CHAPTER 8

accounting for receivables

CHAPTER STUDY OBJECTIVES

1. Prepare journal entries for accounts receivable transactions. Accounts receivable are recorded at the invoice price. Their amounts are reduced by sales returns and allowances and sales discounts. Accounts receivable subsidiary ledgers are used to keep track of individual account balances. When interest is charged on a past-due receivable, this interest is added to the accounts receivable balance and is recognized as interest revenue. Some retailers issue their own credit cards and these are accounted for as a type of accounts receivable transaction.

2. Demonstrate how to value accounts receivable and prepare adjusting journal entries for uncollectible accounts. Accounts receivable must be reported at their carrying amount on the balance sheet. The allowance method is used to record the estimated uncollectible accounts in the Allowance for Doubtful Accounts. The carrying amount of the receivables is equal to the gross accounts receivable minus the allowance. There are two approaches that can be used to estimate uncollectible accounts: (a) percentage of receivables, or (b) percentage of sales. The percentage of receivables approach emphasizes determining the correct carrying amount of the accounts receivable. An aging schedule is usually used with the percentage of receivables approach where percentages are applied to different categories of accounts receivable to determine the allowance for doubtful accounts. The percentage of sales approach emphasizes achieving the most accurate matching of expenses to revenues. A percentage is applied to credit sales to determine the bad debt expense.

When a specific account receivable is determined to be uncollectible, the account is written off and the allowance is reduced. When a previously written-off account is collected, the entry previously made to write off the account is reversed and the collection is recorded.

3. Prepare journal entries for notes receivable transactions. Notes receivable are recorded at their principal amount. Interest is earned from the date the note is issued until it matures and must be recorded in the correct accounting period. Interest receivable is recorded in a separate account from the note. Like accounts receivable, notes receivable are reported at their carrying amount.

Notes are normally held to maturity. At that time, the principal plus any unpaid interest is due and the note is removed from the accounts. If a note is not paid at maturity, it is said to be dishonoured. If eventual collection is still expected, an account receivable replaces the note receivable and any unpaid interest. Otherwise, the note must be written off.

4. Demonstrate the presentation, analysis, and management of receivables. Each major type of receivable should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts/notes is required to be reported in the balance sheet or the notes to the financial statements. Bad debt expense is reported in the income statement as an operating expense.

The liquidity of receivables can be evaluated by calculating the receivables turnover and collection period ratios. The receivables turnover is calculated by dividing net credit sales by average gross accounts receivable. This ratio measures how efficiently the company is converting its receivables into sales. The collection period converts the receivables turnover into days, dividing 365 days by the receivables turnover ratio. It shows the number of days, on average, it takes a company to collect its accounts receivable. The combination of the collection period and days sales in inventory is a useful way to measure the length of a company’s operating cycle.

Companies may accelerate the collection of cash by using the receivables to secure a loan or by selling the receivables.

Exercises

Exercise 1

McDougal Sales had the following transactions during 2021:

Jan 3 Sold merchandise with a cost of $ 2,900 to Fencing’s Co. for $ 4,500.

Jan 10 Fencing’s Co. returned one-third of the items they bought. The merchandise was returned to inventory for resale.

Jan 13 Fencing’s Co. paid the balance that was owed to McDougal.

Jan 20 Sold merchandise with a cost of $ 6,400 to Williamson for $ 10,000.

Jan 21 Williamson returned merchandise that was defective. The sales price of the returned items was $ 750 and had an original cost of $ 480. McDougal cannot resell the merchandise to other customers due to the defects.

Feb 21 Calculated and recorded interest charges on Williamson’s account. No further interest will be added until March 21.

Mar 3 Williamson paid the entire balance owing.

All sales terms are 2/10, n/30 unless otherwise indicated, and interest is charged at 18% on late accounts. Clayton uses a perpetual accounting system.

Instructions

Record the transactions described.

Exercise 2

On July 1, 2021, Massey Gifts had the following accounts receivable:

College Sales $ 1,950

Chutes Company 13,000

Burks Shell 2,600

Massey’s normal credit terms are 2/10, n/30 and interest on late accounts is 29%. Massey uses the periodic inventory system.

During July 2021, the following transactions occurred:

Jul 2 College purchased goods for $ 1,300, FOB destination.

Jul 3 The appropriate party paid $ 40 for freight on the College purchase.

Jul 11 Chutes paid one half of its account, within 30 days of the sale.

Jul 12 College paid its account in full.

Jul 15 Burks Shell purchased goods for $ 8,200, FOB shipping point.

Jul 15 The appropriate party paid $ 100 for freight on the Burks Shell purchase.

Jul 31 Interest was calculated and added to all accounts that are past due.

Instructions

a) Record Massey's July transactions.

b) Prepare a list of Massey’s accounts receivable at July 31, 2021.

Exercise 3

Joe’s Home Improvement Centre charges 19% interest on all unpaid Joe’s credit card transactions beyond 30 days. On August 31, Rico purchased merchandise totalling $ 6,500 from Joe. On September 30, Rico failed to pay off his Joe’s credit card balance of $ 6,500.

Instructions

Prepare all required journal entries for Joe’s Home Improvement Centre assuming the company uses a perpetual inventory system. Round all amounts to the nearest whole dollar and ignore any cost of goods sold entries.

Exercise 4

On June 1, Bridgette sold merchandise on account to Nepal for $ 16,000, terms 2/10, net 30. Bridgette has a stated return policy of 10 days from the date of sale. On June 10, Nepal returned merchandise with a sales price of $ 500. On June 11, Bridgette received payment from Nepal for the balance due.

Instructions

Prepare journal entries to record the transactions for Bridgette and ignore any cost of goods sold entries.

Exercise 5

Moca Capa Company sells beverage supplies. The company has a return policy of 10 days from the date of sale and uses the perpetual inventory system. The following transactions occurred during the month of November:

Nov. 4 Sold merchandise for $ 800 on account to Java Joe, terms 2/10, n/30. The original cost of the merchandise to Moca Capa was $ 300.

8 Java Joe returned goods with a selling price of $ 100 and a cost of $ 38. The goods are restored to inventory.

14 Received the correct payment from Java Joe.

Instructions

Prepare journal entries to record the transactions for Moca Capa Company.

Exercise 6

Revis Flooring has a December 31 year end and uses the perpetual inventory system. The following transactions occurred during 2021 and 2022:

2021

Aug 30 Sold goods with a cost of $ 8,250 to Jules Harrison for $ 14,500 on account, terms 2/15, n/30.

Oct 18 Jules ran into some financial troubles and reached an agreement with Revis to convert the account receivable into a 90-day, 8% note receivable.

Dec 18 Sold goods with a cost of $ 1,420 to Flore Hardy for $ 2,900 on account, terms 2/15, n/30.

Dec 31 Prepared the adjusting entries to record accrued interest and an estimated allowance for doubtful accounts of $ 2,750.

2022

Jan 2 Collected the amount due from Flore.

Jan 16 Jules dishonoured the note receivable. Revis expects to collect the account.

Dec 31 Wrote off the amount owing from Jules.

Instructions