LECTURE NOTES: ACCOUNTING FOR RECEIVABLES

Study Objectives:

1. Identify the different types of receivables.

2. Explain how accounts receivable are recognized in the accounts.

3. Distinguish between the methods and bases used to value accounts

receivable.

4. Describe the entries to record the disposition of accounts receivable.

5. Compute the maturity date of and interest on notes receivable.

6. Explain how notes receivable are recognized in the accounts.

7. Describe how notes receivable are valued.

8. Describe the entries to record the disposition of notes receivable.

9. Explain the statement presentation and analysis of receivables.

I. Accounts Receivables

A. Types of Receivables

1. The term “receivables” refers to amounts due from

individuals and other companies; they are claims expected to be collected
in cash.

2. Three major classes of receivables are:

a) (1) Accounts Receivable - amounts owed by customers

on account.

b) (2) Notes Receivable - claims for which formal

instruments (promissory notes) of credit are issued.

c) (3) Other Receivables - include non-trade receivables.

Examples are:

1) interest receivable and

2) advances to employees

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 3. Three primary accounting issues are associated with
accounts receivable:

a) (1) Recognizing accounts receivable.

b) (2) Valuing accounts receivable.

c) (3) Disposing of accounts receivable.

B. Recognizing Accounts Receivables

1. When a business sells merchandise to a customer on

credit, Accounts Receivable is debited and Sales is credited:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
July 1 A/R—Polo Company 1,000
Sales 1,000
(To record sales on account)

2. When a business receives returned merchandise previously

sold to a customer on credit, Sales Returns and Allowances is debited and
Accounts Receivable is credited:

General Journal Page 1

Date Account Title P.R. Debit Credit
20--
July 1 Sales Returns and Allowances 100
A/R—Polo Company 100
(To record merchandise returned)

3. When a business collects cash from a customer for

merchandise previously sold on credit during the discount period, Cash
and Sales Discounts are debited and Accounts Receivable is credited:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
July 11 Cash ($900-$18) 882
Sales Discounts (2% x $900) 18
A/R—Polo Company 900
(To record collection of A/R)

4. When you use a retailer’s credit card, such as those issued by

Sears, JCPenney Co., Target, Wal-Mart, Macy’s, etc., the retailer charges
interest on the balance due if not paid with a specified period (usually 25-

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 30 days). For example if JCPenney Co. had sales of $300 and if the
amount was not paid within the discount period, a common rate of 18%
per year (1.5% per month) finance charge would be added as follows:

General Journal Page 1

Date Account Title P.R. Debit Credit
20--
July 1 Accounts Receivable—name of customer 300
Sales 300
(To record sale of merchandise)

Aug. 1 Accounts Receivable—name of customer 4.50

Interest Revenue (1.5% x$300) 4.50
(To record interest on amount due)

C. Valuing Accounts Receivable

1. To ensure that receivables are not overstated on the balance
sheet, they are stated at their cash (net) realizable value.

2. Cash (net) realizable value is the net amount expected to

be received in cash and excludes amounts that the company estimates it
will not be able to collect.

3. Credit losses are debited to Bad Debts Expense and are

considered a normal and necessary risk of doing business.

a) Bad debt or uncollectible accounts: A business's

accounts receivable that, for one reason or another, cannot be collected. 
There are several ways to determine whether an account has become
uncollectible.

1) Receive notice of a customer's personal bankruptcy, disability, or

death.
2) Unable to contact the customer as left the area, telephone
disconnected, mail is returned with no forwarding address.

3) The cost of collecting a past due account does not justify the amount
that may be received.

b) Bad debts expense: The expense that results from the

inability to collect receivables—an ordinary and necessary expense when
selling on account. With many companies, Bad debts expense is an
operating expense classified as an administrative expense because
decisions to grant credit are usually made by management, not
salespeople. But this textbook indicates on page 380 that bad debts

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 expense is reported as a selling expense Therefore it is not a part of the
selling function of the business.  Most all types of businesses that
regularly sell goods and/or services on account will have bad debts. To
avoid bad debts, some retail businesses only accept credit cards for credit
sales. This practice shifts the risk of uncollectible accounts to banks and
credit card companies. Other retail businesses, such as Sears, J.C. Penney,
Mervyns, have created their own credit cards as well.
4. Two methods of accounting for uncollectible accounts:

a) (1) Direct write-off method

1) Under the direct write-off method, bad debt

losses are not anticipated and no allowance account is used.

2) No entries are made for bad debts until an

account is determined to be uncollectible at which time the loss is
charged to Bad Debts Expense.

3) No attempt is made to match bad debts to sales

revenues or to show cash realizable value of accounts receivable
on the balance sheet.

4) Consequently, unless bad debt losses are

insignificant, this method is not acceptable for financial reporting
purposes.

b) (2) Allowance method

1) The allowance method is required when bad

debts are deemed to be material in amount.

2) Uncollectible accounts are estimated and the

expense for the uncollectible accounts is matched against sales in
the same accounting period in which the sales occurred.

3) Recording Estimated Uncollectibles. The

adjusting entry under the allowance method:

General Journal Page 1

Date Account Title P.R. Debit Credit
20--
Dec. 31 Bad Debts Expense 12,000
Allowance for Doubtful Accounts 12,000
(To record estimate of uncollectible
accounts)

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 4) Presentation of allowance for doubtful accounts:
a. The Allowance for doubtful accounts
shows the estimated amount of claims on customers that are
expected to become uncollectible in the future.

b. This contra account is used instead of

direct credit to Accounts Receivable because we do not know
which customers will not pay.

c. The amount of the $188,000 represents

the expected cash realizable value of the accounts receivable
at the statement date.

d. Allowance for Doubtful Accounts is not

closed at the end of the fiscal year.

D. THE DIRECT WRITE-OFF METHOD: The method of

accounting for bad debts in which the expense from a bad debt is recorded at
the time of write-off; no advance estimate is made for bad debts.  When the
direct write-off method is used, no entry is made for the bad debt until the
management of the business thinks that a customer’s account will be
uncollectible. The direct write-off method is used mainly by professional
service firms and small merchandising businesses that do not get a significant
portion of their revenue from credit sales.  The direct write-off method is the
only method that can be used for tax purposes per the Tax Reform Act of
1986. The direct write-off method must be used for tax purposes.

1. To Write-Off Accounts under the Direct Write-off Method:

Essentially, under the direct write-off method, you wait until you know
the account has gone bad. At this point, the uncollectible amount is
transferred from the Accounts Receivable account to the Bad Debts Expense
account. The basic entry is a debit to Bad Debt Expense and a credit to
Accounts Receivable.

Owner's

Assets = Liabilities + Equity + Revenues - Expenses

 Accounts_Receivable                   Bad_Debts_Expense
600                   600  
                       

Warden Co. writes off M. E. Doran’s $200 balance as uncollectible on December

12. When this method is used, Bad Debts Expense will show only actual losses
from uncollectibles and is entered into the general journal as follows:

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 General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Dec. 12 Bad Debts Expense 200
Accounts Receivable—M.E. Doran 200
(To record write-off of account)

2. Recovery of Bad Debts: If recovery is made in the same

period as the write-off, the expense account has not been closed, so the
account can just be reinstated. If an account that has been written off is later
collected, the account is said to be recovered and its balance is reinstated. 
Under the direct write-off method, the entry for reinstatement depends on
whether the recovery occurs in the same period as the write-off or in a later
period. Basically both methods have the same two-step process where the
first step is to reinstate the account and the second step is to collect the cash.

a) Recovery in the same accounting period:

1) The first entry to reinstate the account means to reverse the

write-off to bad debts, which cancels the expense. The reason the
Accounts Receivable account is debited when a recovery is made is to
reinstate the customer’s account. In other words, the customer’s
account in the accounts receivable SUBSIDIARY ledger needs to
show that the customer did make payment. If the customer’s account
was not debited and updated for a reinstatement and payment, it
would appear as if the customer had been written off and never paid. :

Owner's
Assets = Liabilities + Equity + Revenues - Expenses
 Accounts_Receivable                   Bad_Debts_Expense
600                       600
                       
2) The second entry is to record the cash collected from the
customer:
Owner's
Assets = Liabilities + Equity + Revenues - Expenses

Cash                   Bad_Debts_Expense
600                       600
                       
 Accounts_Receivable                      
600 600                      
                       
                       

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 b) Recovery in a later period: If recovery is made in a later period
than the write-off, the expense account has been closed, so another
account must be credited. It is not possible to use a current period expense
account to correct an entry made in a previous period, because expenses
are closed each year into the owner’s capital account as part of the net
income figure. Thus, when a bad debt written off in one year is collected
in another year, a special account, Recovery of Bad Debts, must be used.
1) The first entry to reinstate the account will use a different
account than Bad Debts Expense so that the amount of bad debts
expense for the later period will not be understated. The account,
Recovery of Bad Debts, should be used as the credit entry which can
be listed as a miscellaneous income item.
Owner's
Assets = Liabilities + Equity + Revenues - Expenses

 Accounts_Receivable             Recovery_of_Bad_Debts   
600                 600      
                       
2) The second entry is to record the cash collected from the
customer:
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Cash             Recovery_of_Bad_Debts     
600                 600      
                       
 Accounts_Receivable                      
600 600                      
                       

E. THE ALLOWANCE METHOD: For a business with a large

amount of credit sales, the direct write-off could result in an improper matching
of revenues and expenses in the same accounting period because the direct write-
off method does not always conform to the matching principle. 

1. Advantages of the Allowance Method: Since the matching

principle of accounting requires that expenses incurred during an accounting
period should be matched with (subtracted from) the revenue that was earned

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 during the same period, most large business use the allowance method where
an estimate of the total bad debts expected for the coming year is made at the
end of the current year as an adjusting entry. 
2. According to G.A.A.P. (Generally Accepted Accounting
Principles), there are two methods that can be used under the
allowance method. The choice is a management decision as it depends on
the relative emphasis that management wishes to expenses and revenues on
the one hand or the Cash (net) realizable value (the actual amount of
receivables that is expected to be collected or the amount of cash expected to
realize). At the end of the year, then, management must decide
(management decision) which approach to use:  income statement approach

vs. the balance sheet approach ??????

a) The income statement approach (since the estimate is

based on an income statement amount) bases the estimate on a
percentage of credit sales for the current year.
1) Percentage of Sales—Matching Sales to Bad
Debts Expense:
Percentage of Sales
Matching
Sales ↔ Bad Debts Expense

2) The balance sheet approach (since the

estimate is based on a balance sheet amount) bases the estimate on
aging accounts receivable and applying a percent to various ranges
according to how long the receivables within the range have been
outstanding or sometimes a percentage of the total receivables is used.
3) Percentage of Receivables—Matching
Accounts Receivable to Allowance for Doubtful Accounts (AFDA):
Percentage of Receivables

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 Cash Realizable Value
Matching to achieve
Accounts Receivable ↔ AFDA

b) The Income Statement Approach (Percentage of

Sales) to Estimating Bad Debts (also called the percentage of sales
method) is an estimate of the amount of credit sales that will go to bad
debts expense.

c) The adjustment cannot directly reduce Accounts

Receivable (see reason below); must use the Contra-Asset account. Any
previous balance in the allowance account is ignored in this method.
Based on past experience with the business, an estimated rate (a percent)
is multiplied times the credit sales to make the journal entry. Since the
entry is recorded as an adjusting entry at year end, the actual accounts
that will be written off is not known at the time and since the accounts
receivable account is a controlling account to the accounts receivable
subsidiary ledger, the credit cannot be made to the accounts receivable or
the controlling account would not balance to the subsidiary ledger.
Therefore a contra asset (contra to accounts receivable) account is used
called Allowance for Doubtful Accounts (AFDA) similar to the contra
asset account, Accumulated Depreciation as follows:

1) They are similar as both are contra asset assets

—AFDA is contra to accounts receivable and Accumulated
Depreciation is contra to a fixed asset account.

2) They differ in the place on the Balance Sheet

where they are reported—AFDA is reported in the current assets
section as a reduction in the amount of accounts receivable.
Accumulated depreciation is reported in the plant assets section as a
reduction of the related plant asset balance.

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 d) The adjusting entry under the allowance method serves
two purposes:
1) It reduces the value of the receivable to the
amount of cash expected to be collected in the future (called the
cash (net) realizable value.)
2) It matches the bad debt expense of the current
period with the related sales of the period.

e) Under the income statement approach, where the

emphasis is only on the income statement—ANY PRIOR BALANCE
IN THE ALLOWANCE FOR DOUBTFUL ACCOUNTS IS
"IGNORED."  When completing problems dealing with the percentage
of sales method, the current balance in the Allowance for Doubtful
Accounts is always given as part of the information so you think that you
should consider it as part of the calculation. But the manager who chooses
the income statement method in estimating bad debts DOES NOT
CARE how the entry affects the balance sheet so it DOES NOT
MATTER what balance is in the Allowance for Doubtful Accounts. What
matters to this manager is that the bad debts Expense amount is
matched to the credit sales for the period.  Refer to the accounting
equation below where the green (shaded) area is the only place that the
income statement approach manager will focus his or her attention
when making the adjusting entry.

f) What shows in the Allowance for Doubtful Accounts

before or after the adjustment is of NO significance to this manager.  The
example to illustrate this method where the credit sales for the period are
$800,000 x 1% = $8,000 estimated to adjust to bad debts expense. The
computation is made and the entry is recorded without looking at all
to the balances in accounts on the balance sheet side.
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Income_Statement_Emphasis
Balance_Sheet_Emphasis            
 Accounts_Receivable             Sales Bad_Debts_Expense

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                 800,000   8.000
                x 1%    
Allowance_for_Doubtful_Accts.               8,000    

Balance ??_or_Balance??  

8,000 Prior_Balance_does_not_matter!!!

3. The Balance Sheet Approach of Estimating Bad Debts

(also called the percent of receivables method) is an estimate of the
amount of receivables that will go to bad debts expense. The Balance
Sheet approach will either take a single percent of receivables or will base
the expense on the aging of accounts receivable where an increasing rate of
receivables is used based on the length of time the receivables has been
outstanding. Under the balance sheet approach, where the emphasis in on
the net realizable value (Accounts Receivable - Allowance for Doubtful
Accounts) or the estimate of cash to be realized from the receivables, ANY
PRIOR BALANCE IN THE ALLOWANCE FOR DOUBTFUL
ACCOUNTS MUST BE "CONSIDERED," as the goal of the manager
who chooses the Balance Sheet method for estimating bad debts is to have
the balance in the Allowance for Doubtful Accounts match the total
estimated uncollectible accounts on the Aging Schedule "after" the
adjusting entry so this manager DOES NOT CARE what affect the entry
will have on the income statement. Refer to the accounting equation below
where the blue (shaded) area is the only place that the balance sheet
approach manager will focus his or her attention when making the
adjusting entry. What shows as a balance in the Allowance for Doubtful
Accounts before and after  the adjustment is of GREAT significance to this
manager as that determines what the adjusting entry will be.  What shows
in the bad debts expense account after the adjustment is of NO significance
to this manager who has a balance sheet emphasis. The following examples

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 illustrate the situation when there is a prior credit balance of $528 and where
there is a prior debit balance of $500.

a) Adjusting Entry When the Allowance for Doubtful

Accounts has a prior CREDIT balance of $528:
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Balance_Sheet_Emphasis             Income_Statement_Emphasis
 Accounts_Receivable             Sales      
          39,600                 800,000      
                       
Allowance_for_Doubtful_Accts.                   Bad_Debts_Expense
  $528 Balance_"before"_adjustment     1,700  
  1,700 Adjustment_REQUIRED_to_bring_balance_to_aging_schedule
  2,228 Aging_schedule_indicates_balance_MUST_BE_this_amount!!!

b) Adjusting Entry When the Allowance for Doubtful

Accounts has a prior DEBIT balance of $500:
Owner's

Assets = Liabilities + Equity + Revenues - Expenses

Balance_Sheet_Emphasis Income_Statement_Emphasis
 Accounts_Receivable Sales
39,600   800,000
   
Allowance_for_Doubtful_Accts. Bad_Debts_Expense
$500 Balance_"before"_adjustment 2,728
  2,728 Adjustment_REQUIRED_to_bring_balance_to_aging_schedule
  2,228 Aging_schedule_indicates_balance_MUST_BE_this_amount!!!

Partial Balance Sheet showing the allowance for doubtful accounts:

HAMPSON FURNITURE
Balance Sheet (partial)
December 31, 20--
Assets
Current assets:
Cash $14,800.00
Accounts receivable $200,000.00
Less: Allowance for doubtful accounts 12,000.00 188,000.00
Merchandise inventory 310,000.00
Prepaid expense 25,000.00
Total current assets $537,800.00

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 F. RECORDING THE WRITE-OFF OF A CUSTOMER'S
ACCOUNT USING THE ALLOWANCE METHOD: The allowance
account is always debited regardless of the amount. When the actual
accounts receivable that does need to be written off, under the Allowance
Method (either income statement (Percent of Sales) or balance sheet
(Percent of Receivables) approach) in the next year, you do NOT WANT TO
DEBIT the Bad Debts Expense account as you have already allowed for the bad
debt as an adjusting entry at the end of the prior year.  You debit the Allowance
for Doubtful Accounts and credit Accounts Receivable--customer's account as
now you know which account has gone bad. The cash (net) realizable value
of accounts receivable does not change. The Cash Realizable Value (CRV)
before and after the entry is the same and that is still the dollar amount, you think
you will realize from your receivables.  The entry to write-off a customer's
account:
Owner's

Assets = Liabilities + Equity + Revenues - Expenses

Allowance_Method              
 Accounts_Receivable                    
          200,000 500 Write_off_of_an_account          
                     
Allowance_for_Doubtful_Accts.     CRV_=_$188,000          
12,000                      
500 Write_off_of_an_account                
G. RECOVERY OF ACCOUNTS UNDER THE ALLOWANCE
METHOD—time does not matter in this method:  If an account that has
been written off is later collected, the account is said to be recovered and its
balance is reinstated.  Under the allowance method (either the income
statement or the balance sheet approach), the entry is the same no matter
what period the reinstatement occurs.  Basically the process is the same two-
step process where the first step is to reinstate the account (reverse the original
write-off of the account) and the second step is to collect the cash.

1. The first entry to reinstate the account  means to reverse the

write-off to Allowance for Doubtful Accounts as a credit to the account:
Owner's

Assets = Liabilities + Equity + Revenues - Expenses

Allowance_Method                      
 Accounts_Receivable                      
199,500                        
    500 Reverse_write_off                  
      CRV_=_$37,300            
Allowance_for_Doubtful_Accts.                      
11,500                      
  500 Reverse_write_off_of_an_account        

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 2. The second entry is to collect the cash from the customer:

Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Cash                    
500                        
                       
 Accounts_Receivable                      
200,000 500                      
                       
Allowance_for_Doubtful_Accts.                      
12,000                      

To recap the difference between the Percentage of Sales vs. Percentage of

Receivables, a three-year illustration of the differences between the two
methods:
Three-Year Illustration of Allowance Method: Income Statement Approach
Year 1: 2014 Company has credit sales of $90,000. Bad Debts have been about 3% of credit sales.
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Bad Debts
Accts. Receivable Sales Expense

40,000   90,000 2,700  

x 3% Adj.
  12/31  
2,700
Allow. For Dbt. Accts,
2,700 Adj. 12/31/08
Year 2: 2015 Company has credit sales of $110,000. Bad Debts estimated 3% of credit sales.
  Note: in AFDA account the write-offs of accounts during the year      
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Bad Debts
Accts. Receivable Sales Expense
110,000
40,000 300 Jan. 3,300  
Adj.
110,000 500 Apr x 3% 12/31  
600 July 3,300
700 Aug
400 Oct

Allow. For Dbt. Accts,

Jan 300 2,700 Bal. 1/1/09
Apr. 500  
July 600  
Aug. 700  
Oct. 400  
2,500 2,700

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 200 Bal Before Adj.
3,300 Adj. 12/31/09
3,500 Bal. 12/31/09 After Adj.

Year 3: 2016 Company has credit sales of $150,000. Bad Debts estimated 3% of credit sales.
Note: in AFDA account the write-offs of accounts during the year
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Bad Debts
Accts. Receivable Sales Expense
150,000
45,000 700 Jan. 4,500  
Adj.
150,000 1,500 Apr x 3% 12/31  
1,100 July 4,500
400 Aug
1,300 Oct

Allow. For Dbt. Accts,

Jan. 700 3,500 Bal. 1/1/09
Apr. 1,500  
July 1,100  
Aug. 400  
Oct. 1,300  
5,000 3,500
Bal
Before
1,500 Adj.
4,500 Adj. 12/31/10
3,000 Bal. 12/31/10 After Adj.

Three-Year Illustration of Allowance Method: Balance Sheet Approach

Year 1: 2014 Company's Aging Schedule shows total estimated uncollectible Accounts - $2,742.  
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Accts. Receivable Sales

Bal. 44,990   150,000

Bad Debts
  Expense
Allow. For Dbt. Accts, 2,742  
Adj.
    2,742 Adj. 12/31/08 as no prior balance     12/31  
Year 2: 2015 Company's Aging Schedule shows total estimated uncollectible Accounts - $3,245  
Note: in AFDA account the write-offs of accounts during the year.
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Accts. Receivable Sales
44,990 300 Jan. 165,000
165,000 500 Apr
600 July
700 Aug

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 400 Oct

  xxxxx
Bal. 54,083  
Bad Debts
Allow. For Dbt. Accts, Expense
Jan. 300 2,742 Bal. 1/1/09 3,003  
  Adj.
Apr. 500 12/31  
July 600  
Aug. 700  
Oct. 400  
2,500 2,742
Bal Before
242 Adj.
Adj. 12/31/09 (amount needed for correct
3,003 balance)
Bal. 12/31/09 After Adj (Agrees to Aging
    3,245 Schedule)      

Year 3: 2016 Company's Aging Schedule shows total estimated uncollectible Accounts - $3,888  
Note: in AFDA account the write-offs of accounts during the year
Owner's
Assets = Liabilities + Equity + Revenues - Expenses
Accts. Receivable Sales
54,083 700 Jan. 220,000
220,000 1,500 Apr
1,100 July
400 Aug
1,300 Oct
xxxxx

Bal. 64,800
Bad Debts
Allow. For Dbt. Accts. Expense
Jan. 700 3,245 Bal. 1/1/09 5,643  
Adj.
Apr. 1,500   12/31  
July 1,100  
Aug. 400  
Oct. 1,300  
5,000 3,245
1,755 Bal Before Adj.
5,643 Adj. 12/31/10 (amount needed for correct balance)
3,888 Bal. 12/31/10 After Adj. (Agrees to Aging Schedule)
H. Disposing of Accounts Receivable
1. Companies frequently dispose of accounts receivable in one
of two ways:
a) (1) Sell to a factor such as a finance company or a bank:

16
 1) A factor buys receivables from businesses for a
fee and collects the payments directly from customers.
2) Receivables are sold for two major reasons:
a. (1) They are the only reasonable source
of cash.
b. (2) Billing and collection are often time
consuming and costly.
3) Example: Hendrendon Furniture factors
$600,000 of receivables to Federal Factors, Inc. Federal Factors
assesses a service charge of 2%of the amount of receivables sold.
The journal entry:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Mon. Day Cash ($600,000-$12,000) 588,000
Service Charge Expense (2% x $600,000) 12,000
A/R—Polo Company 600,000
(To record the sale of A/R)

b) (2) Make credit card sales

1) Credit cards are frequently used by retailers
who wish to avoid the paperwork of issuing credit.
2) Retailers can receive cash more quickly from the
credit card issuer.
3) A credit card sale occurs when a company
accepts national credit cards, such as Visa, MasterCard, Discover,
and American Express.
4) Three parties involved when credit cards are
used in making retail sales are:
a. (1) the credit card issuer,
b. (2) the retailer, and
c. (3) The customer.
5) The retailer pays the credit card issuer a fee of 2-
6% of the invoice price for its services.
6) From an accounting standpoint, sales from Visa,
MasterCard, and Discover (bank cards) are treated differently
than sales from American Express (non-bank cards).
a. Sales resulting from the use of VISA,
MasterCard, and Discover are considered cash sales by the
retailer.
1. These cards are issued by banks.
2. Upon receipt of credit card sales slips from a retailer, the
bank immediately adds the amount (cash) to the seller’s
bank balance.

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 3. To illustrate: Anita Ferreri purchases a number of compact
discs for her restaurant from Karen Kerr Music Co. for
$1,000 using her VISA First Bank Card. The service fee
that First Bank charges is 3%. The entry would be:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Mon. Day Cash ($1,000-$30) 970
Service Charge Expense (3% x $1,000) 30
Sales 1,000
(To record VISA credit card sales)

b. Sales using American Express cards are

reported as credit sales, not cash sales.
1. Conversion into cash does not occur until the companies
remit the net amount to the seller.
2. To illustrate: Four Seasons restaurant accepts an
American Express card for a $300 bill. The service fee
that American Express charges are 5%. American
Express will subsequently (may be the next month) pay
the restaurant $285. The entries the restaurant records
are as follows:
General Journal Page 1
Date Account Title P.R Debit Credit
20--
Mon. Day A/R—American Express ($300-$15) 285
Service Charge Expense (5% x $300) 15
Sales 300
(To record Am. Express credit card sales)

Mon. Day Cash 285

A/R—American Express 285
(To record redemption of credit card billings)

II. Notes Receivable

A. Introduction
1. A promissory note is a written promise to pay a specified
amount of money on demand or at a definite time.
2. A promissory note may be used:
a) (1) When individuals and companies lend or borrow
money.
b) (2) When the amount of the transaction and the credit
period exceed normal limits.
c) (3) In settlement of accounts receivable.

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 3. Parties involved in promissory notes:
a) The party making the promise is the maker.
b) The party to whom payment is made is called the
payee.

B. Determining the Maturity Date:

1. When the life of the note is expressed in terms of months, the
due date is found by counting the months from the date of issue
a) Example: The maturity date of a 3-month note dated
May 31 is August 31.
b) A note drawn on the last day of the month matures on
the last day of a subsequent month. Two months from July 31 is
September 30.
2. When the life of the note is expressed in terms of days, you
need to count the days.
a) In counting, the date of issue is omitted but the due date
is included.
b) If the note is in days, you must know the days in each
month to calculate the exact number of days. Count days after the date
of the note up to and including the date of maturity. The poem helps:
Thirty days has September, April, June, and November. All the rest
has 31 except for February (where for purposes of this course, we will
consider it to be 28). There is also the knuckle method where you make
a fist out of both hands and beginning with your left hand, the knuckles
have 31 days and the valley between the knuckles has 30 days or in the
case of February 28 days. So with the left hand, it begins with a knuckle
which is January (31 days), February (28 days), then March (31), April
(30), May (31), June (30) July (31 which ends the left hand). Then your
right hand begins with a knuckle which is August (31), September (30),
October (31), November (30), December (31).

c) TO CALCULATE THE DUE DATE OF A NOTE, USE

THE METHOD BELOW (Example used: 90 days after June 20):

Last day of month that note is dated =  June June has 30 days
 30
- Date of the note                               =   June Note is dated June 20
-20
= Days in the first month                   =   June Subtract for days in 1st month
10
+ Days in the following month           =   July Number of days in July
31
+ Days in the next month                  =  
Number of days in August
August 31

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 + Days needed in the next month     =  Sept. DUE DATE OF NOTE
18
Total of all the days in the months to length of note Number of days of the note
90

Example of 90 days after March 11:

Number of days in March (the month the note was dated)
March  31
Subtract the date of the note
March -11
Number of days to count for March
March 20
Number of days in April
April 30
Number of days in May
May 31
Number of days needed in June to reach 90 days=DUE DATE
June  9 OF NOTE
Total "exact" days of the note
Total 90
d) Example: The maturity date of a 60-day note dated July 17
is:
Term of note 60 days
July (31 – 17) 14
August 31 45
Maturity date: September 15
C. Computing Interest (PRT)
1. The basic formula for computing interest:
Face Value of Note x Annual Interest Rate x Time in Terms of 1 Yr. = Interest
2. The interest rate specified on the note is an annual rate of
interest.
3. Computation of interest for various time periods:
Terms of Note Interest Computation
Face x Rate x Time = Interest
$730, 18%, 120 days $730 x 18% x 120/360 = $43.80
$1,000, 12%, 6 months $1,000 x 15% x 6/12 = $75.00
$2,000, 12%, 1 year $2,000 x 12% x 1/1 = $240.00
D. Recognizing Notes Receivable
1. To illustrate: Wilma Company receives a $1,000, 2-month,
12% promissory note from Brent Company to settle an open account. The
entry to record:
General Journal Page 1
Date Account Title P.R. Debit Credit

20
 20--
May 1 Notes Receivable 1,000
Accounts Receivable—Brent Company 1,000
(To record acceptance of note)
2. A note is recorded at its face value, the value shown on the
face of the note.

E. Valuing Notes Receivable

1. Like accounts receivable, short-term notes receivable are
reported at their cash (net) realizable value.
2. The notes receivable allowance account is Allowance for
Doubtful Accounts.

F. Disposing of Notes Receivable:

1. Honor on Notes Receivable
a) A note is honored when it is paid in full at its maturity
date.
b) For an interest-bearing note, the amount due at
maturity is the face value of the note plus interest for the length of
time specified on the note.
c) To illustrate: Betty Co. lends Wayne Higley Inc.
$10,000 on June 1, accepting a 5-month, 9% interest-bearing note
($10,000 x 9% x 5/12= $375 interest. Betty collects the maturity value
of the note from Higley on November 1. The entry to record the
honoring of the note:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Nov. 1 Cash 10,375
Notes Receivable 10,000
Interest Revenue 375
(To record collection of Higley, Inc. note)

d) If Betty Co. prepares financial statements as of

September 30, interest for 4 months, or $300, would be accrued as
follows:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Sept. 30 Interest Receivable ($10,000 x 9% x 4/12) 300
Interest Revenue 300
(To accrue 4 months interest)
e) When interest has been accrued, it is necessary to credit
Interest Receivable at maturity. The entry to record the honoring of the
note:

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 General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Nov. 1 Cash 10,375
Notes Receivable 10,000
Interest Receivable 300
Interest Revenue ($10,000 x 9% x 1/12) 75
(To record collection of Higley, Inc. note)

2. Dishonor of Notes Receivable

a) A dishonored note is a note that is not paid in full at
maturity.
b) A dishonored note receivable is no longer negotiable.
c) Since the payee still has a claim against the maker of the
note, the balance in Notes Receivable is usually transferred to
Accounts Receivable.
d) To illustrate, assume that Wayne Higley, Inc. on
November 1 indicates that it cannot pay at the present time. The
entry to record the dishonor of the note if Betty Co. expects eventual
collection:
General Journal Page 1
Date Account Title P.R. Debit Credit
20--
Nov. 1 Accounts Receivable—Wayne Higley, Inc. 10,375
Notes Receivable 10,000
Interest Revenue 375
(To record dishonor of Higley, Inc. note)

III. Statement Presentation and Analysis

A. Presentation
1. In the balance sheet, short-term receivables are reported
in the current assets section below short-term investments.
2. Report both the gross amount of receivables and the
allowance for doubtful accounts. See illustrations in textbook.
3. In a multiple-step income statement, bad debts expense
and service charge expense are reported as selling expenses in the
operating expenses section.
4. Interest revenue is shown under “Other revenues and
gains” in the nonoperating activities section of the income
statement.
B. Analysis

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 1. Financial ratios dealing with receivables are computed to
evaluate the company’s ability to pay debt and the liquidity of a
company’s accounts receivable.
2. The acid-test ratio is the sum of cash, cash equivalents,
short-term investments, and net current receivables to total current
liabilities. The ratio tells whether the entity could pay all its current
liabilities if they came due immediately. What is an acceptable acid-test
ratio depends on the industry but generally a ratio of 1.00 or 1:1 or better
is considered safe.
3. The accounts receivables turnover ratio is used to assess
the liquidity of the receivables.

4. If Cisco Systems had net sales of $24,801 million for the

year and beginning net accounts receivable (accounts receivable less
AFDA) balance of $1,825 million and an ending accounts receivable
(net) (accounts receivable less AFDA) of $2,216 million, its turnover
ratio is computed as follows:
Net Credit Sales ÷ Average “NET” Receivables = Receivables Turnover
$1,825 + $2,216
$24,801 ÷ = 12.3 Times
2
5. The average collection period in days is a variant of the
turnover ratio that makes liquidity even more evident.
6. This is done by dividing the turnover ratio into 365 days. The
general rule is that the collection period should not exceed the credit
term period (the time allowed for payment).
7. Cisco’s turnover ratio is computed as follows:
Days in year. ÷ Receivables Turnover = Average Collection Period
365 ÷ 12.3 = 29.7 days or 30 days

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