L Manage Overdue Customer Accounts

The main objectives of this unit are correctly to initiate and complete the management of
customer accounts which have outstanding payments.
After completing this learning guide, you should be able to:
LO1: Identify customers requiring collection activity
LO2: Establish contact with customer and attempt to resolve outstanding payment matters
LO3: Negotiate resolution of outstanding payments
LO4: Agreement is monitored to ensure adherence o1 I
Distinguishing Current Liabilities from Long Term Liabilities
With the wide availability of credit comes the risk that the credit provided will not be returned
and promised payments will not be made. This course explores the skills and knowledge
needed to correctly initiate and complete the management of customer accounts which have
outstanding payments.
This course deals with the key aspects of dealing with overdue customer accounts -
 Identify customers requiring collection activity – including the need to monitor your organization
overdue account reporting system, access and retrieve relevant information and records, and
review overdue debtors in accordance with relevant policies.
 Establish contact with a customer and attempt to resolve outstanding payment matters
– including proposing appropriate communication with the customer and obtaining appropriate
authorization, making contact with the customer and building rapport, and advising relevant
organization(s) regarding the purpose of contact.
 Negotiate resolution of outstanding payments with the customer – including advising debtors of
the possibility of legal action for non-payment, using appropriate techniques to achieve
resolution, confirming negotiation outcomes and diarizing further actions
 Monitor payment agreement to ensure the customer has adhered to the agreement – including
reviewing accounts regularly to check payments have been received, dealing with breaches of the
agreement promptly and appropriately, and referring outstanding payment matters to appropriate
personnel.
 A liability is a probable future payment of assets, services that a company is presently obligated to
make as a result of past transactions or events.
This definition includes three crucial factors.
Þ Due to a past transaction or event
Þ Present obligation
Þ Future payment of assets or services.
Classification of Liabilities
Information about Liabilities is more useful when the balance sheet identifies them as either
current or long -term. Decision makers need to know when obligations are due so they can plan for
them and take appropriate action
Current Liabilities- also called short term liabilities are obligations expected to be paid using
current assets or by creating other current liabilities – current liabilities are due within one year or
the company operating cycle, whichever is longer.
Example
 Account payable
 Short term note payable
 Wages payable
 Lease liabilities
 Taxes payable
 Unearned revenue
Long-term Liabilities – Non-current Liabilities
A company debt and obligations expects to pay after one year, longer operating cycles reported on
balance sheet as long-term liabilities.
Example
 Bonds payable
 Long-term notes payable
 Mortgages payable
 RECEIVABLES
 The term receivable includes all money claims against other entities people, business
firms and the organization.
 The term receivable refers to amounts due from individuals and companies.
 Receivables are claims that are expected to be collected in cash.
 Receivables represent one of a company’s most liquid assets.
Classification of Receivables
-The receivables that result from sales on account are normally accounts receivable or notes
receivable. The term receivables includes all money claims against other entities, including
people, companies, and other organizations.
-Receivables are usually a significant portion of the total current assets.
The common classes of receivables
1. Accounts Receivable
2. Notes Receivable
3. Other Receivables
Accounts receivable
• The most common transaction creating a receivable is selling merchandise or services on
account (on credit). The receivable is recorded as a debit to Accounts Receivable and credit to
sales revenue. Such accounts receivable are normally collected within a short period, such as
30 or 60 days.
 The amounts monies owed by customers on account
 Customers are individuals or business entities that purchase goods or services
 Result from the sale of goods and services (often called trade receivables).
 Usually the most significant type of claim held by a company.
Notes receivable:
 Represent claims for which formal instruments of credit are issued as evidence of debt.
Other receivables:
 Nontrade receivables including interest receivable, loans to company officers, advances to
employees, and income taxes refundable.
 Generally classified and reported as separate items in the balance sheet.
ACCOUNTS RECEIVABLE
The most common transaction creating a receivable is selling merchandise or services on
account (on credit). The receivable is recorded as a debit to Accounts Receivable. Such
accounts receivable are normally collected within a short period, such as 30 or 60 days. They are
classified on the balance sheet as a current asset.
Uncollectible for Receivables
The accounting for sales of merchandise or services on account (on credit) was described and
illustrated. A major issue that has not yet been discussed is that some customers will not pay
their accounts. That is, some accounts receivable will be uncollectible. Companies may shift the
risk of uncollectible receivables to other companies.

For example, some retailers do not accept sales on account, but will only accept cash or credit
cards. Such policies shift the risk to the credit card companies. Companies may also sell their
receivables. This is often the case when a company issues its own credit card.
For example, MC and JC issue their own credit cards. Selling receivables is called factoring
the receivables. The buyer of the receivables is called a factor.
An advantage of factoring is that the company selling its receivables immediately receives cash
for operating and other needs. Also, depending on the factoring agreement, some of the risk of
uncollectible accounts is shifted to the factor. Regardless of how careful a company is in granting
credit, some credit sales will be uncollectible. The operating expense recorded from uncollectible
receivables is called bad debt expense, uncollectible accounts expense, or doubtful accounts
expense. There is no general rule for when an account becomes uncollectible.
Some indications that an account may be uncollectible include the following:
1. The receivable is past due.
2. The customer does not respond to the company’s attempts to collect.
3. The customer files for bankruptcy.
4. The customer closes its business.
5. The company cannot locate the customer.

If a customer doesn’t pay, a company may turn the account over to a collection agency. After the
collection agency attempts to collect payment, any remaining balance in the account is
considered worthless.
Establish contact with customer and attempt to resolve outstanding payment matters
Credit Terms can be:
1. Open Account: seller ships goods and sends the invoice.
2. Bill of Exchange: a more secure arrangement that represents an unconditional order by the
seller asking the buyer to pay on demand or at certain future date, the amount specified on it
3. Consignment: agent relationship between the seller and the buyer
4. Letter of Credit: issued by a bank on behalf of its customer to the seller.
The credit policies have a bearing on the level of sales, bad debt loss, discounts taken by
customers, and collection expenses. The important dimensions of credit policy are:
1. Credit Standards: What standard should be applied in accepting or rejecting an account for
credit granting? Can range from Liberal to stiff credit policy …
2. Credit Period: Has a direct proportionality with sales
3. Cash Discount: Firms generally offer cash discounts to induce customers to make prompt
payments.
4. Collection Effort: aimed at timely collection of the R & consists of:
• Monitoring the state of receivables,
• Dispatch of letters to customers whose due date is approaching,
• Electronic and telephonic advice to customers around the due date,
• Threat of legal action to overdue accounts,
• Legal action against overdue accounts.
The Two Methods of Accounting for Uncollectible Receivables:
1. The direct write-off method records bad debt expense only when an account is determined
to be worthless.
2. The allowance method records bad debt expense by estimating uncollectible accounts at
the end of the accounting period. The direct write-off method is often used by small
companies and companies with few receivables.

Generally accepted accounting principles (GAAP), however, require companies with a large
amount of receivables to use the allowance method.
Direct Write-Off Method for Uncollectible Accounts

1. July 9. Received $1,200 from Jay Burke and wrote off the remainder owed of $3,900 as
uncollectible.
2. Oct. 11. Reinstated the account of Jay Burke and received $3,900 cash in full payment.
Entry:
July 9 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ......1,200
Bad Debt Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3,900
Accounts Receivable—Jay Burke . . . . . . . . . . . . . . .. . 5,100
Oct. 11 Accounts Receivable—Jay Burke . . . . . . . . . . . . . . . . . . . . .3,900
Bad Debt Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,900
11 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,900
Accounts Receivable ………….. . . . . . . . . . . . . . . . . . 3,900

Allowance Method for Uncollectible Accounts

The allowance method estimates the uncollectible accounts receivable at the end of the
accounting period. Based on this estimate, Bad Debt Expense is recorded by an adjusting entry.

To illustrate, assume that Ex-Tone Company began operations August 1. As of the end of its
accounting period on December 31, 2009, Ex Tone has an accounts receivable balance of
$200,000. This balance includes some past due accounts. Based on industry averages, Ex Tone
estimates that $30,000of the December 31accounts receivable will be uncollectible.

However, on December 31, Ex-Tone doesn’t know which customer accounts will be
uncollectible. Thus, specific customer accounts cannot be decreased or credited. Instead, a contra
asset account, Allowance for Doubtful Accounts, is credited for the estimated bad debts.

Using the $30,000 estimate, the following adjusting entry is made on December 31:
December 31 Bad Debt Expense………………. 30,000
Allowance for Doubtful Accounts…………..30,000
(Uncollectible accounts estimate)
On the balance sheet, the value of the receivables is reduced to the amount that is expected to be
collected or realized. This amount, $170,000 ($200,000 - $30,000), is called the net realizable
value of the receivables.

Estimating Un-collectibles
The allowance method requires an estimate of uncollectible accounts at the end of the period.
This estimate is normally based on past experience, industry averages, and forecasts of the
future.
The two methods used to estimate uncollectible accounts are as follows:
1. Percent of sales method.
2. Analysis of the receivables method.
1. Percent of Sales Method
Since accounts receivable are created by credit sales, uncollectible accounts can be estimated as
a percent of credit sales. If the portion of credit sales to sales is relatively constant, the percent
may be applied to total sales or net sales. To illustrate, assume the following data for Ex Tone
Company on December 31, 2010, before any adjustments:
Balance of Accounts Receivable $240,000
Balance of Allowance for Doubtful Accounts 3,250 (Cr)
Total credit sales 3,000,000 Bad debt as a percent of credit sales 3/4%
Bad Debt Expense estimated as follows:
Bad Debt as Percent of Credit Sales
Bad Debt Expense = Credit Sales * Percent of Credit Sales
Bad Debt Expense = $3,000,000 * 3/4% = $22,500

The adjusting entry for uncollectible accounts on December 31, 2010, is as follows:
Bad Debt Expense ……………………22,500
Allowance for Doubtful Accounts……..22,500
Uncollectible accounts estimate ($3,000,000 * 0.0075 = $22,500)
After the adjusting entry is posted to the ledger, Bad Debt Expense adjusted balance $22,500.
Allowance for Doubtful Accounts will have an adjusted balance of $25,750 ($3,250+$22,500).
2. Analysis of Receivables Method
The analysis of receivables method is based on the assumption that the longer an account
receivable is outstanding, the less likely that it will be collected. The preceding steps are
summarized in an aging schedule, and this overall process is called aging the receivables.

To illustrate, assume that Ex Tone Company uses the analysis of receivables method instead of
the percent of sales method. Ex Tone prepared an aging schedule for its accounts receivable of
$240,000 as of December 31, 2010, as shown

Total sales Uncollectible % estimate amount

 Not past due 125000 2% 2,500
 1–30 days past due 64000 5% 3,200
 31–60 days past due 13100 10%
 61–90 days past due 8900 20%
 91–180 days past due 5000 30%
 181–365 days past due 10,000 50%
 Over 365 days past due 14000 80%
240,000 26490
Problem: At the end of the current year, Accounts Receivable has a balance of $800,000;
Allowance for Doubtful Accounts has a credit balance of $7,500; and net sales for the year total
$3,500,000. Using the aging method, the balance of Allowance for Doubtful Accounts is
estimated as $30,000.
Determine
a. The amount of the adjusting entry for uncollectible accounts;
b. The adjusted balances of Accounts Receivable, Allowance for Doubtful Accounts, and Bad
Debt Expense; and
c. The net realizable value of accounts receivable.
Solution
a. $22,500 ($30,000 - $7,500)
b. Accounts Receivable Balance. . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . .$ 800,000
Allowance for Doubtful Accounts . . .. . ……………………………. . .30,000
Bad Debt Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …22,500
c. net realizable value of accounts receivable $ 770,000 ($800,000 - $30,000)
NOTES RECEIVABLE
A note has some advantages over an account receivable. By signing a note, the debtor recognizes
the debt and agrees to pay it according to its terms. Thus, a note is a stronger legal claim.
Characteristics of Notes Receivable
Notes receivable are amounts that customers owe for which a formal, written instrument of
credit has been issued. If notes receivable are expected to be collected within a year, they are
classified on the balance sheet as a current asset. Notes are often used for credit periods of more
than 60 days. For example, an automobile dealer may require a down payment at the time of
sale and accept a note or a series of notes for the remainder. Such notes usually provide for
monthly payments.
A promissory note is a written promise to pay the face amount, usually with interest, on demand
or at a date in the future. Promissory Note -a written promise to pay a specified amount of
money either on demand or at a definite future date.

Promissory Notes may be used in exchange for goods or services, in exchange for loaned funds,
or in exchange for an outstanding account receivable.
 Principal-amount stated on the face of the note.
 Payee- person to whom the principal is owed.
 Maker- person who signs the note and promises to pay the principal.
Interest the charge for the use of money over a period of time. Interest is generally stated as an
annual percentage rate. The maker of the note will have interest expense. The payee of the note
will have interest revenue.
 Origination Date -the day the note was “made”.
 Maturity Date-the date the principal and interest are due to the payee.
 Maturity Value-the total amount due on the maturity date. Principal plus interest.
The time of the note is the period of time from the origination date to the maturity date. Time
may be expressed in days, months, or years.
 Honoring a Note -paying the note in full on the maturity date.
 Dishonoring a Note -not paying the note at the maturity date.
Additional Terms Factoring-selling accounts receivable to a financial institution. The financial
institution usually charges a factoring fee for their services. The amount a company receives for
factoring accounts receivable is the amount of the accounts receivable less the factoring fee.

Discounting-selling notes receivable to a financial institution.

Proceeds-amount the seller receives from discounting a note. For a calculation of proceeds from
discounting a note.
The proceeds received for discounting a note may be more or less than the principal of the note.
Factors affecting this amount include the interest rate, the discount rate, and the period of time
the note has been held by the payee.
 Discount Rate-the amount the financial institution charges for discounting a note.
 Note Discounted With Recourse-the seller of the note retains the risk of loss if the note is
dishonored.

If the maker of a note fails to pay the note on the due date, the note is a Dishonored Note
Receivable.
Since we are dealing with Notes Receivable, the entries will be from the perspective of the
payee.
1. Receipt of the Note
Notes Receivable --------------------------xx
Sales or Cash or Accounts Receivable ---------------- xx
A subsidiary ledger is generally not kept for Notes Receivable. The notes are filed and serve as a
reference for all information regarding each Note Receivable account.
2. Payment of the Note by the Maker- Honored Note
Cash -----------------------------xx
Notes Receivable -------------------------xx
Interest Income -----------------------------xx
Cash should generally be debited for the maturity value of the note.
3. Dishonored Note
Accounts Receivable -------------------xx
Notes Receivable ----------------- xx
Interest Income -------------------- xx
Dishonored notes do not disappear, but are removed from notes receivable and become an
unsecured account receivable. Even though no cash has been received, interest has been
earned through the use of the money by the maker of the note and therefore interest income
should be recognized.
4. Adjustment for Accrual of Interest
Interest Receivable ------------xxx
Interest Income ---------------xxx
This adjustment is made (if necessary) at the end of the fiscal period.
INTEREST COMPUTATION
Interest is generally recorded when the note is repaid.
The interest on a note is computed as follows:
 Interest
 Face Amount
 Interest Rate
(Term/360 days) The interest rate is stated on an annual (yearly) basis, while the term is
expressed as days. Thus, the interest on the note in 4 is computed as follows:
Interest = Principal X Interest Rate X Time (P x R x T)
The time period of a note is stated as a fraction of days, months, or years. For example, interest
on a 90-day note with a principal of $1,000 and an annual interest rate of 10% would be
calculated as follows:
I = Principal * Rate * Time
= $1,000 * 0.1 * 90/360 = 25
For simplicity, a year is treated as having 360 days.
Illustrates
A promissory note. The maker of the note is Song Company, and the payee is Pearland
Company. The face value of the note is $2,000, and the issuance date is March 16, 2009. The
term of the note is 90days, which results in a due date of June 14, 2009, as shown below
 Days in March 31 days
 Minus issuance date of note 16
 Days remaining in March 15 days
 Add days in April 30 Add days in May 31
 Add days in June (due date of June 14) 14
 Term of note 90 days
Interest = Principal X Interest Rate X Time
= $2,000 x 10% (90/360) = $50
To simplify, we will use 360 days per year. In practice, companies such as banks and mortgage
companies use the exact number of days in a year, 365. The maturity value is the amount that
must be paid at the due date of the note, which is the sum of the face amount and the interest.
The maturity value of the note is $2,050 ($2,000 + $50).

Exercise
1. What is the maturity value of a 90-day, 12% note for $10,000?
2. What is the due date of a $12,000, 90-day, and 8% note receivable dated August 5?
3. When a note receivable is dishonored, Accounts Receivable is debited for what amount?
A. The face value of the note
B. The maturity value of the note
C. The maturity value of the note less accrued interest
D. The maturity value of the note plus accrued interest

Illustration
A company receiving a note should record an adjusting entry for any accrued interest at the end
of the period. For example, assume that Crawford Company issues a $40,000, 90-day, 12% note
dated December 1, 2010, to settle its account receivable. If the accounting period ends on
December 31, the company receiving the note would record the following entries:
Dec. 1 Notes Receivable 40,000
Accounts Receivable 40,000
Dec. 31 Interest Receivable 400
Interest Revenue 400
Accrued interest ($40,000 * 12% * 30/360)
March. 1 Cash 41,200
Notes Receivable 40,000
Interest Receivable 400
Interest Revenue 800
(Total interest of $120 ($4,000 * 12% * 90/360