The Nature of Receivables

Receivables represent rights to receive cash in the future for goods and services
sold on credit and for lending money now. Receivables are treated as assets on the
statement of financial position. The two common types of receivables are: accounts
receivable and notes receivable.

Accounts Receivable
Accounts receivable are amounts to be collected from customers for sales made on
credit. It is a control account in the general ledger that summarizes the total of all
individual customer receivables. The individual customer accounts appear in the
subsidiary ledger called
accounts receivable ledger or customers' ledger.

Notes Receivable
Notes receivable are rights to receive cash in the future from a customer or other
party. This right is evidenced by a formal and written promise to pay called
promissory note. A note is usually interest bearing. Notes receivable due within one
year from the balance sheet date are classified current assets. Notes due beyond
one year are classified as non-current.

Internal control, the application for credit should be evaluated by the credit
department. The credit handlers should not receive cash from the customers as they
can pocket the same and label the account as uncollectible.

Accounting for Uncollectible Accounts

To capture a wide range of customers, many companies sell on credit. This benefits
the company in terms of increased revenue and profit. But there is a cost. Some of
the receivables may not be collected. This creates an expense called uncollectible
accounts expense, doubtful accounts expense, or bad debt expense. These
three accounts are used interchangeably with one another but have the same
meaning. The customer did not pay his balance.

Two methods of accounting for uncollectible accounts. 

1. allowance method and
2. the direct write-off method.
The allowance method is based on the matching concept. It recognizes
the expense in the same period it recognizes the revenue. The credit is
made to Allowance for uncollectible accounts or Allowance for doubtful
accounts, a contra-asset account whose balance is deducted from
accounts receivable on the balance sheet. 

The company doesn't wait to see which customer will not pay. Instead, it records an
expense based on estimates from past experience and uses the allowance to house
the pool
of unknown bad debtors.

Methods of Estimating Uncollectible Accounts

 Sales method and the aging of accounts receivable method. The percent
of sales method calculates the uncollectible accounts expense as a
percentage of net credit sales. This is known as the income statement
approach because it focuses on the expense. 
 Aging of accounts receivable method or the balance sheet approach
determines the target balance of the allowance based on the aging of
receivables. Thedifference between the target balance and the current
balance of the allowance is the uncollectible accounts expense.

Illustration
During 2018, Company A had net credit sales of P600,000. Its Accounts
Receivable and Allowance for Uncollectible Accounts as of December 31, 2018
before adjustment are P100,000 and P2,000, respectively. Prepare the adjusting
entry to record Uncollectible Accounts Expense for the year assuming

A. One percent of net credit sales is deemed uncollectible based on past experience.
B. P40,000 of accounts receivable are aged 0-60 days and the rest are over 60 days.
An allowance equal to 2% of accounts aged 0-60 days and 10% of accounts aged
over 60 days is needed.

Answer:
A. Uncollectible accounts expense                                            6000
            Allowance for uncollectible accounts [600,000 x 1% = P6,000]           6000

B. Uncollectible accounts expense                                         4800

        Allowance for uncollectible accounts                                                4,800

Target allowance
(40,000 x 2%) +(60,000 x 10%) =800+6000
Current allowance Uncollectible accounts expense 2,000.00

Write-off of an Account
When a specific account, say Customer X with a balance of P2,000, is deemed to be
worthless and has to be written-off, what will be the entry under the allowance
method? The entry will be:

Allowance for uncollectible accounts  2,000.00

   Accounts receivable - Customer X      2,000.00

Recovery of an Account Previously Written-Off

If a customer pays after his account was written-off, two entries are account. This
reverses the entry to record the write-off of the account. Second is to record the
collection of the account. 

Assume that the account needed in the books of the seller. One is to record the
reinstatement of the Receivables of Customer X previously written-off was
subsequently collected. The corresponding entries are:

Accounts receivable - Customer X 2,000

  Allowance for uncollectible accounts  2,000

Cash                                            2,000.00
  Accounts receivable - Customer X     2,000.00

Direct Write-Off Method

Under the direct write-off method, no allowance account is maintained and what is
considered as uncollectible accounts expense is the amount written-off. The credit is
made directly to accounts receivable. Hence, if Customer X account with a balance
of P2,000 is deemed worthless and uncollectible, the entry to record the write-off of
his account is:

Uncollectible accounts expense  2,000.00

Accounts receivable - Customer X   2,000.00

The direct write-off method is defective because it presents accounts receivable at

their full or overstated amount. Furthermore, the uncollectible accounts expense is
not matched with the related revenue because oftentimes the write-off would occur in
the period subsequent to the period in which the related revenue was recognized.

Credit Card Sales

Credit cards offer the convenience of buying without having to pay cash or issue a
check immediately. Credit card companies pay the seller and then bill the customers.
The customer can just write a check later to cover several purchases. The seller
does not have to check the credit worthiness of the customers or pursue collection of
accounts. This, however, does not
come free of charge. The credit card company charges a fee of 1% to 5% on sales. 

The pro-forma entry to record credit card sales is:

Accounts receivable - Credit Card Company 
Credit card discount expense
        Sales revenue

Debit Card Sales

Debit card sales are similar to cash sales. When the debit card is account is debited
(decreased) and the seller' bank account is credited swipe through a special terminal
to pay for purchases, the customer' bank (increased).

Notes Receivable

A promissory note is a written promise to pay a certain amount in the future. The
relevant terms related to a promissory note are the following 
Maker (Debtor) - the party promising to pay, from the point of view of the maker, a
promissory note is a liability (Note Payable)
Payee (Creditor) - the party to whom the promise to pay is made, a promissory note
from the point of view of the payee is an asset (Note Receivable)
Due date - the maturity date of the note which can be specified or determined from
the date and term of the note express in number of days, months, or years.
Principal (Face Value) - the amount loaned out by the payee and borrowed by the
maker of the note
Interest rate - the percentage rate of interest specified by the note; without any
qualification, the interest rate specified is the annual interest rate
Interest - the amount of interest revenue earned by the payee and interest
expense incurred by the maker of the note