estimates the percentage of A/R that
will be uncollectible. An adjustment is made to the
allowance account to reflect that estimate, and the bad
debts expense equals the amount of the adjustment.
 1. Provided $5,000 services on
account.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+5000 A/R +5000 Sales

Revenue

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
2. Collected $4,000 cash on
accounts receivable.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4000 cash
(4000) A/R

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
 3. Adjusting entry recorded to reflect the
estimate of 5% of ending A/R to be
uncollectible.

Assets = Liab. + C C. + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
 Financial statements at the end of
Year 1:
Statement of Cash Flows
Income Statement
for the Year 1
for Year 1

Sales $5,000 Cash from operations $4,000

Bad debt expense 50 Cash from investing -0-
Cash from financing -0-
Net Income $4,950
Total change in cash $4,000
Balance Sheet at the end of Year 1

Assets: Liab. + Equity:

Cash $4000
AR 1,000
Allowance (50)
Net A/R 950 RE $4,950

Total Assets $4,950 $4,950

 Year 2:
1-Wrote off a $40 A/R that was
determined to be uncollectible

Assets = Liab. + CC + Ret. Earnings

(40) AR
+40 Allowance

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
2-Provided $6,000 worth of services
on account.

Assets = Liab. + CC. + Ret. Earnings

+6000 AR +6000 revenue

• Income Statement:
• Statement of Changes in Equity:
• Statement of Cash Flows:
 3- Collected $4,500 cash from
accounts receivable.
Assets = Liab. + CC. + Ret. Earnings

+4500 Cash
(4500) AR

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
4-Adjust the accounting records to reflect
the expectation that 5% of the ending AR
balance would be uncollectible.
(Balance is $2460.)
Assets = Liab. + CC. + Ret. Earnings

• Income Statement:
• Statement of Changes in Equity:
• Statement of Cash Flows:
 Where Do We Stand?
We overestimated bad debts by $10--we estimated $50
but we only wrote off $40 in the subsequent year.

This year our estimate is 5% of $2,460 (BB 1,000 + 6,000

credit sales - $4,500 collections -$40 accounts written off)=
$123. But since we overestimated last year, we only need
to record $113 this year.
4.b Adjust the accounting records to
reflect the expectation that 5% of the
ending A/R balance would be
uncollectible.
Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad

for doubtful debts expense
accounts

• Income Statement
• Statement of Changes in Equity
• Statement of Cash Flows
Summary Of The Allowance Method

One way to estimate bad debt

expense is to use a percentage of
ending A/R (or an aging schedule)
When an actual account is written
off as uncollectible, it is removed
from A/R and the Allowance
Account. THERE IS NO NET EFFECT
ON ASSETS and NO EXPENSE at the
time of the write-off.
Accounts Receivable for
Hershey Foods