Fundamentals of Accounting I

Chapter Five

Accounting for Receivables

 Definition and nature of receivable
• 

Receivables, are debts owed to a company by its customers for goods or

services that have been delivered or used but not yet paid for
Classification of receivables
• 

1. Based on the amount of time it will take to collect them,

o Current versus non-current Receivables
2. Based on the sources from which the receivables arise
o Trade Receivables versus Non-Trade Receivables
3. Based on how strong they are in the eyes of the law.
o Account Receivables versus Notes Receivables
 Un-collectable Receivable

•Receivable that will never be collected, have a zero value and the expense
resulted from failure of the credit customer to settle the open account, is
called uncollectable account, doubtful account or bad debt.

The objective of estimating doubtful account expense is to prevent an over

statement of assets and revenue in the accounting period in which sales
are made.
Accounting Treatment of uncollectable

•There are two methods of accounting for receivable that are believed to be
uncollectable.
1. The allowance method, which is sometimes called reserve method,
o Provides in advance provision for uncollectable receivables.

2. The direct write off /direct charge- off/ method

o Recognizes the expense only when accounts are judged to be worthless.
 1. The Allowance Method of Accounting for Uncollectable

The uncollectable is made by an adjusting entry at the end of the accounting period.

The adjusting entry at the end of the year serves two purposes:
 Reducing the value of the receivable to the amount of cash expected to be realized from them
in the future.
 The allocation to the current period of expected expense resulting from such reduction.

• The estimated doubtful account is carried as a credit balance in a valuation account

title known as Allowance for Doubtful account or Allowance for uncollectable
accounts.
 Illustration

• ABC co. began business in August 2010. The accounts receivable has
a balance of Birr 105,000.00 at the end of the year. Based on careful
study, it is estimated that receivables worth of Birr 3,000.00 will
eventually prove to be uncollectable.

December 31, 2010 Uncollectable Account Expense 3,000.00

Allowance for Doubtful accounts 3,000.00
 Writing off an allowance account
Example: On January 21, 2011, Birr 110.00 of the receivables is proved to be uncollectible.

January 21, 2011 Allowance for doubtful account 110.00

Account Receivable –Mr. B 110.00
It is practical to collect an account, which was written off same times ago. In that case
before recognizing the collection, accounts should be reinstated.
Example: If MR B. on March 05, 2011 settled the Birr 110.00 he owes to ABC Company
1st we reinstate the account
Account receivable-MR. B 110.00
Allowance for doubtful account 110.00
2nd record collection
Cash 110.00
Account Receivable Mr. B 110.00
2. Direct write off method of accounting for uncollectable

The justification of this method being, if uncollectable could not

possibly be reasonably estimated, if credit sales are not significant (i.e.
most goods and services are sold on cash basis), thus the amount of
uncollectable is usually small in relation to total sales.
•For this case allowance for uncollectable accounts is not required, nor
any adjusting entry for the period.
•Under this method, uncollectable receivable are written off by debit to
doubtful accounts expense and credit to account receivable.
 Illustration

WD enterprise uses direct write off method of accounting for uncollectable. On

February 27, 2011 it was known that the account receivable from ABC Company
For The Amount Of Birr 10,000.00 was uncollectable since ABC was bankrupted.
The entry to record the direct write off of the receivable would be:

February 27, 2002 uncollectable account expense Br 10,000.00

Account receivable –ABC co. Br 10,000.00
 Illustration …….cont’d
On October 15, 2002 Sami enterprise collected Birr 3,000.00 from ABC Company
in settlement of the account receivable which was written off on February 27, 2002.
1st to reinstate the account receivable
October 15, 2002 Account receivable – ABC Company Br 3,000.00
Uncollectable account Expense Br 3,000.00
 
2nd to record the collection
October 15, 2002 Cash Br 3,000.00
Account Receivable – ABC Company Br 3,000.00
 Note Receivable
Characteristics to a Note Receivable
1. Due/Maturity Date: The date on which a note is to be paid
Nb: The term of a note may be stated in days or in months such as a three-month note, dated June 5, 2010,
would mature on September 5, 2010.
For example the due date for a 120 Days note dated Jan.30, 2010:
• Term of the Note 120 days = Jan(1) + Feb(28) + Mar(31) + Apr(30) + May (30) = 120 days
Therefore, the due ( maturity) date of note is May 30

2. Types of Notes:
a) Interest-bearing note
b) Non- interest bearing note:

3. Maturity Value: the amount that the company (maker) must pay on a note on its maturity date
Accounting Treatment for Notes Receivable:
Interest Bearing Note
Example: On December 15, 2010 the enterprise received birr 10,000.00, 90 day,
12% note dated December 15, 2010 for settlement of the open account.

Recording the transaction on October 02, 2010 and converting the open account to a
note receivable on December 15, 2010 is the same.

December 31st, 2010, adjusting entry for recording the accrual of the interest
December 15, 2010 to December 31, 2010:
 Solution

Interest earning Period = December 31, 2010 – December 15, 2010 = 16 days
Interest = 10,000 * 0.12* 16/360

Interest Receivable 53.33

Interest Income 53.33
 
 
March 15, 2011 Cash 10,300.00
Interest Receivable 53.33
Interest Income 246.67
Notes Receivable 10,000.00
 
Discounting Notes receivable???
Reading assignment
End of the course Fundamentals of
Accounting I

Thank you very much !!

Learning never ends!!!