Accounts Receivable

Receivable is an amount due from another party.
The two most common receivables are accounts receivable and notes receivable. Other receivables include interest receivable, rent receivable, tax refund receivable, and receivables from employees.

amounts due from customers for credit sales.
A/R Account is an current asset account and increased with Debit

Credit sale is recorded by debiting A/R Account.
A company must maintain separate account for each customer that tracks how much that customer purchases, has already paid, and still owes.

general ledger (Balance Sheet) continues to have a single A/R account called a control account, but a supplementary record is created to maintain a separate account for each customer. This record is called the A/R ledger (or A/R subsidiary ledger)

Credit sales
A/R-debit
      Sales-credit
Collection from prior credit sales
Cash - debit
      A/R credit

If Company has $100 of CC sales with 4% fee and $96 cash is received immediately on deposit, the entry is
Cash (debit)....................................................96
Credit Card Expense (debit)..........................4
      Sales (credit)....................................................100

If Company must remit electronically CC sales receipts to the CC Company and wait for the cash payment, the entry on the date of sales is
A/R-Credit Card Co. (debit)............................96
Credit Card Expense (debit)............................4
      Sales (credit)..................................................100

When cash is later received
Cash (debit).....................................................96
      A/R -Credit Card Co. (credit)............................96

amounts owed by customers from credit sales for which payment is required in periodic amounts over an extended time period. Although installment A/R have credit period of more then one year, they are classified as current assets if the seller regularly offers customers such terms.

records the loss from an uncollected accounts receivable when it is determined to be uncollected. No attempt is made to predict bad debt expense. 

If Company determines that it can not collect $520 owed by its customer, recognizes loss as follows:
Bad Debt Expense (debit)..................520
  A/R (credit)........................................................520
The debit in this entry charges the noncollectable amount directly to the current period's Bad Debt Expense account. The Credit removes its balance from the A/R account in the general ledger (and its subsidiary ledger)

If the account that was written off directly to Bad Debt Expense is later collected in full. Following entries record this recovery:
A/R (debit)......................................520
      Bad Debt Expense (credit).................520
  To reinstate A/R previously written off
Cash (debit)....................................520
      A/R (credit)........................................520
  To record full payment of account

when using Direct write off method we at least need to consider 2 accounting concepts:

1. matching principle
   
2. materiality constraint

requires expenses to be reported in the same accounting period as the sales they helped produce. This means that if extending credit to customers helped produce sales, the bad debt expense linked to those sales is matched and reported in the same period. Direct write off usually does nor best match sales there required a company to estimate future uncollectibles.

this constraint states that an amount can be ignored if its effect on the financial statement is unimportant to users' business decisions. Constrain permits the use of the direct write-off method when bad debt expenses are very small in relation to a company's other financial statement items such as sales and net income. 

the allowance method matches the estimated loss from uncollectible a/r against the sales they helped produce.We must use estimated losses because when sales occur, management does not know which customers will not pay their bills. This means that at the end of each period, the allowance method requires an estimate of the total bad debts expected to result from that period's sales

Direct write off method - the future when account is deemed uncollectable

Allowance Method - current period to yield realizable A/R Balance

Allowance for Doubtful Accounts is contra asset account. A contra asset account is used instead of reducing a/r directly because at the time of the adjusting entry, the company does not know which customers will not pay. The AFDA account credit balance has the effect of reducing a/r to its estimated realizable value

refers to the expected proceeds from converting an asset into cash. The amount of the outstanding balances in accounts receivable that will ultimately be collected. In the balance sheet, the AFDA is subtracted from A/R and is often reported as shown
Current Assets
  Accounts Receivable...............................................20,000
  Less Allowance for doubtful accounts    1500
                                                                  18500

when specific accounts are identified as uncollectable, they are written off against the Allowance for doubtful accounts. Company decides that client's $520 account is uncollectible and makes following entry to write it off
Allowance for doubtful accounts..............520
  Accounts Receivable.........................................520
The Bad Debt expense account is not debited in the write-off entry because it was recorded in the period when sales occurred

The write-off does not affect the realizable value of a/r. Neither total assets not net income is affected by the write -off of a specific account. Instead both assets and net income are effected in the period when bad debt expense is predicted and recorded with adjusting entry.
                            Before Write-off      After write off
A/R.........................20,000                    19,480
Less allowance........1,500                      980
Estimated A/R      18,500                    18,500

When customer pays all or part of the amount owed. after write off. A/R............................................520       Allowance for DD..................520 To reinstate account previously written off Cash........................................520       A/R.....................................................520 To record full payment of accounts

if company used a collection agency and paid a 35% commission on $520 collected from client. Cash.........................................338 Collection Expense.......182       A/R.....................................................520

there are 2 common methods

1. one is based on the income statement relation between bad debt expense and sales
2. second is based on the balance sheet relation between A/R and the allowance for doubtful accounts

referrers to as the income statement method, is based on the idea that a given percent of a company's credit sales for a period is uncollected. Focus on credit sales because cash sales do not produce bad debts. If cash sales are a small or stable percent of credit sales, total sales can be used.

Company has credit sales of $400,000 in year 2013, base on experience estimate 0.6% of sales to be uncollectible. This implies that $2,400 ($400,000*0.006) of bad expense Bad debts expense............................................2400     Allowance for DD...........................................2400 To record estimated bad debts. The allowance account ending balance on the Balance sheet would rarely equal the bad debts expense on the income statement

Also referred to as balance sheet method, A method of estimating uncollectible receivables by determining the balance of the Allowance for Bad Debts account based on a percentage of accounts receivable.

make the Allowance for DA balance equal to the portion of A/R that is estimated to be uncollectible. The estimated balance for the Allowance account is obtained either by

1. computing the percent uncollectible from the total of A/R
2. aging A/R

this method assumes that a given percent of a company's A/R is collectible. This percent is based on past experience and is impacted by current economic conditions. The total dollar amount of all receivables is multiplied by this percent to get the estimated amount of uncollectible accounts - reported in the Balance Sheet as the Allowance for Doubtful Accounts

Company has $50,000 of A/R . Experience suggests 5% of it is uncollectible. Bad debt expense.......................2500     Allowance for DA......................2500 to record estimated bad debt When using an A/R method of estimating uncollectibles, the allowance account balance is adjusted to equal the estimate of uncollectibles.

this method uses both past and current receivables information to estimate the allowance amount. Specifically, each receivable is classified by how long it is past its due date. Then estimates of uncollectible amounts are made assuming that the longer an amount is past due, the more likely it is to be uncollectible. Classification is often based on 30-day period

after the amounts are classified (or aged), experience is used to estimate the percent of each uncollectible class. These percents are applied to the amounts in each class and then totaled to get the estimated balance of the Allowance for Doubtful Accounts. The aging of A?R method is an examination of specific accounts and is usually the most reliable of the estimation methods

a debit balance implies that write-offs for that period exceed the total allowance. 

1. Percent of sales, with its income statement focus , does a good job at matching bad debts expense with sales.
   
2. The accounts receivable methods, with thier balance sheet focus, do a better job at reporting accounts receivable at realized value.
3. 
   

written promise to pay a specific amount of money, usually with interest, either on demand or at a definite future date. Sellers sometime ask for a note to replace an a/r account when a customer requests additional time to pay a past-due account. usually when the credit period is long and the receivable is for a large amount. In case of lawsuit note is written acknowledgement of the debt, its amount, and its terms. 

The original (specified) amount of money borrowed.

The person or business who signed a note and promised to make pay it at maturity To Maker , the note is a liability and called a Note Payable. For Maker Interest is an Expense

the person or business to whom the amount of a note is payable. To Payee the note is an asset and called Note Receivable To Lender , Interest is a Revenue.

Cost of borrowing money for the borrower or, alternatively, the profit from lending money for the lender. Unless otherwise stated, the rate of interest on the note is the rate charged for the use of the principal for one year. 

the maturity date of a note is the day the note (principal and interest) must be repaid. The period of a note is the time from the note's (contract) date to its maturity date. 

maturity date is specified number of days after the note's date. As an example,a 5 day note dated June 15 matures and due on June 20. 

When months are used, the note matures and is payable in the month of its maturity on the same day of the month as its original date. A 9 month note dated July 10, for instance, is payable on April 10, The same analysis applies when years are used. 

Principal of the note * Annual Interest Rate* Time expressed in fraction of year = Interest to simplify interest computations, a year is commonly treated as having 360 days ( called the banker's rule in the business world).

Using the promissory note where we have a 90-day, 12%, $1,000 note, the total interest is computed as follows:

if the banker's rule is not followed, interest is computed as: $1000*12%*90/365=29,589041 The banker's rule would yield $30 which is easier to account for that $29,589041

usually recorded in a single Noted Receivable account to simplify record-keeping. The original noted are kept on file, including information on the maker, rate of interest and due date.When company holds large number of notes , it sets up controlling account and a subsidiary ledger for notes Notes Receivable......................1000     Sales..............................................................1000 Sold goods in exchange for a 90-day , 12% note

When seller accepts a note from an overdue customer as a way to grant a time extension on a past -due A/R, it will often collect past due balance in cash. This partial payment forces a concession from the customer, reduces the customer's debt (and seller's risk) , and produces a note for a smaller amount. 

Company agreed to accept $232 in cash along with a $600, 60-day, 15% note from client to settle $832 past-due account. Cash.............................................232 Note Receivable.........................600     Accounts Receivable....................832 Received cash and note to settle account

The principal and interest of a note are due on its maturity date. The maker of the note usually honors the note and pays it in full. Cash.........................................615     Note Receivable......................600     Interest Revenue....................15 Collect note with interest of $600*15%*60/360

when a note's maker is unable or refuses to pay at maturity, the note is dishonored. The act of dishonoring a note does not relieve the maker of the obligation to pay. The balance of the Notes Receivable account should include only note that have not matured. Thus, when note is dishonored, we remove the amount of this note from N/R account and charge it back to A/R from its maker

Company holds an $800, 12%, 60-day note of client. At maturity, client dishonors the note. A/R...................................816     Interest Revenue..............16     Note Receivable.................800 to charge account of client for a dishonored note and interest of $800*12%-60/360

When posting a dishonored note to customer's account, an explanation is included so as not to misinterpret the debit as a sale on account. Reporting the details of notes is consistent with the Full Disclosure principal, which requires financial statements (including footnotes) to report all relevant information

When notes receivable are outstanding at the end of a period, any accrued interest earned is computed and recorded. on Dec. 16 Company accepts a $3,000, 60-day, 12% note from customer in granting an extention ona past due account. When Company accounting period end on Dec. 31 , $15 interest is accrued (3000*12*15/360) Interest Receivable.....................15     Interest Revenue...................................15 To record accrued interest earned

When December 16 Note is collected on Feb. 14. Company entry to record cash receipt is Cash......................3060     Interest Revenue....................45     Interest Receivable................15     Notes Receivable.....................3000 Total Interest earned on 60 day note is $60.. The $15 credit to Interest Rec. on Feb 14 reflects collection of the interest accrued from December 31 adj. entry. $45 is for Jan 1- Feb 14

           

Company can convert receivables to cash before they are due. Reasons for this include the need for cash or the desire not to be involved in collection activities. Converting receivables is usually done either by 1) selling them 2) using them as security for a loan.

A Company can sell all or a portion of its receivables to a finance company or a bank. The buyer, called a Factor, charges the seller a factoring fee and then the buyer takes ownership of the receivables and receives cash when they come due. By incurring factoring fee, the seller receives cash earlier and can pass the risk of bad debt to the factor. The Seller can also choose to avoid costs of billing and accounting for the receivables, 

Company sells $20,000 of its accounts receivable and is charged a 4% factoring fee, it records this sale as follows Cash....................................................9,200 Factoring Fee.................................800   Accounts Receivable................20000 Sold a/r for cash less 4% fee

Company can raise cash by borrowing money and pledging its receivables as security for the loan. Pledging receivables does not transfer the risk of bad debts to the lender because the borrower retains ownership of the receivables. if the borrower defaults on the loan, the lender has a right to be paid from the cash receipts of the receivable when collected. 

When Company borrows $35,000 and pledges its receivables as security, it records this transaction as follows: Cash...................................35,000     Notes Payable..............................35000 the borrower financial statement needs to disclose the pledging of a/r. Inventory and a/r are 2 assets commonly demanded by bankers as collateral when making business loan.

Both GAAP and IFRS have similar criteria that apply to recognition of receivables (especially receivables that arise from revenue-generating activities). Specifically, both refer to the realization principle and an earning process. 

Under GAAP realization principle implies an arm's-length transaction occurs, whereas under IFRS this notion is applies in terms of reliable measurement and likelihood of economic benefits.Regarding GAAP's reference to an earnings process, IFRS instead refers to risk transfer and ownership reward. While these criteria are broadly similar, differences do exist, and they arise mainly from industry-specific guidance under GAAP , which is very limited under IFRS.

Both require that receivables be reported net of estimated uncollectibles. Further, both systems require that the expense for estimated uncollectibles be recorded in the same period when any revenues from those receivables are recorded. This means that for accounts receivable, both GAAP and IFRS require the allowance method for uncollectible (unless uncollectibles are immaterial)

Both GAAP and IFRS apply broadly similar rules in recording disposition of receivables. We should be aware of an important difference in terminology. Companies under GAAP disclose Bad Debts Expense, which is also referred to as Provision for Bad Debts or the Provision for Uncollectible Accounts, for GAAP provision here refers to expense. Under IFRS, the term provision

usually refers to a liability whose amount or timing (or both) is uncertain.

For a company selling on credit , we want to assess both quality and liquidity of its A/R. Quality of receivables refers to the likelihood of collection without loss. Liquidity refers to the speed of collection. A/R turnover is a measure of both the quality and liquidity of A/R. It indicates how often, on average, receivables are received and collected during the period.

Accounts Receivable turnover = Net Sales/ Average accounts receivable, net Average A/R balance computed as (Beginning balance + Ending Balance )/2

A/R turnover reflects how well management is doing in granting credit to customers in a desire to increase sales. High turnover in comparison with competitors suggests that management should consider using more liberal credit terms to increase sales. A low turnover suggests they should consider stricter credit terms and more aggressive collection efforts to avoid having its resources tied up in Accounts receivable. 

Credit Risk Ratio is computed by dividing the Allowance for Doubtful Accounts by Accounts Receivables. The higher this ratio, the higher is credit risk.