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Chapter 8

Chapter 8 Notes

Financial Accounting
Course Code
G.Quan Fun

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Chapter 8 Reporting and Analyzing Receivables Notes
Types of Receivables
x the term “receivables” refers to amounts that are due from individuals and other companies
x receivables are claims that are expected to be collected in cash, and they are frequently classified as (1) accounts receivable, (2)
notes receivable, and (3) other receivables
x accounts receivable : amounts owed by customers on account; result from sale of goods and services
x these receivables are generally expected to be collected within 30 days or so, and are classified as current assets; they are usually
the most significant type of claim held by a company
x notes receivable : claims that are backed up by formal instructions of credit that are issued as evidence of the debt
x the credit instrument normally requires the debtor to pay interest and is for time periods of 30 days or longer
x notes receivable may be either current assets or non-current assets , depending on their due dates
x trade receivables : notes and accounts receivable that result from sales transactions
x other receivables include credit card receivables, interest receivable, loans to company officers, advances to employees, and
recoverable sales taxes and income taxes
x all of these different types of receivables are generally classified and reported as separate items in the current or non-current
assets section of the balance sheet, according to their due dates
Accounts Receivable
Recognizing Accounts Receivable
x the first step in recognizing an account receivable is straightforward
x for a service company, a receivable is recorded when a service is provided on account
x for a merchandising company, a receivable is recorded at the point of sale of merchandise on account
x revenue (and any related receivable) should be recognized when the sales effort is substantially complete
x this normally occurs either when the service is performed or when the good is delivered at the point of sale
x in addition, collection must be reasonably certain and measurable
x receivables are created by services or sales on account and reduced by sales discounts and sales returns
Accounts Receivable Subsidiary Ledger
x subsidiary ledger : a group of accounts that provide details of a control account in the general ledger
x unlike general ledger, which has single account for receivables, subsidiary ledger has receivable account for each customer
x the total of all the customer accounts in the subsidiary ledger should equal the total in the general ledger receivable account
x the subsidiary ledger provides supporting detail to the general ledger, freeing it from excessive detail
x it is common to have subsidiary ledgers for accounts receivable (to track individual customer balances), inventory (to track
inventory quantities and balances), accounts payable (to track individual creditor balances), and payroll (to track individual
employee pay records)
x in the case of an accounts receivable subsidiary ledger, it contains all the individual customer receivables accounts
x control account : an account in the general ledger that summarizes the details for a subsidiary ledger and controls it
x at all times, control account balance must equal total of all the individual customer receivables balances in the subsidiary ledger
x under this system of control and subsidiary accounts, each journal entry that affects accounts receivable must therefore be posted
twice—once to the subsidiary ledger account and once to the general ledger control account
x entries to the general ledger are normally summarized and posted monthly in a manual accounting system
x in a computerized accounting system, the posting to both ledgers occurs simultaneously
Interest Revenue
x at the end of each month, the company can use the subsidiary ledger to easily determine the transactions in each customer’s
account and then sends the customer a statement of transactions that occurred that month
x if customer does not pay in full within specified period of time, most retailers add interest (financing) charge to the balance due
x when financing charges are added, the seller recognizes interest revenue and increases the AR amount owed by the customer
x this can be a substantial amount for some service and merchandising companies
Valuing Accounts Receivable
x each customer must satisfy seller’s credit requirements before credit sale is approved, inevitably some AR become uncollectible
x credit losses are debited to an account called Bad Debts Expense (BDE)
x credit losses are considered a normal and necessary risk of doing business
x the key issue in valuing accounts receivable is when to recognize these credit losses
x if the company waits until it knows for sure that the specific account will not be collected, it could end up recording the bad
debts expenses in a different period than when the revenue was recorded
x if bad debt expenses are not recorded until they occur, no attempt is made to match this expense to sales revenue in the SE
x in addition, AR in the balance sheet are reported at the amount actually expected to be collected
x allowance method : method of accounting for bad debts that involves estimating uncollectible accounts at end of each period
x Allowance for Doubtful Accounts is a contra asset account that shows receivables that are expected to become uncollectible
x a contra account is used instead of a direct credit to Accounts Receivable for two reasons
1. it is not known which individual customers will not pay
2. the balance in Allowance for Doubtful Accounts (ADA) is just an estimate
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