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Chapter 9:

RECEIVABLES

INTRODUCTION TO RECEIVABLES
Receivables are any monetary claims against debtors. Credit can be
granted in two forms: open account or evidenced by a formal
instrument. When a formal instrument of credit, that is a
promissory note, the creditor has a stronger legal claim and can
endorse it to a third party. The party that promises payment is
known as the maker, and the party entitled to receive the payment
is the payee. Notes receivable can be interest or non-interest
bearing. The amount due at maturity, known as maturity value, is
equal to the face value plus any accrued interest. Receivables
not expected to be collected within the current year, should be
listed as investments on the balance sheet.

RECEIVABLE CONTROLS
Receivables require the same internal controls as other assets of
a business. Employees responsible for collecting and approving
receivables should not be involved with accounting aspect related
to them. All accounting functions should be designed so that the
work of one employee can be used as verification of another
employee's work. A business that has a substantial amount of notes
may find the use of a notes receivable register very helpful. It
provides detailed information on each note, and assists in the timely
collection of notes. Proper controls of receivables also includes
obtaining approval for credit sales, sales returns and allowances,
and sales discounts.

CALCULATING INTEREST
Interest rates are usually stated on an annual basis. The interest
is computed by multiplying principal by rate and then by time
(principal x rate x time). The maturity value is determined by
calculating interest and adding it to the face value of the note.
When interest is computed for periods of less than a year, time is
is expressed as a fraction. The numerator of the fraction is the
length of the note and the denominator is the number of days in a
year. Government agencies use 365 days in the denominator, while
the private sector uses 360 days.

ACCOUNTING FOR NOTES RECEIVABLE
When a note is received from the debtor (i.e. open account
customer), a journal entry should be made debiting Notes Receivable
and crediting Accounts Receivable account. Notes receivable that do
not mature by the end of a fiscal period, require both adjusting and
reversing entries for the accrued interest. This is done so that
interest income is allocated to the proper financial periods. When a
note matures and is paid, the Cash account is debited and the Notes
Receivable and Interest Income accounts is credited.

DISCOUNTING A NOTE RECEIVABLE
In the event a business is in need of cash, it has the option to
transfer its notes receivable to a bank, which is known as
discounting. The interest a bank charges on the period it holds a
note is known as discount. Depending upon the arrangement with
the bank, the company may still be liable in the event a debtor
defaults on the payment. It is necessary to disclose these
contingent obligations on a firm's Balance Sheet in a foot note.
When proceeds are received for the discounted notes, the Cash
account is debited, and the Notes Receivable account credited. If
the proceeds exceed the face value of the note, the Interest
Income account is credited. If the proceeds are less than the
face value of the note, Interest Expense is debited.

DISHONORED NOTES RECEIVABLE
When the maker of a note fails to pay on the due date, the note
receivable is considered to be dishonored. A dishonored note is no
longer negotiable. In the books of creditors, the following entry
is made :
Debit Accounts Receivable
Credit Notes Receivable
Credit Interest Income or Interest Receivable
When a note previously discounted with a bank is dishonored, the
holder of the note (the bank) notifies the endorser (i.e the
company) of non-payment. Protest fees are charged to the endorser
for legal fees.

RECEIVABLES WHICH BECOME UNCOLLECTIBLE
No matter what kind of credit policy or collection procedures a
business establishes, a certain percentage of receivables will
usually turn out to be uncollectible. When a receivable is
determined to be uncollectible, it is written-off as an operating
expense. Strong indications that a receivable may be uncollectible
are the declaration of bankruptcy by the debtor, repeated failures
to collect, disappearance of the debtor, and debts that are beyond
the statute of limitations. Two methods exist to write-off
receivables. The direct write-off method records the expense when
the receivable is uncollectible, while the allowance method makes
a provision for a portion of the current year sales to become
uncollectible throughout the entire year.

THE ALLOWANCE METHOD
The allowance method of accounting for uncollectibles estimates
the percentage of accounts that will be uncollectible. Once the
amount is determined, an adjusting entry is made that debits the
Uncollectible Accounts Expense and credits the Allowance for
Doubtful Accounts (also known as Allowance for Bad Debt). When a
specific account is determined to be uncollectible, the Allowance
for Doubtful Accounts is debited and the Accounts Receivable
account is credited. The advantage of using the allowance method is
it provides a reduction of the value of receivables and recognition
of expense in the period the corresponding sales have taken place.

METHODS USED TO ESTIMATE UNCOLLECTIBLES
There are several methods of estimating uncollectibles. The most
commonly used methods base their estimates on sales data or the age
of the receivables. Estimates based on sales figures can be
determined by taking a percentage of either total sales or credit
sales. An estimate of uncollectibles based on an analysis of
receivables, classifies accounts into outstanding age groups. The
longer a receivable is past due, the higher the probability of
nonpayment. If the estimate is larger than the balance of the
Allowance for Doubtful Accounts, the excess should be debited to the
Uncollectible Accounts Expense and credited to the Allowance for
Doubtful Accounts.

THE DIRECT WRITE-OFF METHOD
The direct write-off method only records an uncollectible account
expense when an account has been determined to be uncollectible.
This method is not recommended the recognition of the expense
does always occur in the year the corresponding revenues were
recorded. It has, however, the advantage of simplicity since no
adjusting entry is necessary at the end of a financial period.
The method is best used by businesses that do not have a large
number of credit sales. In the event an account needs to be
reinstated, the Accounts Receivable account is debited.
Uncollectible Accounts Expense should be credited.

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