Reporting and analyzing receivables

Chapter 8


Accounting for Receivables
• A receivable is a company’s claims for
money, goods, or services.
• An account receivable is classified as a
current asset representing money due
for services performed or merchandise
sold on credit.
• When an account becomes
uncollectible, a bad debt expense is
incurred.


Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:


Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:
Credit Sale:
Accounts Receivable
Sales Revenue

1,000
1,000

Example: Accounts Receivable
Assume merchandise is sold on account for $1,000.
The terms of the agreement were 2/10, n/30. The
entries are as follows:
Credit Sale:
Accounts Receivable..... 1,000
Sales Revenue.........

1,000

Collection--2/10,n/30:
Cash..............................
Sales Discounts.............
Accounts Receivable

1,000

980
20


Uncollectible Accounts
Some receivables will never be
collected and must be written off
as uncollectible.


Uncollectible Accounts

• Occurs when customers do not pay for
items or services purchased on credit.
• Bad Debts are uncollectible accounts
receivables.
• The uncollectible expense is placed on
the income statement as a selling
expense.


Two Methods of Accounting for
Uncollectible Accounts
•Direct Method
Or:

•Allowance Method


EXAMPLE:
If We Have $100,000 in A/R
Invoice
ABC Inc.

$

They would be represented by a
stack of invoices
Under the

Direct Method
• All invoices are presumed to be good . . .

• (Valued at $100,000)
• until we discover someone can’t pay
the amount owed.


Direct Method

Invoice
ABC Inc.

$

• When an invoice is discovered to
be uncollectible — it must be
removed from A/R.
• That is it must be expensed or
written off.


Direct Method

Invoice
ABC Inc.

$

Journal Entry to record Bad Debt:

Dr.
Bad Debt Expense

Accounts Receivable

Cr.

500
500


Direct Method

Invoice
ABC Inc.

$

Problem:
Accounts Receivable is reported at
the full $100,000 until bad debts are
specifically identified.
But, we know some customers in the
stack will not pay.
So, what is the real value of A/R?


Direct Method

Invoice
ABC Inc.

$

Like all assets, the value of A/R is
only what you expect to collect.

1. Accounts Receivable is overstated.
2. Bad debt expense is understated!
It is not recorded in the same period the sale
was made.


The Matching Principle
• Requires expenses be recorded in the
same period the corresponding revenue
is recognized.
Direct Method is in conflict with the
Matching Principle
Not accepted under GAAP


Under the

Allowance Method

Invoice
ABC Inc.

$

If We Have $100,000
in A/R

• We presume some invoices will not
be good . . .
• We just don’t know which ones.


Allowance Method
How do we write off an unknown
amount of Accounts Receivable?

ESTIMATE the amount,
but don’t remove any
invoices from A/R


Allowance Method

• An estimate can be based on:
a)
b)
c)
d)

Size of the receivables
Age of the receivables
Past loss experience
All of the above


Allowance Method

• An estimate can be based on:
a)
b)
c)
d)

Size of the receivables
Age of the receivables
Past loss experience
All of the above


Allowance Method
Assume you made an estimate that
$2000 will not be collectable. What
journal entry would you make?
Dr.

Cr.

Hint: Accounts Receivable is NOT reduced because
which invoices will become uncollectable is unknown!


Allowance Method
Dr.

Cr.

Bad Debt Expense
2000
Allowance for Doubtful Accounts
2000
To record estimated bad debts


Balance Sheet Presentation
Assets:
Cash
20,000
Accounts Receivable
100,000
Supplies
2,500
PP&E
3,000,000
Total Assets
3,120,500

The Allowance
for Doubtful
Accounts is a
contra asset
that follows A/R


Balance Sheet Presentation
Assets:
Cash

20,000
Accounts Receivable
100,000
Less Allowance for DA
2,000
Net Accounts Receivable
98,000
Supplies
2,500
PP&E
3,000,000
Note: Accounts Receivable is NOT reduced but the
Total
Assets is!
net receivable
3,120,500


Allowance Method
Journal Entry needed when an account
is identified as uncollectible:
Dr.

Cr.

Allowance for Doubtful Accounts 500
Accounts Receivable

500

To write off Smith Co. (in bankruptcy)


Direct vs. Allowance Methods
Direct Method
May 5

Bad Debt Expense

Dr.
500

Accounts Receivable

Allowance Method
Dec 31 Bad Debt Expense
Allowance for DA
May 5

Allowance for DA
Accounts Receivable

Cr.
500
The
difference is

Dr.

TIMING

Cr.

2000
2000
500
500


Allowance Method
(1) The Allowance for Doubtful Accounts is a
contra-asset account which is subtracted from
accounts receivable on the balance sheet.
(2) The actual write-off entry does not reduce net
receivables, as shown below:
Acct Receivable
$100,000
Less Allowance for
Doubtful Accounts
2,000
1,500
Net Receivables

$ 98,000

Acct Receivable
$99,500
Less Allowance for
Doubtful Accounts
Net Receivables

$98,000