PRINCIPLES OF ACCOUNTING II

CHAPTER ONE
ACCOUNTING FOR RECEIVABLES
The term “Receivables”
 Refers to amounts due from individuals and other companies, or
 Includes all money claims against people, organizations, or other debtors, or
 Are claims that are expected to be collected in cash
Classification of Receivables
Receivables are frequently classified as:
1. Accounts Receivables
2. Notes Receivable and
3. Other Receivables
Accounts Receivables
Accounts Receivables are amounts owed by customers on account. They result from the
sale of goods and services. These receivables generally are expected to be collected within 30
to 60 days. They are the most significant type of claims held by companies. Account
Receivables are often called open account in sense it depends upon oral agreement.
Since Account Receivables are depends upon strong relationship between customers and
sellers, they are subject to uncollectible.
Notes Receivables
Credit may be granted on open account or on the basis of a formal instrument of credit, such
as a promissory note.
A promissory note, frequently referred to as a note, is a written promise to pay a sum of
money on demand or at a definite time.
Note receivables represent claims for which formal instrument of credit are issued as
evidence of the debt. Notes are usually used for credit periods of more than sixty days, as in
sales of equipment on the installment plan, and for transactions of relatively large dollar
amounts. Notes may also be used in settlement of an open account and in borrowing or
lending money. The enterprise owing a note refers to it as a note receivable.
Notes and accounts receivables that result from sales transactions are often called trade
receivables.

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Other Receivables
 Includes non-trade receivables such as interest receivables, loans to company officers,
advances to employees, income taxes refundable and loans to affiliated companies.
All receivables that are expected to be realized in cash within a year are presented in the
current asset section of the balance sheet. Those that are not currently collectible, such as
long term loans, should be listed under the caption “Investments” below the current assets
section.
Advantages of Notes Receivable over the Accounts Receivable
From the point of view of the creditor, a claim evidenced by a note has some advantages over
a claim in the form of an account receivable:
a) The note is a stronger legal claim than an open account if there is court action.
By signing a note, the debtor acknowledges the debt and agrees to pay it according to
the terms given.
b) Notes receivable is more liquid than an open account because the holder can
usually transfer it more readily to a bank or other financial agency in exchange
for cash.
Characteristics of Receivables
It must be payable to the order of a certain person or firm, or to bearer.
It must also be signed by the person or firm that makes the promise.
Parties that are involved in promissory note:
 Payee the party to whom payment of promissory note is to be
made, or the one to whose order the note is payable.
 Makerthe party in a promissory note who is making the promise
to pay, or the one making the promise.
Due Date (Maturity Date)
Due date is the date on which a note becomes due and must be paid. Term of note is the
period of time between the issuance date and the due date of a short term note and may be
stated either days or months.
e.g., –for 30 days, 60 days
- for one months, 2 months
- for one year, two years

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When the term of a note is stated in days, the due date is the specified number of days after
its issuance. In this case, it is necessary to count the exact number of days to determine the
maturity date. In counting, the date the note is issued is omitted because it is considered as
preparation date but the due date is included.
Example:
a) What is the due date of 90-days note issued on January 8, 2008?
Solution:
Term of the note------------------------------------------------90 days
Remaining days in January (31-8) -------------23
Days in February ---------------------------------28
Days in March-------------------------------------31 82
Maturity date, April ------------------------------------------- 08

b) What is the due date of 30 days note issued on May 15?

Term of the note------------------------------------------------30 days
Remaining days in May (31-15) ----------------------------- 16
Due date, June --------------------------------------------------- 14
c) What is the due date of 60 days note dated July 17?
Term of note 60 days
Remaining days in July (31-17) 14
Days in August 31 45
Due date, September 15
When the term of a note is stated as a certain number of months after the issuance date, the
due date is determined by counting the number of months from the issuance date.
For example, what is the maturity date of a 2-month note dated July 31?
Answer: September 30.
In those cases in which there is no date in the month of maturity that corresponds to the
issuance date, the due date becomes the last day of the month. For example, a 2-month note
dated July 31 would be due on September 30.

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Interest-Bearing Notes and Non-Interest-Bearing Notes

A note that provides for the payment of interest for the period between the issuance date and
the due date is called an interest-bearing note. If a note makes no provision for interest, it is
said to be non-interest-bearing note.
Interest – is the fee charged for use of money through time. To the maker of the note, or
borrower, interest is an expense; to the payee of the note, or lender, interest is a revenue. A
borrower incurs interest expense; a lender earns interest revenue.
The basic formula for computing interest is as follows:
Interest = Principal x Rate X Time
Where:
Principal (P) - is the face value of a note.
The Rate (R) - is the stated interest rate on the note; interest rates are generally stated on an
annual basis. Interest rates for interest bearing notes are usually stated in terms of a period of
one year, regardless of the actual period of time involved.
Time (T) - which is the amount of time the note is to run, can be expressed in either days or
months. When the term of a note is stated in months instead of in days, each month may be
considered as being 1/12 of a year, or, alternatively, the actual number of days in the term
may be counted.
 When the maturity date is stated in days, the time factor is frequently the number of
days divided by 360.
 When the due date is stated in months, the time factor is the number of months divided
by 12.
Maturity Value
Maturity value is the amount that is due at the maturity or due date. The maturity value of
non-interest bearing note is the face amount i.e., Maturity Value = Face Amount.
The maturity value of an interest- bearing note is the sum of the face amount and the
interest i.e., Maturity Value = Face Value + Interest.

Maturity Value (MV) = Face Value + Interest

= FV + (FV x R x T)
= FV(1+RT)

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ILLUSTRATION 1.1
Determine the due date and the maturity value of the following notes:
Face Issuance Interest
Value Date Term of note Rate Due date Maturity Value
$2000 May 16 30 days 10%
3000 Sep. 3 120 days 12%
4000 Aug. 15 2 Months 8%

ILLUSTRATION 1.2
Determine the due date and the amount of interest due at maturity on the following notes:
Date of Face Term of Interest Due Amount of
Note Amount Note Rate Date Interest
a) April 5 $5,000 60 days 9%
b) May 20 8,000 90 days 11%
c) June 30 10,000 75 days 12%
d) August 9 3,000 120 days 10%
e) October 11 7,500 60 days 12%

Accounting for Notes Receivable

Many companies accept notes receivable for:
1) Granting credit in certain sales transactions
The buyer’s written promise gives the seller assurance of collection than a regular (open)
account. The note applies moral pressure on the buyer and gives legal protection to the seller.
The seller may also earn interest in return for granting credit.
When a firm accepts a notes receivable from customer at the time of credit sale, the
journal entry would be:
Note Receivable------------------------------xx
Sale---------------------------------------------------------xx
2) Settlement of past-due (over-due) accounts receivable
When a customer does not pay an account receivable when due, the company (creditor) may
insist that the customer (debtor) give a note in place of the open account. This action allows
the customer more time to pay the balance of the account, and the company earns interest on

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 PRINCIPLES OF ACCOUNTING II

the balance until paid. Also, the company (creditor) may be able to sell the note to a bank or
other financial institution i.e., if the creditor needs more funds, the note may be endorsed and
transferred to a bank or other financial agency.
When a note is received from a customer to apply on account, the facts are recorded by
debiting the notes receivable account and crediting the accounts receivable controlling
account and the account of the customer from whom the note is received.
The journal entry to be made for the settlement of over-due accounts receivable would be:
Note Receivable--------------------------------------------xx
Accounts Receivable----------------------------------------------xx
When the amount due on the note is collected, the journal entry would be:
 For interest bearing notes:
Cash-------------------------------xx
Notes receivable--------------------xx
Interest income----------------------xx
 For non-interest bearing notes:
Cash-----------------------------------xx
Notes receivables-------------xx
ILLUSTRATION 1.3
On January 10, 2000, X Company sold merchandise on account to Y Company for
$12,000, n/30. On the February 9, Y Company gave X Company a 10% promissory note
in settlement of this account.
Required:
Prepare the journal entry to record the sale and the settlement of the accounts receivable.

Interest -Bearing Notes Receivable

If the note received from a customer on account is interest bearing, interest must be
recorded as appropriate.
Adjusting and reversing entries (optional) are required to recognize interest earned on
outstanding notes receivable at the accounting period.
Adjusting entries: Interest Receivable-------------------xx
Interest Income---------------------------xx
Reversing Entries: Interest Income----------------------------xx
Interest Receivable----------------------xx

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ILLUSTRATION 1.4
The following selected transactions were completed by Boothe Company during the
current year:
Dec. 1. Received from Adams Co., on account, a $5000, 120-days, 12% note
dated December 1.
31. Recorded an adjusting entry for accrued interest on the note of
December 1.
31. Closed the interest income account. The only entry in this account is
originated from the December 31 adjustment.
Jan. 1. Recorded a reversing entry for accrued interest.
March 31. Received $5,200 from Adams Co. for the note due today.
Instruction:
a. Record the transactions in general journal form.
b. What is the balance in interest income after the entry of March 31?
c. How many days interest on $5,000 at 12% does the amount reported in (b)
represent?
Discounting Notes Receivables
Discounting a note receivable is the act of selling note receivable. When a company is
in need of cash, it may transfer its notes receivable to a bank by endorsement. The bank
takes the note and charges interest at a specified rate.
The rate of interest the bank charges on the discounted note is called the discount rate. The
discount (interest) charged by the bank is computed on the maturity value of the note for the
period of time the bank must hold the note, namely the time that will pass between the date of
the transfer and the due date of the note.
Discount = Maturity Value (MV) X Discount Rate X Discount Period
Discount period is the number of the days from the date of discounting (date of sale) to the
maturity date.
The amount of the proceeds paid to the endorser is the excess of the maturity value over the
discount.
Proceeds = Maturity Value (MV) ─ Discount

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 The excess of the proceeds from discounting the note over its face value is recorded
as interest income.
 If the proceeds from discounting a note receivable are less than the face value, the
excess of the face value over the proceeds is recorded as interest expense.
The cash proceeds are computed as follows:
1) Determine the maturity value of the note (face value plus interest), since this
is the amount on which the bank discount is calculated.
2) Determine the discount period. Count the exact number of days from the date
of sale (discounting) to the maturity date. Exclude the date of sale, but include
the maturity date in the count.
3) Using the bank’s discount rate, compute the bank discount on the maturity
value for the discount period.
4) Deduct the bank discount from the maturity value to determine the cash
proceeds.
Illustration 1.5
Assume that United Company accepts 60 days, 7% note of $600 dated April 17 from
National Company in settlement of the past-due account. On May 2, United Company has
discounted the note at Dashen Bank at 8%. The Maturity date of the note is June 16. On
May 2, the United Company decided to discount National Company’s note at the bank at
stated rate.
a) Determine the Maturity Value of the note.
b) Determine the number of days in the discount period.
c) Determine the bank discount.
d) Determine the proceeds.
e) Present the entry, in general journal form, to record the discounting of the note on
May 2.
Illustration 1.6
Bosely Company holds a 90-days, 10% note for $20,000, dated April 20, that was received
from a customer on account. On May 20, the note is discounted at the Wegagen Bank at the
rate of 12%.
a) Determine the Maturity Value of the note.
b) Determine the number of days in the discount period.

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c) Determine the amount of the discount.

d) Determine the amount of the proceeds.
e) Present the entry, in general journal form, to record the discounting of the note on
May 20.
A note may be sold with recourse or without recourse basis. With recourse means that if
the maker does not pay the bank at maturity, the bank can collect the maturity value from the
Company that discounted the note at the bank. Without recourse means the purchaser
assumes risk of collection.

Dishonored Notes Receivable

A note is said to be honored when it is paid in full at its maturity date. A note is said to be
dishonored if the maker of a note fails to pay the debt on the due date. A dishonored notes
receivable is no longer negotiable, and for that reason the holder usually transfers the claim,
including any interest due, to the accounts receivable account.
The journal entry made at the time the note is dishonored would be:
Accounts Receivable----------------------xx
Notes Receivable-----------------------------------------xx
Interest Income--------------------------------------------xx
When a discounted notes receivable is dishonored, the holder usually notifies the endorser of
such fact and asks for payment. If the request for payment and notification of dishonor are
timely, the endorser is legally obligated to pay the amount due on the note.
In some cases, the holder of a dishonored note gives the endorser a notarized statement of the
facts of the dishonor. The fee for this statement, known as protest fee, is charged to the
endorser, who in turn charges it to the maker of the note. The entire amount paid to the holder
by the endorser, including the interest and protest fee, should be debited to the account
receivable of the maker.
Accounts Receivable----------------------xx
Cash ------------------------------------------xx
ILLUSTRATION 1.7
Record the following transactions, in general journal form, in the accounts of XYZ Company.
March 1. Received an $8,000, 60-day, 12% note dated March 1 from ABC Company on
account.

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21. Discounted the note at Awash International Bank at 13%.

April 30. The note is dishonored, paid the bank the amount due on the note plus a protest
fee
of $15.
May 20. Received the amount due on the dishonored note plus interest for 20 days at
12% on the total amount charged to ABC Company on April 30.
Illustration 1.8
The following were selected from among the transactions completed by Dry Co. during the
current year:
Jan. 10. Loaned $5,000 cash to Susan Butler, receiving a 90-day, 12% note.
Feb. 8. Sold merchandise on account to Warren Enterprises, $8,000
20. Sold merchandise on account to Good Luck Co. $7,100
Mar. 2. Received from Good Luck Co. the amount of the invoice of February 20, less 2%
discount.
10. Accepted a 60-day, 15% note for $8,000 from Warren Enterprises on account.
Apr. 10. Received the interest due from Susan Butler and a new 90-day, 14% note as a
renewal of the
loan of January 10.
May 9. Received from Warren Enterprises the amount due on the note of March 10.
July 2. Sold merchandise on account to Swartz and sons, $20,000.
9. Received from Susan Butler the amount due on her note of April 10.
Aug. 1. Accepted a 60-day, 12% note for $20,000 from Swartz and sons on account.
31. Discounted the note from Swartz and sons at the Dashen bank at 14%.
Sept. 30. Received notice from the Dashen bank that Swartz and sons had dishonored its
note. Paid the bank the maturity value of the note.
Oct. 30. Received from Swartz and sons the amount owed on the dishonored note, plus
interest for 30 days at 12% computed on the maturity value of the note.
Instructions:
Record the transactions in general journal form.

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Exercise
On January 1, 2007, R Company had Accounts Receivable $146,000, Notes Receivable
$15,000, and Allowance for Doubtful Accounts $13,200. The note receivable is from the
ABC Company. It is a 4-month, 12% note dated December 31, 2006. Uptown Company
prepares financial statements annually. During the year the following transactions occurred.
Jan. 5. Sold $12,000 of merchandise to G Company, terms n/15.
20. Accepted G Company’s 12,000, 3-month, 9% note for balance due.
Feb. 18. Sold $8,000 of merchandise to S Company and accepted S`s $8,000,
6-month, 10% note for the amount due.
April 20. Collected G Company note in full.
30. Received payment in full from ABC Company on the amount due.
May 25. Accepted XYZ Company’s $7,000, 3-month, 8% note in settlement of a
past-due balance on account.
Aug. 18. Received payment in full from S company on note due.
25. The XYZ Company note was dishonored. XYZ Co. is not bankrupt and
future payment is anticipated.
Sept. 1. Sold $10,000 of merchandise to Y Company and accepted a $10,000,
6-month, 10% note for the amount due.
Instructions: Journalize the transactions.

Uncollectible Receivables
When merchandise or services are sold without the immediate receipt of cash, a part of the
claims against customers usually proves to be uncollectible. This situation is common,
regardless of the care used in granting credit and the effectiveness of the collection
procedures used. The operating expense incurred because of the failure to collect receivables
is called an expense or a loss from uncollectible accounts, doubtful accounts, or bad
debts. There is no single general rule for determining when an account or a note becomes
uncollectible. The fact that a debtor fails to pay an account according to a sales contract or
dishonors a note on the due date does not necessarily mean that the account will be
uncollectible. Bankruptcy of the debtor is one of the most significant indications of partial
or complete worthlessness of a receivable. Other evidence includes closing of the debtor`s

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business, disappearance of the debtor, failure of repeated attempts to collect, and the
baring of collection by the statute of limitation.
There are two methods of accounting for receivables that are believed to be uncollectible.
1. Allowance Method (Reserve Method)
2. Direct write-off Method (Direct charge-off Method)

Allowance Method of Accounting for Uncollectible.

The allowance method, which is sometimes called the reserve method, provides in advance
for uncollectible receivables.
Most large business enterprises provide currently for the amount of their trade receivables
estimated to become uncollectible in the future. The advance provision for future
uncollectibility is made by adjusting entry at the end of the fiscal period. Estimated
uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful
Accounts through an adjusting entry at the end of each period.
Adjusting Entries:
Uncollectible account expense---------------xx
Allowance for uncollectible accounts-----------xx
(To record estimate of uncollectible accounts)

As with all periodic adjustment, the entry serves two purposes:

1) It provides for the reduction of the value of the receivables to the amount of cash
expected to be realized from them in the future.
2) It provides for the allocation to the current period of the expected expense resulting
from such reduction.
Uncollectible accounts expense (also called bad debts expense) is generally reported on the
income statement as an administrative expense, because the credit- granting and collection
duties are the responsibilities of departments within the general administrative framework. To
adhere to the matching principle, the uncollectible accounts expense must be matched
against the revenues it generates.
Allowance for Uncollectible Accounts reported on the balance sheet as a contra-asset
account to the accounts receivable account. It reduces accounts receivable to their net
realizable value (the amount expected to be realized in cash). When the allowance account

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includes provision for doubtful notes as well as accounts, it should be deducted from the total
of Notes Receivable and Accounts Receivable.
Accounts Receivable on the Balance Sheet
Current Assets:
Cash xxx
Accounts receivable xxx
Less: Allowance for doubtful accounts (xx) xx

Recording the write-off of an uncollectible accounts

When all means of collecting a past-due account have been exhausted and collection appears
impossible, the account should be written –off. To prevent premature write-offs, each write-
off should be formally approved in writing by authorized management personnel.
When an account is believed to be uncollectible, it is written-off against the allowance
account as in the following entry:
Allowance for Doubtful Accounts------------------xxx
Accounts Receivable----------------------------------xxx
(To write-off the uncollectible account)
A write-off affects only balance sheet accounts. The write-off of the account reduces both
accounts receivable and the allowance for doubtful accounts.
Recovery of an Uncollectible Account
Occasionally, a company collects from a customer after the account has been written-off as
uncollectible.
Two entries are required to record the recovery of a bad debt:
1. The entry made in writing-off the account is reversed to reinstate the customers
account. In such cases, the account should be reinstated by an entry that is the exact
reverse of the write-off entry.
Accounts Receivable-----------------------xxx
Allowance for Doubtful Accounts-------xxx
(To reverse write-off entry)
2. The cash received in payment (collection) is journalized in the usual manner:
Cash-----------------------------------------xxx
Accounts Receivable--------------------xxx

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Illustration 1.9
In general journal form, record the following transactions in the accounts of Good Luck
Company, which uses the allowance method of accounting for uncollectible receivables.
Jan. 30. Sold merchandise on account to XYZ Co., $3,300.
July 11. Received $1,980 from XYZ Company and wrote off the remainder owed on the
sale
of January 30 as uncollectible.
Dec. 15. Reinstated the account of XYZ Company that had been written off on July 11
and
received $1,320 cash in full payment.

Estimating Uncollectibles
The estimate of uncollectibles at the end of the fiscal period is based on past experience
and forecasts of future business activity.
The estimate is customarily based on either
1) The amount of sales for the entire fiscal period (percentages of sales)
2) The amount and the age of the receivable accounts at the end of the fiscal period
(percentage of receivables)

Estimate Based on Sales

Accounts receivable are acquired as a result of sales on account. The amount of such sales
during the year may therefore be used to determine the probable amount of the accounts that
will be uncollectible. The amount of this estimate is added to whatever balance exists in
allowance for doubtful accounts.
This basis of estimating uncollectibles emphasizes the matching of expenses with revenues.
As a result, bad debts expense will show a direct percentage relationship to the sales base on
which it is computed.
When the adjusting entry is made, the existing balance in the Allowance for Doubtful
Accounts is disregarded.
The percentage of sales basis results in a better matching of expenses with revenues- an
income statement approach.

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Matching
Sales Bad Debts Expense

Estimates Based on Analysis of Receivables

The process of analyzing the receivable accounts in terms of the length of time past due is
sometimes called aging the receivables. The base point for determining age is the due date
of the account.
The percentage of receivables basis produces the better estimate of net realizable value- a
balance sheet approach.
Net realizable value
Accounts Receivable Allowance for Doubtful Accounts
The amount of bad debt adjusting entry is the difference between the required balance and the
existing balance in the allowance account.
Occasionally the allowance account will have a debit balance prior to adjustment, because
write-offs during the year have exceeded previous provisions for bad debts. In such a case the
debit balance is added to the required balance when the adjusting entry is made.
The percentage of receivables method will normally results in the better approximation of
Net realizable value (Accounts Receivable minus Allowance for Doubtful Accounts).
This method, however, will not result in the better matching of expenses with revenues if
some customers` accounts are more than one year past due. Under such circumstances, bad
debts expense for the current period would include amounts applicable to the sales of a prior
period.
Illustration 1.10
At the end of the current year, the accounts receivable account has a debit balance of
$112,500, and net sales for the year total $1,200,000. Determine the amount of the adjusting
entry to record the provision for doubtful accounts under each of the following assumptions:
a) The allowance account before adjustment has a credit balance of $750.
1) Uncollectible account expense is estimated at 1% of net sales.
2) Analysis of the accounts in the customers’ ledger indicates doubtful accounts
of $12,450.
b) The allowance account before adjustment has debit balance of $500.
1) Uncollectible account expense is estimated at ¾ of 1% of net sales.

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2) Analysis of the accounts in the customers’ ledger indicates doubtful accounts

of $8,850.

Direct Write-off Method of Accounting for Uncollectibles

The direct write –off method or direct charge-off method, recognizes the expense only
when certain accounts are judged to be worthless.
Under the direct write-off method,
 An allowance account or an adjusting entry is not needed at the end of the period.
 Bad debt losses are not estimated.
I. Recording the Write-off an Uncollectible Accounts
When an account is determined to be uncollectible, the loss is charged to Bad Debts
Expense.
The entry to write-off an account when it is believed to be uncollectible is as follows:
Uncollectible Accounts Expense---------------------xx
Accounts Receivable---------------------------------------xx
(To write-off uncollectible account)
When this method is used, bad debts expense will show only actual losses from
uncollectibles. Accounts receivable will be reported at its gross amount.
II. Recovery of an Uncollectible Account
If an account that has been written-off is collected later, the account should be reinstated.
If the recovery is in the same fiscal year as the write-off, the earlier entry should be
reversed to reinstate the account.
The entry to reinstate the account would be as follows:
Accounts Receivable---------------------------------xx
Uncollectible Accounts Expense----------------------xx
(To reinstate account written –off earlier in the year)
The collection is journalized as:
Cash-------------------------------------------xx
Accounts Receivable------------------------------xx
When an account that has been written-off is collected in a later fiscal year, it may be
reinstated by an entry:
Accounts Receivable-------------------------------------------xx

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Recovery of Uncollectible Accounts Written-off---------xx

The credit balance in Recovery of Uncollectible Accounts Written-off account at the
end of the year are reported on the income statements as a deduction from Uncollectible
Accounts Expense (or contra to uncollectible accounts expense).
The collection is recorded as:
Cash-------------------------------------------xx
Accounts Receivable------------------------------xx
Illustration 1.11
In general journal form, record the following transactions in the account of ABC Company
which uses the direct write-off method of accounting for uncollectible receivables.
Feb. 20. Sold merchandise on account to Zebra Company $2,500.
July 1. Received $1,500 from Zebra Company and wrote off the remainder owed on the
sale of February 20 as uncollectible.
Dec. 10. Reinstated the account of Zebra Company that had been written off on July 1 and
received $1,000 cash in full payment.

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