Receivables, Bad Debt, and Interest Reporting

Chapter 8

Reporting and
Interpreting Receivables,
Bad Debt Expense, and
Interest Revenue

Learning Objectives
1. Describe the trade-offs of extending
credit.
2. Estimate and report the effects of
uncollectible accounts.
3. Compute and report interest on notes
receivable.
4. Compute and interpret the receivables turnover
ratio.

Sales on Account
 When companies allow customers to purchase
merchandise on an open account, the customer
agrees to pay the company in the future
 For sales on account, credit is extended without a
formal note for a short period (30 to 60 days)
 Although cash is not received initially, if collection is
reasonably certain, sales revenue and an account
receivable are recorded at the time of the sale.
 Advantages: Increases the seller’s revenues.
 Disadvantages:
 Increased wage costs.
 Bad debt costs.
 Delayed receipt of cash.

Accounting for Bad Debts

Bad debts result from credit customers
who will not pay the business the amount
they owe, regardless of collection efforts.

Bad debts are likely to be discovered in
periods after the credit sale.
If bad debts are not reported until discovered,
income is distorted in the periods of sale as
well as in the period of bad debt discovery.

Year 1 Year 2
(Credit Sale Occurs) (Bad Debt discovered)
Revenues $ 10,000 Revenues 0
Cost of goods sold 6,000 Cost of goods sold 0
Bad debt expense 0 Bad debt expense 1,000
Net income $ 4,000 Net income $ (1,000)

Can you find any problem in this example?


Bad Debt
Expense
Matching Record in same
Principle accounting period.

Sales Revenue

Accounts receivable should be carried at
net realizable value

Allowance Method for
Uncollectible Accounts
Allowance method follows a two-step
process:
1. It records an estimated bad debt expense
in the period when the related sales take
place, by making an adjusting journal entry
at the end of that period.
2. It removes (write off) accounts receivable
in the period they are determined to be
uncollectible.


Revision of the example using Allowance Method: in Year
1, suppose the firm estimated and recorded a bad debt
expense $1,000.

Year 1 Year 2
(Credit Sale Occurs) (Bad Debt discovered)
Revenues $ 10,000 Revenues 0
Cost of goods sold 6,000 Cost of goods sold 0
Bad debt expense 1,000 Bad debt expense -
Net income $ 3,000 Net income $ -

Recording Bad Debt Expense
Estimates
Timberland estimated bad debt expense for
2009 to be $2,000,000.
Prepare the adjusting entry.

GENERAL JOURNAL Page 78
Date Description Debit Credit
Dec. 31

Recording Bad Debt Expense
Estimates
Timberland estimated bad debt expense for
2009 to be $2,000,000.
Prepare the adjusting entry.

Bad Debt Expense is normally classified as aPage 78
GENERAL JOURNAL
Date selling expense and is closed at year-end. Credit
Description Debit
Dec. 31 Bad Debt Expense (+E, -SE) 2,000,000
Allowance for Doubtful Accounts(-A) 2,000,000

Contra asset account

Allowance for Doubtful Accounts

Balance Sheet Disclosure

Accounts receivable 67,000,000
Less: Allowance for doubtful accounts (2,000,000)
Net realizable value of accounts receivable 65,000,000

Amount the business
expects to collect.

Writing Off Uncollectible Accounts

When it is clear that a specific
customer’s account receivable will be
uncollectible, the amount should be
removed from the Accounts Receivable
account and charged to the Allowance for
Doubtful Accounts.


Timberland’s total write-offs for
2009 were $1,480,000.
Prepare a summary journal
entry for these write-offs.



Timberland’s total write-offs for
2009 were $1,480,000.
Prepare a summary journal
entry for these write-offs.

Allowance for Doubtful Accounts(+A) 1,480,000
Accounts Receivable(-A) 1,480,000


Assume that before the write-
off, Timberland’s Accounts Receivable
balance was $81,000,000 and the
balance was $2,000,000.

Let’s see what effect the total write-offs
of $1,480,000 had on these accounts.


Before Write- After Write-
Off Off
Accounts receivable $ 81,000,000 $ 79,520,000
Less: Allow. for doubtful accts. (2,000,000) (520,000)
Net realizable value $ 79,000,000 $ 79,000,000

Notice that the total write-offs of $1,480,000 did not
change the net realizable value nor did it affect any
income statement accounts.

Write-off of Uncollectible Accounts
 Write-off of A/R deemed uncollectible
DOES NOT create an expense.
 Write-offs decrease A/R and the Allowance
for Doubtful Accounts by like
amounts, therefore it DOES NOT affect the
net receivable balance.
 There is no net effect on the total assets

Allowance Method Recap
 The ADA is a contra-asset that is subtracted
from accounts receivable
 It is “fed” with bad debt expense
 It is “eaten up” by account write-offs

Allowance for
doubtful accounts

Bad debt Write-
expense offs

Summary of allowance method
Step Timing Accounts F/S effects

1.Record End of Bad debts E Net Income
estimated period in
bad debts which sales ADA Assets
adjustment are made

2. Identify Throughout Accounts R Net income (N)
And write period as
off actual bad debts ADA Assets (N)
bad debts become known

Methods for Estimating Bad Debts
 Income Statement Approach
 Percent of Credit Sales

 Balance Sheet Approach
 Aging of Accounts Receivable

????

Percentage of Credit Sales

Bad debt percentage is based
on actual uncollectible accounts
from prior years’ credit sales.

Focus is on determining the amount to
record on the income statement as
Bad Debt Expense.


Net Credit Sales
 % Estimated Uncollectible
Amount of Journal Entry

In 2009, Kid’s Clothes had credit sales of
$60,000. Past experience indicates that
bad debts are one percent of credit
sales.
What is the estimate of bad debts
expense for 2009?

In 2009, Kid’s Clothes had credit sales of
$60,000. Past experience indicates that
bad debts are one percent of credit
sales.
What is the estimate of bad debts
expense for 2009?
$60,000 × .01 = $600
Now, prepare the adjusting entry.


Dec. 31 Bad Debt Expense 600
Allowance for Doubtful Accounts 600

Methods for Estimating Bad Debts
% of Sale method
Net Credit Sales

Bad debt expense XXX
Allowance for doubtful accounts XXX

Allowance for doubtful accounts
Existing Balance
Aging of A/R method XXX adjustm ent

Accounts Receivable *
% estimated uncollectible End. Balance
Desired balance in ADA

Balance Sheet Approach
1. Determine the amount of A/R that are expected
to be uncollectible
2. This is equal to the required ADA balance
3. If existing ADA balance is not high enough then
increase the balance by recognizing bad debt
expense
Hint: Use of t-accounts is
very helpful here!

Allowance for doubtful accounts
Existing Balance
Aging of A/R method
XXX adjustm ent
Accounts Receivable *
% estimated uncollectible
End. Balance
Desired balance in ADA

Aging Schedule

Each customer’s account is aged by
breaking down the balance by
showing the age (in number of days)
of each part of the balance.

An aging of accounts receivable for
Kid’s Clothes in 2009 might look like
this . . .

Aging Schedule
Days Past Due
Total
Not Yet A/R
Customer Due 1-30 31-60 61-90 Over 90 Balance
Aaron, R. $ 235 $ 235
Baxter, T. $ 1,200 300 1,500
Clark, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325
Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660

Based on past experience, the business
estimates the percentage of uncollectible
accounts in each time category.

Aging Schedule
Days Past Due
Total
Not Yet A/R
Aaron, R. $ 235 $ 235
Baxter, T. $ 1,200 300 1,500
Clark, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325
Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660
% Uncollectible 0.01 0.04 0.10 0.25 0.40

These percentages are then multiplied
by the appropriate column totals.

Aging of Accounts Receivable
Days Past Due
Record the Dec. 31, 2009, adjusting Total
entry assuming that the Allowance A/R
Not Yet
Aaron, R. for Doubtful Accounts currently has $ 235
$ 235 a
Baxter, T. $50 300
$ 1,200 credit balance. 1,500
Clark, J. $ 50 $ 200 $ 500 750

Zak, R. 325 325
Total $ 3,500 $ 2,550 $ 1,830 $ 1,540 $ 1,240 $10,660
% Uncollectible 0.01 0.04 0.10 0.25 0.40
Estimated
Uncoll. Amount $ 35 $ 102 $ 183 $ 385 $ 496 $ 1,201

Allowance for
Kids clothes’ balance in the Doubtful Accounts
allowance account is credit $50. 50
1,151
We estimated the proper 1,201
balance to be $1,201.

Post.
Date Description Ref. Debit Credit
Dec. 31 Bad Debt Expense 1,151
Allowance for Doubtful Accounts 1,151

What if the existing balance of ADA is debit??


50 Balance at
12/31/2003
before adj.
1,251 2003 adjustment
1,201 Balance at
12/31/2003
after adj.

Accounts Receivable
Desired Balance in Allowance Account
- Allowance Account Credit Balance
Accounts Receivable
Desired Balance in Allowance Account
+ Allowance Account Debit Balance

Summary of Methods to Estimate Bad Debts

Income
Balance Sheet
Statement
Approach
Approach
Emphasis on Emphasis on Net
Matching Realizable Value

Sales Accts.
Bad Rec. All. for
Debts Uncoll.
Exp. Accts.

Income
Balance Sheet
Statement
Focus
Focus

Recovery of a Bad Debt
Subsequent collections on accounts written
off require that the original write-off entry be
reversed before the cash collection is
recorded.

DR CR
Feb. 8 Accounts Receivable - Martin 300
Allowance for Doubtful Accounts 300
To reinstate account previously written off

Feb. 8 Cash 300
Accounts Receivable - Martin 300
To record full payment on account

Notes Receivable

Accounts receivable do not
charge interest until they
become overdue, but notes
A note is a receivable start charging
written interest the day they are created.
promise to
pay a
specific
amount at a
specific
future date.

Notes Receivable
Term
$1,000.00 July 10, 2007
Payee
Ninety days after date I promise to pay to
the order of Barton Company, Los Angeles, CA
One thousand and no/100 --------------------------------- Dollars

Payable at First National Bank of Los Angeles, CA
Maker
Value received with interest at 12% per annum

No. 42 Due Oct. 8, 2007 Julia Browne

Notes Receivable

$1,000.00 July 10, 2007

Ninety days after date I promise to pay to
thePrincipal Barton Company, Los Angeles, CA
order of
One thousand and no/100 --------------------------------- Dollars

Payable at First National Bank of Los Angeles, CA
Interest Rate
Value received with interest at 12% per annum
No. 42 Due Oct. 8, 2007 Julia Browne

Due Date

Interest Computation

Interest is the compensation to the
lender for giving up the use of money
for a period of time.
To the lender, interest is a revenue.
To the borrower, interest is an expense.

Interest (less than one year)
Computation

Principal Annual Time
of the × interest × expressed = Interest
note rate in years

Even for Number of
maturities less months out of
than one year, twelve
the rate is that interest
annualized. period covers.

Computing Maturity and Interest
On March
1, 2009, Matrix, Inc.
purchased a copier for
$12,000 from Office
Supplies, Inc. Matrix
gave Office Supplies a
9% note due on May
30, 2009 in payment
for the copier.

Computing Maturity and Interest

Principal Annual Time
of the × interest × expressed = Interest
note rate in years

$ 12,000 × 9% × 3/12 = $ 270

Total interest due
at May 30.

Recognizing Notes Receivable
Here are the entries to record the note on
March 1, and the settlement on May 30, 2009.

DR CR
Mar. 1 Notes Receivable 12,000
Sales 12,000
Sold goods in exchange for note

DR CR
May 30 Cash 12,270
Interest Revenue 270
Notes Receivable 12,000
Collected note and interest due

Recording End-of-Period Interest
Adjustments

When a note
receivable is
outstanding at the
end of an accounting
period, the company
must prepare an
adjusting entry to
accrue interest
income.

Reporting Interest on
Notes Receivable
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.

Record Record interest
note Accrue and principal
receivable interest received

2007 Interest 2008 Interest

11/01/07 12/31/07 10/31/08

Recording Notes Receivable on Nov. 1
On November 1, 2007, Skechers loaned $100,000
cash and accepted a $100,000 one-year, 12
percent note. Skechers will receive the principal
and all interest earned on October 31, 2008.

On November 1, to record the note:
Accounts Debit Credit
Note Receivable (+A) 100,000
Cash (-A) 100,000

Accruing Interest Earned at fiscal year
end (12/31/2007)

$ 100,000 12% 2/ = $ 2,000
× × 12

On December 31, to accrue $ 2,000 interest receivable:

Interest Receivable (+A) 2,000
Interest Revenue (+R, +SE) 2,000

Recording Interest Received and Principal at
Oct 31, 2008
On October 31, to record $112,000 cash received:

 $100,000 principal (note receivable)
 $2,000 interest receivable (2007 interest revenue)
 $100,000 x 12% x 10/12 = $10,000 (2008 interest revenue)

Cash (+A) 112,000
Interest Revenue (+R, +SE) 10,000
Interest Receivable (-A) 2,000
Note receivable (-A) 100,000

Quick check
 On July 1, Barton Co. received a $1,000, 3
months, 10% note in exchange for merchandise sold to
a customer (the merchandise cost was $600).
Perpetual inventory system.
Notes receivable $1,000
Sales revenue $1,000

Cost of Goods sold $600
Inventory $600

 On Sep 30, the customer paid interest and principal on
the note. $1,000 × 10% × 3/12 = $25

Cash $1,025
Interest revenue $25

 On Nov 1, received $2,000 cash plus a one
year, 12 %, $10,000 note from another customer
in exchange for merchandise (its cost was
$8,000).
Cash $2,000
Sales revenue $12,000

Cost of Goods sold $8,000
Inventory $8,000

 On Dec 31, prepare the adjusting entry for the
above note $10,000 × 12% × 2/12 = $200
Interest receivable $200
Interest revenue $200

 On Oct 31 of the next year, received interest and
principal on the note.
Cash $11,200
Interest revenue $1,000
Interest receivable $200

Accounts Receivable Turnover

Accounts Net Sales
Receivable = Average Net Accounts Receivables
Turnover

This ratio measures how many times average
receivables are recorded and collected for the year.

Accounts Receivable Turnover
Receivable Net Sales
Turnover = Average Net Accounts Receivables

Receivable $1,091,478,000
=
Turnover ($105,727,000 + $78,696,000) ÷ 2
= 11.8 times

Timberland reported 2008 net sales of $1,091,478,000.
December 31, 2007, net receivables were $78,696,000 and
December 31, 2008, net receivables were $105,727,000.

In-class problem #1
At the start of 2009, Accounts receivable showed a
$35,000 debit balance, and the Allowance for doubtful
accounts showed an $1,000 credit balance. During the
year of 2009, the firm had sales revenue of
$200,000, of which $100,000 was on credit.
Collections of accounts receivable during 2009
amounted to $88,000.
(a) On April 5, 2009, a customer balance of $1,500 from a
prior year was determined to be uncollectible, so it
was written off.
(b) On December 31, 2009, the firm estimated bad debt
expense for 2009 to be $2,000.

Give the required journal entries for the two
events, Show how the amounts related to Accounts
receivable and Bad debt expense would be reported
on the balance sheet and income statement for 2009.

In class problem #2
Barton’s year-end unadjusted trial balance
shows accounts receivable of
$1,000, allowance for doubtful accounts of
$6 (debit), and credit sales of
$2,000, uncollectibles are estimated to be
1% of credit sales. Prepare the year-end
adjust entry for uncollectibles. Show the
A/R accounts in B/S.

In-class problem #3
Suppose the beginning balance of A/R is $55,000, and
ADA is $290 (credit). Assuming Perpetual inventory
system. During the period.
 Writes off a $750 account receivable arise from a sale
to Briggs Co. the dates to 10 months ago.
 Received the full amount of $750 from Briggs Co. that
was previously written off.
 Collected cash $5,250 from A/R.
 Sold $7,000 of merchandise to customers on
credit, which cost the firm $4,000.
In the end of the period, the company estimated 1% of
accounts receivable bill be uncollectible.
Give the required journal entries and show how the
Accounts receivable and Bad debt expense would be
reported on the balance sheet and income statement.

In-class problem #4

Q1) The unadjusted balance of the allowance for doubtful accounts of
Johnstone Supplies, Inc., is a credit balance in the amount of
$20,000 on July 31, 2005, its fiscal year end. Assuming that
Johnstone uses the accounts receivable aging report, prepare the
adjusting journal entry to report bad expense.
Q2) August 5, 2005: YOC corporation, Johnstone’s customer, filed
bankruptcy. Accordingly, Johnston writes off $10,000 account
receivable from YOC. Prepare a journal entry to record the account
receivable write-off.
Q3) October 15, 2005: Based on the bankruptcy court’s
decision, Johnstone collects $5,000 accounts receivable from YOC
that they previously wrote off. Prepare a journal entry to record
the recovery of the accounts receivable.

Receivables, Bad Debt, and Interest Reporting

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