Chapter 5 Receivables and Sales

Financial Accounting Fourth Edition
Receivables and
Sales
CHAPTER
5 Spiceland • Thomas • Herrmann
Copyright ©2016 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 1
Learning
Objectives LO5–1 Recognize accounts receivable.
LO5–2 Calculate net revenues using
discounts, returns, and
allowances.
LO5–3 Record an allowance for future
uncollectible accounts.
LO5–4 Use the aging method to
estimate future uncollectible
accounts.
LO5–5 Apply the procedure to write off
accounts receivable as
uncollectible.
Learning
Objectives LO5–6 Contrast the allowance method
and direct write-off method when
accounting for uncollectible
accounts.
LO5–7 Account for notes receivable and
interest revenue.
LO5–8 Calculate key ratios investors use
to monitor a company’s
effectiveness in managing
receivables.
LO5–9 Estimate uncollectible accounts
using the percentage-of-credit-
sales method.
Part A
RECOGNIZING ACCOUNTS RECEIVABLE
Learning Objective 1
LO5–1 Recognize accounts receivable.
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
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
Recording of Credit Sales
• Link’s Dental charges $500 for teeth
whitening. Dee Kay decides to have her teeth
whitened on March 1 but doesn’t 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)
Key Point
Companies record an asset (accounts receivable)
and revenue when they sell products and
services to their customers on account,
expecting payment in the future.
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”)
Concept Check 5–1
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.
LO5–2 Calculate net revenues using discounts,

returns, and allowances.
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
• Link’s Dental typically charges $500 for teeth
whitening. Dr. Link offers a 20% discount on
teeth whitening.
Accounts Receivable ……………………. 400
Service Revenue …………….......... 400
(Make credit sale of $500 with a 20% trade discount)
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
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 Dee’s account balance by $50
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
Common Mistake
Students sometimes misclassify contra revenue
accounts—Sales 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.
Sales Discount
• Offer a customer a reduction if payment is made
within a specified period of time
• Link’s Dental offers Dee terms of 2/10, n/30 on
$350 owed; Dee pays on March 10 (w/in 10 days)
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
Illustration 5–1
Income Statement Reporting Revenues
Net of Sales Allowances and Sales
Discounts
LINK’S 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
Illustration 5–2
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
Concept Check 5–2
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.
Concept Check 5–3
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.
Let’s Review
Snap-Crackle-Pop (SCP) Chiropractic normally charges $120 for a full spinal adjustment.
Currently, the company is offering a $20 discount to senior citizens. In addition, SCP offers
terms 2/10, n/30 to all customers receiving services on account. The following events occur.
June 18 David, age 72, calls to set up an appointment.

June 20 David visits SCP and receives a spinal adjustment for the discounted price.
June 29 David pays for his office visit.
Required:
1. On what date should SCP record patient revenue?
2. Record patient revenue for SCP.
3. Record the cash collection for SCP assuming SCP receives David's payment in full on June
29 (within the discount period).
4. Calculate the balance of Accounts Receivable using a T-account format, and then
calculate the balance of net revenue as shown in the income statement after the cash
payment is received.
Solution:
1. SCO should record patient revenue on June 29 – the date the service
was provided
2. The journal entry to record patient revenue
June 20 Accounts receivable 100
Service revenue 100
3. The journal entry to record the receipt of David’s payment in full

within the discount period
June 29 Cash 98
Sales Discounts 2
Accounts Receivable 100
4. Service Revenue $100

Less: Sales Discounts (2)
Net Revenue $ 98
Revenue Recognition
1. Requires a company to report revenues
equal to the amount of cash the company
“expects to be entitled to receive.”
2. A company must estimate any additional
discounts, returns, and allowances that
will occur in the next year as a result of
sales in the current year.
Revenue Recognition
1. Suppose General Health sells medical parts and
consultation services of $400,000 on account during
2018. Also during 2018, some customers receive sales
discounts totaling $6,000 for quick payment, while
others return unused parts of $10,000 and others
receive allowances of $14,000.
2. Suppose the company estimates an additional $1,000 in
sales discounts, $2,000 in sales returns, and $3,000 in
sales allowances in 2019 associated with sales in 2018
Illustration 5–3
Income Statement Reporting Revenues Net
of Sales Discounts, Returns, and Allowances
GENERAL HEALTH
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
Part B
VALUING ACCOUNTS RECEIVABLE
LO5–3 Record an allowance for future uncollectible

accounts.
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.
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)
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.
Estimating Uncollectible Accounts
• Percentage-of-receivables method
 Bases the estimate of bad debts on a balance
sheet amount—accounts receivable
 Also called the “balance sheet method”
• 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
Accounts Receivable
Of the $20,000,000 accounts receivable, $ 20,000,000
Kimzey estimates that we will not
collect 30% percent of the accounts
receivable balance.
Allowance for Uncollectible Accounts
So $20,000,000 X 30% = $6,000,000 $ 6,000,000
If $6,000,000 will not be collected what

is the Accounts Receivable real value?
The Accounts receivable balance minus

the amount we estimate that we will
not collect is called the Net Realizable
Value of the Accounts Receivable.
Illustration 5–4
Partial Income Statement Showing
Estimated Bad Debt Expense
KIMZEY MEDICAL CLINIC

($ in millions)
Credit sales $50
Bad debt expense (6)
$44
Illustration 5–5
Accounting for Uncollectible Accounts and
the Accounts Receivable Portion of the
Balance Sheet
2018 2019
($ in millions) (next year)
(current year)
$50 $20 $14 Collectible
Credit sales Not collected Estimate
during 2018 by end of year $6 Uncollectible

Asset Balance Sheet (partial) Contra
December 31, 2018 Asset
Current assets:
Accounts receivable $20
Less: Allowance (6)
Net accounts receivable $14
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.
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.
Concept Check 5–4
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 Receivable’s net realizable value.
LO5–4 Use the aging method to estimate future

Illustration 5–6
Kimzey’s Accounts Receivable Aging
Schedule
Days Past Due
More than
Patients Not Yet Due 1–60 61–120 120 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
with age
Estimated Amount
Uncollectible $ 1,000,000 $1,800,000 $1,500,000 $ 700,000 $ 5,000,000
Total estimated
uncollectible
Aging Method
• Considers the age of receivables
 Older accounts are more likely uncollectible
• More accurate than using a single percentage
• From Kimzey’s aging schedule (Illustration 5–6
on the previous slide) the estimate of
uncollectible accounts equals $5 million.
December 31 ($ in millions) Debit Credit
Concept Check 5–5
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.
Illustration 5–7
Excerpt from Tenet Healthcare
Corporation’s 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
0–60 days $262 $ 67 $943 $ 158 $1,430
61–120 days 29 34 229 104 396
121–180 days 13 18 100 60 191
Over 180 days 19 34 157 225 435
Total $323 $153 $1,429 $547 $2,452
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.
LO5–5 Apply the procedure to write off accounts

receivable as uncollectible.
Writing Off Accounts Receivable
• When it becomes clear the customer will not pay,
the company writes off the customer’s 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
Writing Off Accounts Receivable
• Kimzey receives notice that Bruce Easley has filed for
bankruptcy and will not pay $4,000
• Kimzey writes off Bruce’s account receivable
February 23, 2019 Debit Credit
Allowance for Uncollectible Accounts …… 4,000
Accounts Receivable ………………………… 4,000
(Write off a customer’s 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
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
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

Concept Check 5–6
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.
Key Point
Writing off a customer’s account as uncollectible
reduces the balance of accounts receivable but
also reduces the contra asset—allowance 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.
Allowance Method in the Following Year
• At the end of 2019, Kimzey must once again estimate
uncollectible accounts and make a year-end adjustment.
• 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 year’s overestimation?
ESTIMATING UNCOLLECTIBLE
ACCOUNTS IN THE FOLLOWING YEAR
• Suppose that in 2019 Kimzey bills customers
for services totaling $80 million, and $30
million are still receivable at the end of the
year. Of the $30 million still receivable, let's
say Kimzey again uses the aging method and
estimates $8 million will not be collected. For
what amount would Kimzey record the year-
end adjusting entry for bad debts in 2019?
Illustration 5–8
Balance of Kimzey’s Allowance for
Uncollectible Accounts
($ in millions)
5 Beg. balance for 2019
Write-offs in 2019 4
1 Bal. before adjustment
? Year-end adjustment
8 Ending balance for 2019

Illustration 5–9
Bad Debt Expense in the Income
Statement
Income Statement
($ in millions)
Revenue from credit sales $80
Expenses:
Bad debt expense $ 7
Other operating expenses 50 57
Net income $23
Illustration 5–10
Accounts Receivable Portion of the
Balance Sheet
Balance Sheet (partial)
December 31, 2019
Assets
Current assets ($ in millions):
Accounts receivable $30
Less: Allowance for uncollectible accounts (8)
Net accounts receivable $22
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 $8 million.
($ in millions)
5 Beg. balance for 2019
Write-offs in 2019 6
Bal. before adj. 1
? Year-end adjustment
8 Ending balance for 2019

Illustration 5–11
Excerpt from Tenet Healthcare
Corporation’s 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.
Concept Check 5–7
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.
Let’s Review
Community Medical is an outpatient health facility that provides minor surgical and other health-related
services to the local community. Many of the patients do not have medical insurance. These customers
are required to pay for services within 30 days of receiving treatment. At the beginning of 2018,
Community Medical's allowance for uncollectible accounts was a $100,000 credit.
Required:
1. Record the write-off of $120,000 of actual accounts receivable that became uncollectible during 2018.
2. Estimate the allowance for future uncollectible accounts using the following age groups, amount
receivable, and estimated percent uncollectible at the end of 2018:
3. Use a T-account to determine the year-end adjustment to the allowance account.

4. Record the year-end adjustment for bad debt expense.
5. Prepare a partial balance sheet showing accounts receivable and the allowance for uncollectible
accounts.
LO5–6 Contrast the allowance method and direct

write-off method when accounting for
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
Illustration 5–12
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 Bad Debt Expense 2,000
(Actual = $2,000) Allowance for Uncollectible Accounts 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
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.
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.
Concept Check 5–8
On December 31 before adjusting entries, a
company’s 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 year’s estimate of bad debts was too low.
c. The company’s estimate equals actual bad debts.
d. Last year’s 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 year’s actual bad debts.
Concept Check 5–9
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.
Part C
NOTES RECEIVABLE
LO5–7 Account for notes receivable and interest

revenue.
Illustration 5–13
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
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
Replacing an Existing Accounts Receivable
• Justin received $10,000 of services on account, but Kimzey

originally recorded the amount due as Accounts Receivable.
• Over time, it became apparent that Justin would not be able
to pay quickly, so Kimzey required Justin to sign a six-month,
12% promissory note on February 1, 2018.
• When Justin signs the note, Kimzey records the following
transaction to reclassify the existing account receivable as a
note receivable.
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.
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)
Illustration 5–14
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
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)
Concept Check 5–10
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
= × interest rate ×
Revenue value of the year
2018: Interest Revenue = $5,000 × 6% × 4/12 = $100
2019: Interest Revenue = $5,000 × 6% × 6/12 = $150
Let’s Review
1. General Hospital has a policy of lending any employee up to $3,000

for a period of 12 months at a fixed interest rate of 9%. Chevy Chase
has worked for General Hospital for more than 10 years and wishes
to take his family on a summer vacation. On May 1, 2018, he
borrows $3,000 from General Hospital to be repaid in 12 months.
Required:
2. Record the loan of cash and acceptance of the note receivable by
General Hospital.
3. Record General Hospital's year-end adjustment to accrue interest
revenue.
4. Record the collection of the note with interest from Chevy Chase on
May 1, 2019.
End of Chapter 5

Chapter 5 Receivables and Sales

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Chapter 5 Receivables and Sales

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Financial Accounting Fourth Edition

5 Spiceland • Thomas • Herrmann

LO5–1 Recognize accounts receivable.

March 1 Debit Credit

LO5–2 Calculate net revenues using discounts,

Sales Return Sales Allowances

• Sales Returns or Sales Allowances

Mar. 10 350 Cash collection of $343

The effect of a sales allowance is to decrease net

June 18 David, age 72, calls to set up an appointment.

3. The journal entry to record the receipt of David’s payment in full

4. Service Revenue $100

Sales and service revenue $ 400,000

LO5–3 Record an allowance for future uncollectible

• Bad Debt Expense

If $6,000,000 will not be collected what

The Accounts receivable balance minus

KIMZEY MEDICAL CLINIC

KIMZEY MEDICAL CLINIC

• Adjusting for estimates of future uncollectible

LO5–4 Use the aging method to estimate future

The aging method recognizes that the longer

LO5–5 Apply the procedure to write off accounts

• The write-off involves:

September 8, 2019 Debit Credit

• Collection has no effect on total assets or net income

December 31, 2019 ($ in millions) Debit Credit

December 31, 2019 ($ in millions) Debit Credit

3. Use a T-account to determine the year-end adjustment to the allowance account.

LO5–6 Contrast the allowance method and direct

• Allowance account is credited for the estimate and

LO5–7 Account for notes receivable and interest

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

February 1, 2018 Debit Credit

• No interest is recorded on February 1

• Justin received $10,000 of services on account, but Kimzey

August 1, 2018 Debit Credit

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

1. General Hospital has a policy of lending any employee up to $3,000

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