Deswita Triana Ceisilia

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Resume Chapter 8: Accounting for Receivables

The term receivables refer to amounts due from individuals and companies. Receivables are
claims that are expected to be collected in cash. To reflect important differences among
receivables, they are frequently classified as:
1. Accounts receivables are amounts customer owe on account. They result from the sale
of goods and services.
2. Notes receivables are a written promise (as evidenced by a formal instrument) for
amounts to be received. The note normally requires the collection of interest and extends
for time periods of 60–90 days or longer. Notes and accounts receivable that result from
sales transactions are often called trade receivables.
3. Other receivables include non-trade receivables such as interest, receivable, loans to
company offers, advance to employees, and income business. They are generally
classified and reported as separate items of financial position.

Account Receivables
Three accounting issues associated with accounts receivable are:
1. Recognizing accounts receivable
A service organization records a receivable when it provides service on account. A
merchandiser records accounts receivable at the point of sale of merchandise on account.
When a merchandiser sells goods, it increases (debits) Accounts Receivable and increases
(credits) Sales Revenue.
2. Valuing accounts receivable
Companies report accounts receivable on the statement of financial position as an asset.
But determining the amount to report is sometimes difficult because some receivables
will become uncollectible. Each customer must satisfy the credit requirements of the
seller before the credit sale is approved. Inevitably, though, some accounts receivables
become uncollectible.

Two methods are used in accounting for uncollectible accounts:

a. The direct write-off method, under this 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. Although this method is simple, its use
can reduce the usefulness of both the income statement and statement of financial
position. Consequently, unless bad debt losses are insignificant, the direct write-off
method is not acceptable for financial reporting purposes.

b. The allowance method, the allowance method of accounting for bad debts involves
estimating uncollectible accounts at the end of each period. This provides better
matching on the income statement. It also ensures that companies state receivables on
the statement of financial position at their cash (net) realizable value. Cash (net)
realizable value is the net amount the company expects to receive in cash. This
method has three essential features:
- Companies estimate uncollectible accounts receivable. They match this estimated
expense against revenues in the same accounting period in which they record the
revenues.
- Companies debit estimated uncollectible to Bad Debt Expense and credit them to
Allowance for Doubtful Accounts through an adjusting entry at the end of each
period. Allowance for Doubtful Accounts is a contra account to Accounts
Receivable.
- When companies write off a specific account, they debit actual uncollectible to
Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.
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.

There are also steps under the allowance method, such as:
- Recording estimated uncollectible
- Recording the write-off of an uncollectible account
- Recovery of an uncollectible account
- Estimating the allowance, there are two bases are used to determine this amount:
1) percentage of sale; 2) percentage of receivables.
- Percentage-of-Sales, in the percentage-of-sales basis, management estimates what
percentage of credit sales will be uncollectible. This percentage is based on
experience and anticipated credit policy.

Disposing of Accounts Receivables

Companies sell receivables for two major reasons. First, they may be the only reasonable source
of cash. When money is tight, companies may not be able to borrow money in the usual credit
markets. Or, if money is available, the cost of borrowing may be prohibitive. A second reason for
selling receivables is that billing and collection are often time-consuming and costly.
Sales of Receivables
A common sale of receivables is a sale to a factor. A factor is a finance company or bank that
buys receivables from businesses and then collects the payments directly from the customers.
Factoring is a multibillion-dollar business. Factoring arrangements vary widely. Typically, the
factor charges a commission to the company that is selling the receivables. This fee ranges from
1–3% of the amount of receivables purchased.

Credit Card Sales

Credit card use is becoming widespread around the world. Three parties are involved when credit
cards are used in retail sales: (1) the credit card issuer, who is independent of the retailer; (2) the
retailer; and (3) the customer. A retailer’s acceptance of a national credit card is another form of
selling (factoring) the receivable.
Accounting for Credit Card Sales, The retailer generally considers sales from the use of credit
card sales as cash sales. The retailer must pay to the bank that issues the card a fee for processing
the transactions.

Notes Receivable
Companies may also grant credit in exchange for a formal credit instrument known as a
promissory note. 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 (1) when individuals and companies
lend or borrow money, (2) when the amount of the transaction and the credit period exceed
normal limits, or (3) in settlement of accounts receivable.
In a promissory note, the party making the promise to pay is called the maker. The party to
whom payment is to be made is called the payee. The note may specifically identify the payee by
name or may designate the payee simply as the bearer of the note.

Notes receivable give the holder a stronger legal claim to assets than do accounts receivable.
Like accounts receivable, notes receivable can be readily sold to another party. Promissory notes
are negotiable instruments (as are checks), which means that they can be transferred to another
party by endorsement. Companies frequently accept notes receivable from customers who need
to extend the payment of an outstanding account receivable. They often require such notes from
high-risk customers. In some industries (such as the pleasure and sport boat industry), all credit
sales are supported by notes. The majority of notes, however, originate from loans.
The basic issues in accounting for notes receivable are the same as those for accounts receivable:
1. Recognizing notes receivable
2. Valuing notes receivable
3. Disposing of notes receivable
Before we do, we need to consider two issues that do not apply to accounts receivable:
maturity date (when the due date is stated in terms of days, you need to count the exact
number of days to determine the maturity date. In counting, omit the date the note is issued
but include the due date) and computing interest (the interest rate specified in a note is an
annual rate of interest. The formula: face value of note x annual interest rate x time in interest
of one year = interest)

Recognizing Notes Receivable

The company records the note receivable at its face value, the amount shown on the face of
the note. No interest revenue is reported when the note is accepted because the revenue
recognition principle does not recognize revenue until the performance obligation is satisfied.
Interest is earned (accrued) as time passes. If a company lends money using a note, the entry
is a debit to Notes Receivable and a credit to Cash in the amount of the loan.

Valuing Notes Receivable

Valuing short-term notes receivable is the same as valuing accounts receivable. Like
accounts receivable, companies report short-term notes receivable at their cash (net)
realizable value. The notes receivable allowance account is Allowance for Doubtful
Accounts. The estimations involved in determining cash realizable value and in recording
bad debt expense and the related allowance are done similarly to accounts receivable.

Disposing of Notes Receivable

Notes may be held to their maturity date, at which time the face value plus accrued interest is
due. In some situations, the maker of the note defaults, and the payee must make an
appropriate adjustment. In other situations, similar to accounts receivable, the holder of the
note speeds up the conversion to cash by selling the receivables.

Honor of Notes Receivable

A note is honored when its maker pays in full at its maturity date. For each interest-bearing
note, the amount due at maturity is the face value of the note plus, interest for the length of
time specified on the note.
Accrual of Interest Payable
To reflect interest earned but not yet received

Dishonored of Notes Receivable

A dishonored (defaulted) note is a note that is not paid in full at maturity. A dishonored note
receivable is no longer negotiable. However, the payee still has a claim against the maker of
the note for both the note and the interest. Therefore, the note holder usually transfers the
Notes Receivable account to an account receivable.

Sales of Notes Receivable

The accounting for the sale of notes receivable is recorded similarly to the sale of accounts
receivable. The accounting entries for the sale of notes receivable are left for a more
advanced course.

Statement Presentation and Analysis

Presentation
Companies should identify in the statement of financial position or in the notes to the
financial statements each of the major types of receivables. Short-term receivables appear in
the current assets section of the statement of financial position. Short-term investments
appear after short-term receivables because these investments are more liquid (nearer to
cash). Companies report both the gross amount of receivables and the allowance for doubtful
accounts.

Analysis
Investors and corporate managers compute financial ratios to evaluate the liquidity of a
company’s accounts receivable. They use the accounts receivable turnover ratio to assess the
liquidity of the receivables. This ratio measures the number of times, on average, the
company collects accounts receivable during the period.