ACG2021 Chapter 8 (Principles of Financial Accounting)

When a business sells a good or service to another party, and that party pays on credit.

1. Creditor: The one who receives a receivable (asset)
2. Debtor: The one who takes on the liability / payable

1. Accounts Receivable (also called trade receivables)-Represent the right that you will receive cash from a customer for goods/services you have sold them. Accounts receivables are usually collected in a short period of time (such as 30 - 60 days) and therefore are reported as a current asset.

2. Notes Receivable (also called promissory Notes)-Typically have longer terms than accounts receivables-they represent that a customer will pay the principle + interest by a certain date into the future, called the Maturity Date.

3. Other Receivable-Any other type of receivable, where there is a right to receive cash in the future. -Common ones in this category include dividend receivables, interest receivables, and tax receivables.

The date at which the Note is due.

Let's say customers buy something on credit, and then send the money.

Well, the credit department could just take the cash and then mark the customer's account as “uncollectable” (meaning the company believes the customer will not pay the money they owe)

ex)A customer sends the company a check, and they just endorse it to themselves and then write them as “uncollectable”

Contains more details of a general ledger

*The accounts used in the journal btw are always the accounts used in the general ledger, NOT the subsidiary ledger.

Control Account is the main account that shows the total for related accounts

Subsidiary accounts are subsets of a control account

ex)

Control Account: Accounts Receivable

Subsidiary Account:
-Accounts Receivable - Brown
-Accounts Receivable - Smith

When the customer swipes the card, the business receives money from the credit card company with a fee.

So now, the customer owes money to the credit card company.

Factoring: You sell the receivable to someone else for immediate cash. You no longer need to collect money from customers

Pledging: You use the receivable as collateral for a loan. If you can’t pay the loan, then the bank then has the receivable and needs to collect the money

Failure to collect from some customers paying with credit

1. Direct write-off Method

2. Allowance Method

-Used by small, non-public companies-A method of accounting for uncollectable receivables with bad debt expense when a customer's receivable is uncollectable.

Does not follow the matching principle.
The matching principle is when the expenses match the revenue. The revenue of the sale was accounted for before. Then the ‘Bad Debts Expense” was accounted for after.

This is why this method is only used by small, non-public companies.

*The other method, the ‘allowance method’ is the one that follows GAAP

-A method of accounting uncollectable receivables in which the company estimates bad debts expenses instead of waiting to see which customers the company will not collect from.

-The decrease in accounts receivables if from a contra accounts receivables account called “Allowance for Bad Debts”. A credit to this contra-account increases the account, which means more is subtracted from Account receivables.

The purpose of the “Allowance for Bad Debts” is to
1) Firstly, be used in the balance sheet to subtract to accounts receivables to show how much you expect to actually receive. You don’t want to overstate your assets. You also cannot just subtract from the receivable since it still technically exists, even if you don’t expect to make 100% of its returns.

2) Then, if the collections for the receivable is definitely not happening, then you undo the change made by the “Allowance for Bad debts” account and then just reduce Accounts receivable.

It is listed in the Net Realizable Value, which is the value the company expects to collect from accounts receivables

*The image shows how this could look

Explanation:
1) Adjustable entry explained:
-You estimate receivables that are uncollectable.
-You then have the allowance for bad debts to not overstate your accounts receivable (explanation: Account will be used in the balance sheet to subtract to accounts receivables to show how much you expect to actually receive. You don’t want to overstate your assets. You also cannot just subtract from the receivable since it still technically exists, even if you don’t expect to make 100% of its returns. )

2) write off a definite uncollectable receivable
-You undo the changes made from the “Allowance for Bad Debts”
-You then just reduce Accounts receivables

3)
-Redo the write off
-You record the cash and then the decrease in receivables

There are three ways

1. Percent-of-sales

2. Percent-of-Receivables

3. Ageing-of-Receivables

1. Percent-of-sales
-Find the normal percentage of sales which is uncollectable. Then multiple that percentage to the current period sales.

FROMULA: Bad Debt Expense = Credit Sales x Estimated % Uncollectible

ex)
-The percentage of sales which is uncollectable is normally 0.005%.
-The current period sales is 60,000
-60,000 x 0.005 = \$300 Which is the estimate of uncollectibles

2. Percent-of-receivables
-Find the normal percentage of receivables which is uncollectable. Then multiple that percentage to the “unadjusted accounts receivables balance”.

FORMULA:Target Balance = Accounts Receivable × Estimated % Uncollectible

Bad Debt Expense = Target Balance - Unadjusted credit balance of Allowance of Bad Debts

or

Bad Debt Expense = Target Balance + Unadjusted debit balance of Allowance of Bad Debts

Target Balance = Total amount that should be uncollected (Which would be current month + previous months of uncollected receivables)

Credit Balance of Allowance of Bad Debts = The total amount of receivables from all previous periods that are estimately uncollected

*If you subtract Target Balance to (CR) Allowance of Bad Debts, you get the current period amount of receivables that is uncollected.

Debit Balance of Allowance of Bad Debts = the total amount of receivables from all previous periods that are written off but not previously estimated.

* Those previous write-offs need to be accounted for in this current period, so you must add it to the Bad Debt Expense to count it as an expense.

*You have to +/- allowance account since the Accounts receivable account is NOT for that current period, but for all previous periods.

1. Classify receivables by age
Example categories:
0–30 days past due

31–60 days past due
61–90 days past due
Over 90 days past due

2. Assign an uncollectible percentage to each category

0–30 days → 1%
31–60 days → 5%
61–90 days → 10%
Over 90 days → 25%

3. Multiply each category balance by its % uncollectible

4. This gives the estimated bad debt for each category.

5. Add them up to get the Target balance for doubtful accounts. (PS: Target Balance = Total amount that should be uncollected )

FORMULA:
Bad Debt Expense = Target Balance - Unadjusted credit balance of Allowance of Bad Debts

or

Bad Debt Expense = Target Balance + Unadjusted debit balance of Allowance of Bad Debts

*You have to +/- current allowance since the Accounts receivable account is NOT for that current period, but for all previous periods.

A written promise to pay a specified amount of money at a particular future date, usually with interest.

The entity that signs the note and promises to pay the required amount; the maker of the note is the debtor.

The entity to whom the maker promises future payment; the payee of the note is the creditor. The creditor is the company that loans the money.

The amount loaned

The period of time during which interest is computed. It extends from the original date of the note to the maturity date. Also called the note term.

As stated earlier, this is the date when final payment of the note is due. Also called the due date.

The sum of the principal plus interest due at maturity. Maturity value is the total amount that will be paid back.

Amount of Interest = Principal x Interest Rate x Time

REMEMBER:Time can be expressed as a

1) Fraction of a year in months (ex, 9/12)
2) Fraction of a year in days (ex, number of days/ 365)

The payee (guy who gave the money to be borrowed) turns the Notes Payable account into an Accounts Receivable account.

Dishonoring a Note

Acid Test Ratio = (Cash including cash equivalents + Short-term investments + Net Current Receivables) / Total Current Liabilities

-Measures the companies ability to pay current assets

-A ratio higher than 1.0 is considered safe.

Accounts Receivable Turnover Ratio = Net Credit Sales / Average Net Accounts Receivable

-This measures the number of times the company collects the average accounts receivable balance in a year.
-The higher the ratio, the faster they collect

Days’ Sales in Receivables = 365 days / Accounts Receivable Turnover Ratio

-This measures how many days it takes the company to collect the average accounts receivable balance.

“Accounts receivable -Smith”


You MUST SPECIFY the customer name.

Target Balance: Accounts Receivable x % of accounts receivables thats normally uncollectedThen, minus credit balance of Allowance of Bad debts or plus debit balance of Allowance of Bad Debts.

So, target balance is the amount that should be in your allowance of Bad debts, which is estimated debits for current and previous months. You then, just minus or plus the previous Allowance of Bad debts.