Financial Accounting Fourth Edition

Receivables and
Sales

CHAPTER

5 Spiceland Thomas Herrmann

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Part A
RECOGNIZING ACCOUNTS RECEIVABLE

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Learning Objective 1

LO51 Recognize accounts receivable.

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Credit Sales
Transfer products and services to a customer
today and expect to collect cash in the future
Also known as sales on account or services on
account
Common for many business transactions

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Accounts Receivable
Cash owed to the company by its customers
from sales or services on account
Recorded at the time of the sale or service
Also called trade receivables

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Recording of Credit Sales
Links Dental charges $500 for teeth
whitening. Dee Kay decides to have her teeth
whitened on March 1 but doesnt pay cash at
the time of service. She promises to pay the
$500 whitening fee to Link by March 31.

March 1 Debit Credit

Accounts Receivable . 500
Service Revenue .......... 500
(Provide services on account)

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Other Types of Receivables
Nontrade receivables: receivables that
originate from sources other than customers
Tax refund claims, interest receivable, and loans
by the company to other entities, including
stockholders and employees
Notes receivable: formal credit arrangements
evidenced by written debt instruments (or
notes)

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Concept Check 51
Which of the following are sometimes called
trade receivables?
a. Accounts receivable
b. Interest receivable
c. Notes receivable
d. Tax refund claims
Accounts receivable are sometimes called trade
receivables. Nontrade receivables include tax
refund claims, interest receivable, and loans by the
company to other entities.
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Learning Objective 2

LO52 Calculate net revenues using discounts,

returns, and allowances.

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Trade Discounts
Reduction in list price of a product or service
Used to provide incentives to larger customers or
certain consumer groups (senior citizens, military)
Recognized by recording revenue for lower amount
Links Dental typically charges $500 for teeth
whitening. Dr. Link offers a 20% discount on
teeth whitening.
March 1 Debit Credit
Accounts Receivable . 400
Service Revenue .......... 400
(Make credit sale of $500 with a 20% trade discount)
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Sales Returns and Allowances
Customers are sometimes dissatisfied with a
product or service

Sales Return Sales Allowances

Customer returns a Customer does NOT
product return a product
(a) Seller issues a cash (a) Seller issues a cash
refund if original sale refund if original sale
was for cash was for cash
(b) Seller reduces balance (b) Seller reduces balance
of accounts receivable of accounts receivable
if original sale was on if original sale was on
account account
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Sales Allowances
After getting her teeth whited on March 1, Dee
notifies Dr. Link on March 5 that another dentist
is offering the same procedure for $350
Dr. Link reduces Dees account balance by $50
March 5 Debit Credit
Sales Allowances . 50
Accounts Receivable ... 50
(Provide sales allowance for previous credit sale)

Sales Returns or Sales Allowances

Contra revenue accounts
Reported with total revenues in the income
statement, but with negative balances
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Common Mistake
Students sometimes misclassify contra revenue
accountsSales Returns and Sales Allowances
as expenses. Like expenses, contra revenues
have normal debit balances and reduce the
amount of net income. However, contra
revenues represent reductions of revenues,
whereas expenses represent the separate costs
of generating revenues.

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Sales Discount
Offer a customer a reduction if payment is made
within a specified period of time
Links Dental offers Dee terms of 2/10, n/30 on
$350 owed; Dee pays on March 10 (w/in 10 days)
March 10 Debit Credit
Cash . 343
Sales Discounts 7
Accounts Receivable ... 350
(Collect cash on account with a 2% sales discount = $350 2%)

Sales Discounts = Contra revenue account

Reported with total revenues in the income
statement, but with a negative balance
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Illustration 51
Income Statement Reporting
Revenues Net of Sales Allowances
and Sales Discounts
LINKS DENTAL
Income Statement (partial)
Includes $100
Service revenue $400 reduction for
trade discount
Less: Sales allowances (50)
Less: Sales discounts (7)
Net service revenue $343

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 Illustration 52
Balance of Accounts Receivable after
Credit Sale and Subsequent Collection
on Account
Accounts Receivable
Credit sale of $500 with Mar. 1 400
$100 trade discount Mar. 5 50 Sales allowance of $50

Mar. 10 350 Cash collection of $343

with $7 sales discount
Ending balance Bal. 0

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Concept Check 52
The effect of a sales allowance will result in which of
the following:
a. An increase to net income
b. A decrease to net income
c. An increase to accounts receivable
d. An increase to sales revenue

The effect of a sales allowance is to decrease net

income. A sales allowance decreases sales revenue in
the income statement. A sales allowance also decreases
assets by decreasing the balance of accounts receivable.

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Concept Check 53
Which of the following computations would be used
to compute Net Revenue?
a. Total Revenue + Accounts Receivable Sales
Discounts Sales Allowances
b. Net Revenue + Sales Allowances Sales Discounts
c. Total Revenue Sales Discounts Sales
Allowances
d. Net Income Change in Accounts Receivable
Net Revenue is equal to Total Revenue less Sales
Discounts and Sales Allowances.

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Illustration 53
Income Statement Reporting Revenues
Net of Sales Discounts, Returns, and
Allowances
GENERAL HEALTH
Income Statement (partial)
For the year ended 2018

Sales and service revenue $ 400,000

Less: Sales discounts ($6,000 actual + $1,000 estimate) (7,000)
Less: Sales returns ($10,000 actual + $2,000 estimate) (12,000)
Less: Sales allowances ($14,000 actual + $3,000 estimate) (17,000)
Net revenue $364,000

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Part B
VALUING ACCOUNTS RECEIVABLE

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Learning Objective 3

LO53 Record an allowance for future uncollectible

accounts.

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Key Point
We recognize accounts receivable as assets in
the balance sheet and report them at their net
realizable value, that is, the amount of cash we
expect to collect.

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Allowance Method
Some accounts receivable will not be collected
Companies are required to:
Estimate future uncollectible accounts
Record estimates in the current year
Estimated uncollectible accounts
Reduce assets (accounts receivable)
Increase expenses (bad debt expense)

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Key Point
Under the allowance method, companies are
required to estimate future uncollectible
accounts and record those estimates in the
current year. Estimated uncollectible accounts
reduce assets and increase expenses.

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Estimating Uncollectible Accounts

Percentage-of-receivables method
Bases the estimate of bad debts on a balance
sheet amountaccounts receivable
Also called the balance sheet method

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Estimating Uncollectible Accounts
At the end of 2018, Kimzey is owed $20
million from customers and estimates that
30% will not be collected.
December 31, 2018 ($ in millions) Debit Credit
Bad Debt Expense . 6
Allowance for Uncollectible Accounts... 6
(Estimate future bad debts)
($20 million 30% = $6 million)
Bad Debt Expense
Expense reported in the income statement
Allowance For Uncollectible Accounts
Contra asset reported in the balance sheet
Reduces the balance of total assets
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Illustration 54
Partial Income Statement Showing
Estimated Bad Debt Expense

KIMZEY MEDICAL CLINIC

Income Statement (partial)
For the year ended 2018
($ in millions)
Credit sales $50
Bad debt expense (6)
$44

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 Illustration 55
Accounting for Uncollectible Accounts
and the Accounts Receivable Portion of
the Balance Sheet
2018 2019
($ in millions) (next year)
(current year)
$50 $20 $14 Collectible
Credit sales Not collected Estimate
during 2018 by end of year $6 Uncollectible

KIMZEY MEDICAL CLINIC

Asset Balance Sheet (partial) Contra
December 31, 2018 Asset
Current assets:
Accounts receivable $20
Less: Allowance (6)
Net accounts receivable $14
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Key Point

Adjusting for estimates of future uncollectible

accounts matches expenses (bad debts) in the
same period as the revenues (credit sales)
they help to generate.
Recording an allowance for uncollectible
accounts correctly reports accounts receivable
at their net realizable value.

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Common Mistake
Because Allowance for Uncollectible Accounts
has a normal credit balance, students
sometimes misclassify this account as a liability,
which also has a normal credit balance. Instead,
this contra asset represents a reduction in a
related asset account.

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Concept Check 54
Which of the following is true regarding Allowance
for Uncollectible Accounts?
a. It is a liability account.
b. It is added to the total of Sales Discounts, Sales
Returns, and Sales Allowances.
c. It is subtracted from the balance of Accounts
Receivable in the balance sheet.
d. It appears in the income statement as an
expense.
The allowance account is a contra asset and is used to
record estimated future uncollectible accounts. The balance
is subtracted from Accounts Receivable in the balance sheet
to arrive at Accounts Receivables net realizable value.
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Learning Objective 4

LO54 Use the aging method to estimate future

uncollectible accounts.

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Illustration 56
Kimzeys Accounts Receivable
Aging Schedule
Days Past Due
More than
Patients Not Yet Due 160 61120 120 Total
Shirley Akin $ 12,000 $ 12,000
Bruce Easley $ 4,000 4,000
Ben Greene $ 5,000 5,000
Anita Hand $ 7,000 7,000
Ima Hertz 9,000 9,000
Noah Luck 8,000 8,000
Phil Sikley 6,000 6,000
Justin Payne 10,000 10,000
Others 9,973,000 5,987,000 2,993,000 986,000 19,939,000
Total Accounts
Receivable $10,000,000 $ 6,000,000 $ 3,000,000 $1,000,000 $20,000,000
Estimated Percent
Uncollectible 10% 30% 50% 70% % increases
Estimated Amount
with age
Uncollectible $ 1,000,000 $1,800,000 $1,500,000 $ 700,000 $ 5,000,000

Total estimated
uncollectible
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Aging Method
Considers the age of receivables
Older accounts are more likely uncollectible
More accurate than using a single percentage
From Kimzeys aging schedule (Illustration 56
on the previous slide) the estimate of
uncollectible accounts equals $5 million.
December 31 ($ in millions) Debit Credit
Bad Debt Expense . 5
Allowance for Uncollectible Accounts... 5
(Estimate future bad debts)

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Concept Check 55
Which of the following is true about the aging
method?
a. No estimate for uncollectible accounts is made.
b. Older accounts are more likely to be collected.
c. It is not acceptable for GAAP.
d. Older accounts are less likely to be collected.

The aging method recognizes that the longer

accounts are past due, the less likely they are to be
collected. The aging method should provide a more
accurate estimate of total uncollectible accounts
compared to using a single percentage.
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Illustration 57
Excerpt from Tenet Healthcare
Corporations Annual Report
TENET HEALTHCARE CORPORATION
Notes to the Financial Statements (excerpt)
We provide for an allowance against accounts receivable that could become uncollectible by establishing an allowance
to reduce the carrying value of such receivables to their estimated net realizable value. We estimate this allowance
based on the aging of our accounts receivable by hospital, our historical collection experience by hospital and for each
type of payer over a look-back period, and other relevant factors. There are various factors that can impact collection
trends, such as changes in the economy, which in turn have an impact on unemployment rates and the number of
uninsured and underinsured patients, the volume of patients through the emergency department, the increased burden
of co-payments and deductibles to be made by patients with insurance, and business practices related to collection
efforts. These factors continuously change and can have an impact on collection trends and our estimation process.
The following tables present the approximate aging by payer of our continuing operations net accounts receivable.

Indemnity, Self-Pay,
Age Medicare Medicaid Managed Care and Other Total
060 days $262 $ 67 $943 $ 158 $1,430
61120 days 29 34 229 104 396
121180 days 13 18 100 60 191
Over 180 days 19 34 157 225 435
Total $323 $153 $1,429 $547 $2,452

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Key Point
Using the aging method to estimate
uncollectible accounts is more accurate than
applying a single percentage to all accounts
receivable. The aging method recognizes that
the longer accounts are past due, the less likely
they are to be collected.

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Learning Objective 5

LO55 Apply the procedure to write off accounts

receivable as uncollectible.

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Writing Off Accounts Receivable
When it becomes clear the customer will not pay,
the company writes off the customers account
balance as uncollectible
The write-off:
Reduces the balance of Accounts Receivable
Reduces the balance of the Allowance for
Uncollectible Accounts
The write-off has no effect on total assets
(balance sheet) or total expenses (income
statement)
Negative effects of bad debts already recorded
Adjusting entry at the end of the previous year
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Writing Off Accounts Receivable
Kimzey receives notice that Bruce Easley has filed
for bankruptcy and will not pay $4,000
Kimzey writes off Bruces account receivable
February 23, 2019 Debit Credit
Allowance for Uncollectible Accounts 4,000
Accounts Receivable 4,000
(Write off a customers account )

The write-off involves:

Decreasing a contra asset (Allowance for Uncollectible
Accounts)
Decreasing an asset (Accounts Receivable)
The net effect on total assets is zero
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Common Mistake
Students often mistakenly record bad debt
expense when they write off an uncollectible
account. The bad debt expense was recorded in
a prior year at the time of estimating
uncollectible accounts.

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Collection of Accounts Previously
Written Off
Bruce later pays 25% ($1,000) of amount owed
September 8, 2019 Debit Credit
Accounts Receivable 1,000
Allowance for Uncollectible Accounts 1,000
(Reestablish portion of account previously written off)

September 8, 2019 Debit Credit

Cash . 1,000
Accounts Receivable ... 1,000
(Collect cash on account)

Collection has no effect on total assets or net income

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Concept Check 56
When writing off an uncollectible account:
a. Bad debt expense is debited.
b. Net income is decreased.
c. Total assets are unchanged.
d. The allowance account is credited.
The write-off of an account receivable has no effect
on total amounts reported in the balance sheet or
in the income statement. There is no decrease in
total assets and no decrease in net income.

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Key Point
Writing off a customers account as uncollectible
reduces the balance of accounts receivable but
also reduces the contra assetallowance for
uncollectible accounts. The net effect is that
there is no change in the net receivable
(accounts receivable less the allowance) or in
total assets. We recorded the decrease to assets
as a result of the bad debt when we established
the allowance for uncollectible accounts in a
prior year.

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Allowance Method in the Following Year
Recall that using the aging method, Kimzey
estimated bad debts in 2019 to be $5 million
Actual bad debts in 2019 were only $4 million
In other words, bad debts for 2019 were

overestimated by $1 million
Assume Kimzey estimated bad debts in 2020 to be
$8 million
How does Kimzey record its $8 million estimate of
future bad debts at the end of 2019?
How is that estimate affected by last years
overestimation?
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 Illustration 58
Balance of Kimzeys Allowance for
Uncollectible Accounts
Allowance for Uncollectible Accounts
($ in millions)
5 Beg. balance for 2019
Write-offs in 2019 4
1 Bal. before adjustment
? Year-end adjustment
8 Ending balance for 2019

December 31, 2019 ($ in millions) Debit Credit

Bad Debt Expense . 7
Allowance for Uncollectible Accounts... 7
(Estimate future bad debts)

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Illustration 59
Bad Debt Expense in the Income
Statement
KIMZEY MEDICAL CLINIC
Income Statement
For the year ended 2019

($ in millions)
Revenue from credit sales $80
Expenses:
Bad debt expense $ 7
Other operating expenses 50 57
Net income $23

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Illustration 510
Accounts Receivable Portion of the
Balance Sheet
KIMZEY MEDICAL CLINIC
Balance Sheet (partial)
December 31, 2019
Assets
Current assets ($ in millions):
Accounts receivable $30
Less: Allowance for uncollectible accounts (8)
Net accounts receivable $22

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 Underestimating Bad Debts
1. What if actual bad debts in 2019 were $6 million,
compared to an estimate of $5 million?
2. Estimated bad debts for 2020 are $8 million.
Allowance for Uncollectible Accounts
($ in millions)
5 Beg. balance for 2019
Write-offs in 2019 6
Bal. before adj. 1
? Year-end adjustment
8 Ending balance for 2019

December 31, 2019 ($ in millions) Debit Credit

Bad Debt Expense . 9
Allowance for Uncollectible Accounts... 9
(Estimate future bad debts)
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Illustration 511
Excerpt from Tenet Healthcare
Corporations Annual Report
TENET HEALTHCARE CORPORATION
Notes to the Financial Statements (excerpt)
The preparation of financial statements, in conformity with accounting principles generally
accepted in the United States of America, requires us to make estimates and assumptions
that affect the amounts reported in the Consolidated Financial Statements and these
accompanying notes. We regularly evaluate the accounting policies and estimates we use.
In general, we base the estimates on historical experience and on assumptions that we
believe to be reasonable given the particular circumstances in which we operate. Although
we believe all adjustments considered necessary for fair presentation have been included,
actual results may vary from those estimates.

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Concept Check 57
When an entry is made to write off an
uncollectible account,
a. Bad debt expense is debited.
b. Net income is decreased.
c. Total accounts receivable is unchanged.
d. The allowance account is credited.
Overall, the write-off of an account receivable has no
effect on total amounts reported in the balance sheet or
in the income statement. There is no decrease in total
assets and no decrease in net income with the write-off.
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Learning Objective 6

LO56 Contrast the allowance method and direct

write-off method when accounting for
uncollectible accounts.

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Direct Write-Off Method
Write off bad debts only at the time they
actually become uncollectible
Unlike the allowance method, which requires
estimation of uncollectible accounts before they
even occur
Used:
When uncollectible accounts are not anticipated
or are immaterial
Primarily used for tax reporting

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 Illustration 512
Comparing the Allowance Method
and the Direct Write-off Method for
Recording Uncollectible Accounts
2018 Allowance Method Direct Write-off Method
Year-end Adjustment Bad Debt Expense 2,000 No adjustment
(Estimate = $2,000) Allowance for Uncollectible Accounts 2,000

2019
Actual Write-offs Allowance for Uncollectible Accounts 2,000 Bad Debt Expense 2,000
(Actual = $2,000) Accounts Receivable 2,000 Accounts Receivable 2,000

Allowance account is credited for the estimate and

debited for the actual write-off (balance cancels)
Over both years, debit Bad Debt Expense and credit
Accounts Receivable
Difference between the methods is timing
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Common Mistake
Some students erroneously think firms should
reduce total assets and record bad debt expense
at the time the bad debt actually occurs.
However, companies anticipate future bad
debts and establish an allowance for those
estimates.

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Key Point
The direct write-off method reduces accounts
receivable and records bad debt expense at the
time the account receivable proves
uncollectible. If the credit sale occurs in a prior
reporting period, bad debt expense is not
properly matched with revenues (credit sales).
Also, accounts receivable will be overstated in
the prior period. The direct write-off method
typically is not acceptable for financial reporting.

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Concept Check 58
On December 31 before adjusting entries, a
companys balance of Allowance for Uncollectible
Accounts is a credit of $2,000. What does a credit
balance prior to adjusting entries indicate?
a. The company did not estimate bad debts last year.
b. Last years estimate of bad debts was too low.
c. The companys estimate equals actual bad debts.
d. Last years estimate of bad debts was too high.
The Allowance for Uncollectible Accounts is a contra account
with a credit balance. The balance is reduced (debited) for
actual bad debts. If the account balance at the end of the year
is a credit, then estimated bad debts for this year are greater
than this years actual bad debts.
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Concept Check 59
On December 31 before adjusting entries, a company
reports the following balances:
Accounts Receivable $100,000
Allowance for Uncoll. Accts. $2,000 (credit)
The company estimates bad debts to be 20% of accounts
receivable. The adjusting entry would include:
a. A debit to Bad Debt Expense = $18,000
b. A credit to Allowance for Uncoll. Accts. = $24,000
c. A credit to Allowance for Uncoll. Accts. = $22,000
d. A debit to Bad Debt Expense = $20,000
Bad debts are estimated to be $20,000 (= $100,000 20%). The
current $2,000 credit balance of the Allowance needs a credit
adjustment of $18,000 to be equal to $20,000 credit. The
adjustment of $18,000 is recorded as a debit to Bad Debt Expense
and a credit to the Allowance account.
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Part C
NOTES RECEIVABLE

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Learning Objective 7

LO57 Account for notes receivable and interest

revenue.

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Illustration 513
Note Receivable
Similar to accounts receivable but include a
written debt agreement, or note
Normal debit balance
Classified as either current or noncurrent asset
depending on time until due date
Face value $ 10,000 Date February 1, 2018

Due date Six months after date I promise to pay to the

order of Kimzey Medical Clinic
Payee Ten thousand and no/100 dollars
for value received with interest at the rate of 12% .
Interest rate Justin Payne

Maker

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Recording Notes Receivable
Kimzey provided $10,000 of services to Justin
Payne, who is not able to pay immediately
Justin Payne signs a promissory note, offering to
pay $10,000 plus 12% interest in six months
(August 1).
February 1, 2018 Debit Credit
Notes Receivable 10,000
Service Revenue . 10,000
(Accept a six-month, 12% note receivable for services provided)

No interest is recorded on February 1

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Key Point
Notes receivable are similar to accounts
receivable except that notes receivable are
formal credit arrangements made with a written
debt instrument, or note.

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Collection of Notes Receivable
and Interest
After six months, Kimzey collects the full amount
owed by Justin, including interest
Face Annual Fraction
Interest = value interest rate of the year
$600 = $10,000 12% 6/12

August 1, 2018 Debit Credit

Cash . 10,600
Notes Receivable 10,000
Interest Revenue 600
(Collect note receivable and interest)
(Interest revenue = $10,000 12% 6/12)

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Illustration 514
Calculating Interest Revenue over
Time for Kimzey Medical Clinic
2018 2019
Nov. 1 May 1
(Note issued) (Note due)
Nov. Dec. Jan. Feb. Mar. Apr.
$100 $100 $100 $100 $100 $100

2 months of 4 months of
interest revenue interest revenue
In 2018 = $200 in 2019 = $400

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 Accrue Interest and Collect Interest
On December 31, 2018, Kimzey accrues interest for
note receivable accepted on November 1, 2018.
December 31, 2018 Debit Credit
Interest Receivable 200
Interest Revenue 200
(Accrual interest revenue = $10,000 12% 2/12)

On May 1, 2019, the maturity date, Kimzey collects the

note of $10,000 and the interest of $600.
May 1, 2019 Debit Credit
Cash . 10,600
Notes Receivable 10,000
Interest Receivable (from 2018) .. 200
Interest Revenue (from 2019) 400
(Collect note receivable and interest; Interest revenue = $10,000 12% 4/12)
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Concept Check 510
A company accepts a note receivable of $5,000 on
September 1, 2018, that matures in 10 months and
has stated interest of 6%. What amount of interest
revenue will the company record in 2018 and 2019?
a. 2018 = $100; 2019 = $150
b. 2018 = $125; 2019 = $125
c. 2018 = $150; 2019 = $100
d. 2018 = $0; 2019 = $250
Interest Face Annual Fraction
=
Revenue value interest rate of the year
2018: Interest Revenue = $5,000 6% 4/12 = $100
2019: Interest Revenue = $5,000 6% 6/12 = $150
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Learning Objective 8

LO58 Calculate key ratios investors use to monitor

a companys effectiveness in managing
receivables.

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Receivables Turnover Ratio
Number of times during a year the average
accounts receivable balance is collected

Average Collection Period

Number of days the average accounts
receivable balance is outstanding

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Illustration 515
Comparison of Receivables Ratios
between Tenet Healthcare Corporation
and LifePoint Hospitals
Receivables Turnover Ratio Average Collection Period
Tenet Healthcare $17,920 $2,867.5 = 6.2 times 365 6.2 = 58.9 days
LifePoint Hospitals $5,301 $1,399.5 = 3.8 times 365 3.8 = 96.1 days

Tenet:
Higher receivables turnover
Shorter collection period
More efficiently collects cash from patients
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Key Point
The receivables turnover ratio and average
collection period can provide an indication of
managements ability to collect cash from
customers in a timely manner.

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Concept Check 511
Which of the following would be true for a company
that has an accounts receivable turnover of 10?
a. The company turns over their accounts receivable
more than once a month.
b. The company would have an average collection
period of 36.5 days.
c. The company would be considered as doing an
efficient job of collecting receivables if the terms
were net 30.
d. The company would have an average collection
period of 20 days.
The average collection period is computed as 365
divided by the accounts receivable turnover of 10
(= 36.5 days).
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Appendix - Learning Objective 9

LO59 Estimate uncollectible accounts using the

percentage-of-credit-sales method.

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Percentage-of-Credit-Sales Method

Estimates uncollectible accounts based on the

percentage of credit sales
Also called the income statement method
Adjusts the allowance for uncollectible
accounts for the current years credit sales
that we dont expect to collect

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Percentage-of-Credit-Sales
MethodRecording
By the end of 2019, Kimzey has:
Accounts Receivable = $30 million
Allowance for Uncoll. Accts. = $1 million (credit)
Credit Sales = $80 million
Percentage-of-receivables method:
Estimate $8 million of ending accounts receivable
to be uncollectible
Percentage-of-credit-sales method:
Estimate 12.5% of credit sales to be uncollectible

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Illustration 516
Adjusting for Estimates of
Uncollectible Accounts
Percentage-of-Receivables Percentage-of-Credit Sales
Method Method
Estimate of Uncollectible Accounts Estimate of Uncollectible Accounts
Varying percentage based on age 12.5% of credit sales in the current
of accounts receivable. year will not be collected.
Allowance = $8 million. 12.5% of $80 million = $10 million.
Adjust from $1 million existing Ignore $1 million existing balance of
balance of allowance account. allowance account.
Adjustment ($ in millions) Adjustment ($ in millions)
Bad Debt Expense 7 Bad Debt Expense 10
Allowance for Uncoll. Accts. 7 Allowance for Uncoll. Accts. 10

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Illustration 517
Financial Statement Effects of
Estimating Uncollectible Accounts
Percentage-of-Receivables Method Percentage-of-Credit-Sales Method
($ in millions) ($ in millions)
Income Statement Effect Income Statement Effect
Revenues $80 Revenues $80
Bad debt expense (7) Bad debt expense (10)
Net income $73 Net income $70
Balance Sheet Effect Balance Sheet Effect
Accounts receivable $30 Accounts receivable $30
Less: Allowance (8)* Less: Allowance (11)*
Net accounts receivable $22 Net accounts receivable $19
*$8 = $1 + $7 (adjustment) *$11 = $1 + $10 (adjustment)

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Concept Check 512
On December 31 before adjusting entries, a company
reports the following balances:
Accounts Receivable $100,000
Allowance for Uncoll. Accts. $2,000 (credit)
Credit Sales $500,000
The company estimates bad debts to be 4% of credit
sales. The adjust entry would include:
a. A debit to Bad Debt Expense = $18,000
b. A credit to Allowance for Uncoll. Accts. = $24,000
c. A credit to Allowance for Uncoll. Accts. = $22,000
d. A debit to Bad Debt Expense = $20,000
The adjustment equals $500,000 4% = $20,000. The
adjusting entry includes a debit to Bad Debt Expense
and a credit to Allowance for Uncollectible Accounts.
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Summary
1. LO51 Recognize accounts receivable.
2. LO52 Calculate net revenues using
discounts, returns, and allowances.
3. LO53 Record an allowance for future
uncollectible accounts.
4. LO54 Use the aging method to estimate
future uncollectible accounts.
5. LO55 Apply the procedure to write off
accounts receivable as uncollectible.

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Summary
1. LO56 Contrast the allowance method and
direct write-off method when accounting for
uncollectible accounts.
2. LO57 Account for notes receivable and interest
revenue.
3. LO58 Calculate key ratios investors use to
monitor a companys effectiveness in managing
receivables.
4. LO59 Estimate uncollectible accounts using the
percentage-of-credit-sales method.

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End of Chapter 5

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