06/01/2014

Accounting Principles
Receivables

Learning objectives

Define and explain common types of receivables and review

internal controls for receivables

Describe how bad debts arise

Use the allowance method to account for bad debts

Use the direct write-off method to account for bad debts

Journalise credit card and debit card sales

Account for bills receivable

Report receivables on the balance sheet and evaluate a business

using the acid-test ratio, days sales in receivables and the
accounts receivable turnover ratio

Receivables: An introduction

A receivable arises when a business (or person) sells goods or

services to a second business (or person) on credit

The receivable is the sellers claim against the buyer for the
amount of the transaction

The creditor sells goods or a service and obtains a receivable

The debtor makes the purchase and takes on an

obligation/payable (a liability)

The two main types of receivables are accounts receivable and

bills receivable

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Receivables: An introduction

Accounts receivable, sometimes called trade receivables or

trade debtors, are amounts to be collected from customers from
sales made on credit

Bills (and notes) receivable are more formal than accounts

receivable. The debtor in a bill or note receivable arrangement
promises in writing that the creditor will be paid a definite sum
at a specific future date

A promissory note is a special type of bill receivable

Accounting for bad debts (uncollectable accounts)

Some customers do not pay, and that creates an expense called

a bad debt expense, doubtful debt expense or uncollectable
account expense

There are two methods of accounting for uncollectable

receivables, namely the allowance method and the direct writeoff method

The allowance method

It is based on the matching principle, which requires that the

bad debts expense is recorded in the same period as the sales
revenue

The offset to the expense is a contra account called Allowance

for doubtful debts (or the Allowance for bad debts)

The Allowance account shows the amount of the receivables

that the business expects not to collect and reduces Accounts
receivable

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The allowance method

The more accurate the estimate of bad debts, the more reliable
the information in the financial statements

Businesses use their past experience as well as considering the

economy, the industry they operate in and other variables

There are two basic ways to estimate bad debts, namely

percentage of sales method and ageing of accounts receivable
method

The allowance method

The percentage of sales method calculates bad debts expense

as a percentage of net credit sales

This method is also called the income statement approach

because it focuses on the amount of expense to be reported on
the income statement

Bad debts expense is recorded as an adjusting entry at the end

of the period

Date

Account title

Dr

Mar 31

Bad debts expense (E+)

300

GST clearing (L)

30

Allowance for doubtful debts (CA+)

Cr

330

Recorded bad debts expense for the period.

The allowance method

The ageing of accounts method is also called the balance sheet
approach because it focuses on the actual age of the accounts
receivable and determines a target allowance balance from that
age

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The allowance method

The allowance method

When a specific customer account is identified as uncollectible, it is
written off to the allowance account
Date

Account title

Dr

Jul 15

Allowance for doubtful debts (CA)

200

Cr

Accounts receivableAndrews (A)

80

Accounts receivableJones (A)

120

Wrote off doubtful debts.

The allowance method

Sometimes a customer will pay the amount owed after the
customers account is written off. To account for this recovery, the
business must reverse the effect of the earlier write-off to the
Allowance account and record the cash collection.
Date

Account title

Dr

Sep 4

Accounts receivableAndrews (A+)

80

Allowance for doubtful debts (CA+)

Cash (A+)
Accounts receivableAndrews (A)

Cr
80

80
80

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The direct write-off method

Under the direct write-off method of accounting for bad debts,

the business waits until it decides that a customers account
receivable is uncollectable

The accountant then debits Bad debts expense and credits the
customers Account receivable to write off the account

Date

Account title

Dr

Jul 15

Bad debts expense (E+)

200

Cr

Accounts receivableAndrews (A)

80

Accounts receivableJones (A)

120

Wrote off a bad debt.

The direct write-off method

To account for this recovery, the business must reverse the effect
of the earlier write-off to the Bad debts expense account and
record the cash collection
Date

Account title

Dr

Sep 4

Accounts receivableAndrews (A+)

80

Bad debts expense (E)

Cash (A+)
Accounts receivableAndrews (A)

Cr
80

80
80

Credit and debit card sales

Credit card sales are an alternative form of receiving payment

from a customer

There are two main types of credit cards, namely credit cards
that are issued by a financial institution (bank or credit union)
and credit cards that are issued by a credit card company

Credit cards offer customers the convenience of buying without

having to pay the cash immediately

Debit cards are fundamentally different from credit cards

Businesses hire a third-party processor to process credit and

debit card transactions

Transactions are usually entered into an electronic terminal

(card scanner) that the business either purchases or rents from
the processor

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Bills receivable

Bills of exchange are commonly used where foreign trade is

concerned, with businesses selling goods or services in
exchange for bills receivable

A promissory note is defined as an unconditional promise in

writing, signed by the maker, engaging to pay, on demand or at
a fixed or determinable future time, a sum certain in money, to
or to the order of a specified person, or to bearer

A bill of exchange is defined as as an unconditional order in

writing, addressed by one person to another, signed by the
person giving it, requiring the person to whom it is addressed to
pay on demand, or at a fixed or determinable future time, a
sum certain in money to or to the order of a specified person or
bearer

Bills receivable

Identifying a bills maturity date

Maturity date can be a specific date

Maturity date can be stated in terms of number of months

Maturity date can be stated in terms of number of days

The formula for calculating interest is

Principal

Interest
rate

Time

Amount
of
interest

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Recording bills receivable

Date

Account title

Dr

Oct 20

Bill receivable - Dorman Builders (A+)

15000

Cr

Sales revenue (R+)

15000

To record sale.
Jan 18

Cash (A+)

15 370

Bill receivableDorman Builders (A)

15 000

Interest revenue
($15 000 0.10 90/365) (R+)

370

To record collection at maturity.

Recording bills receivable

A business may, by agreement, draw a bill receivable on a trade
customer who fails to pay an account receivable within the
customary 3060 days
Date

Account title

Dr

Oct 1

Bill receivableInterlogic (A+)

2400

Accounts receivableInterlogic (A)

Cr
2400

To draw a bill on account on a customer.

Accruing interest revenue

Date

Account title

Dec 31 Interest receivable

($2 400 0.09 3/12) (A+)

Dr

Cr

54

Interest revenue (R+)

54

To accrue interest revenue earned in

2015 but not yet received.
Sep 30 Cash [$2 400 + ($2 400 0.09)] (A+)
Bill receivableInterlogic (A)

2616
2400

Interest receivable (A)

54

Interest revenue (R+)

162

To collect bill receivable on which

interest has been previously accrued.

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Discounting a bill receivable

Dishonoured bills receivable

If the debtor of a bill doesnt pay a bill receivable at maturity,

the debtor is said to dishonour, or default on, the bill

As the term of the bill has expired, the original agreement is no

longer in force, and no one will buy the bill

However, the payee still has a claim against the debtor and
usually transfers the claim from the Bills receivable account to
Accounts receivable

The payee records interest revenue earned on the bill and

debits Accounts receivable for the full maturity value of the bill

Using accounting information for decision making

In making decisions, owners and managers use some ratios

based on the relative liquidity of assets

A measure of the firms ability to pay current liabilities is the

acid-test (or quick) ratio

The acid-test ratio tells whether the entity could pay all its
current liabilities if they came due immediately

Acid-test ratio = (Cash + Short-term + Net current investments

receivables) / Total current liabilities

The higher the acid-test ratio, the better the business is able to
pay its current liabilities

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Using accounting information for decision making

After a business makes a credit sale, the next critical event in

the business cycle is collection of the receivable

Days sales in receivables, also called the collection period,

indicates how many days it takes to collect the average level of
receivables

The number of days in average accounts receivable should be

close to the number of days customers are allowed to pay

The shorter the collection period, the more quickly the

organisation can use cash for operations

Using accounting information for decision making

The accounts receivable turnover ratio measures the number of

times the business sells and collects the average receivables
balance in a year

The higher the ratio, the faster the cash collections

Accounts receivable turnover ratio = Net credit sales / Average

net accounts receivable

Summary:

A receivable arises when a business (or person) sells goods or

services to a second business (or person) on credit

The two main types of receivables are accounts receivable and

bills receivable

There are two methods of accounting for uncollectable

receivables, namely the allowance method and the direct writeoff method

The allowance method is based on the matching principle, which

requires that the bad debts expense is recorded in the same
period as the sales revenue

Under the direct write-off method of accounting for bad debts,

the business waits until it decides that a customers account
receivable is uncollectable

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Summary:

Bills of exchange are commonly used where foreign trade is

concerned, with businesses selling goods or services in
exchange for bills receivable

In making decisions, owners and managers use some ratios

based on the relative liquidity of assets

Common ratios are acid-test (or quick) ratio, collection period,

and accounts receivable turnover ratio

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