Chapter 1

Receivables
 Learning objectives
• Define and explain common types of receivables and review
internal controls for receivables
• Describe how bad debts arise
• Use the allowance method to account for bad debts
• Use the direct write-off method to account for bad debts
• Account for bills receivable
• Report receivables on the balance sheet and evaluate a
business using the acid-test ratio, days’ sales in receivables
and the accounts receivable turnover ratio

8/28/2024 205002 & 201081 _ Receivables 2

 1.1. Receivables: An introduction
• A receivable arises when a business (or person) sells goods
or services to a second business (or person) on credit
• The receivable is the seller’s claim against the buyer for the
amount of the transaction
• The creditor sells goods or a service and obtains a
receivable
• The debtor makes the purchase and takes on an
obligation/payable (a liability)
• The two main types of receivables are accounts receivable
and bills receivable

8/28/2024 205002 & 201081 _ Receivables 3

 1.1. Receivables: An introduction
• Accounts receivable, sometimes called trade receivables or
trade debtors, are amounts to be collected from customers
from sales made on credit
• Bills (and notes) receivable are more formal than accounts
receivable.
The debtor in a bill or note receivable arrangement promises
in writing that the creditor will be paid a definite sum at a
specific future date
• A promissory note is a special type of bill receivable

8/28/2024 205002 & 201081 _ Receivables 4

 1.2. Accounting for bad debts
(uncollectable accounts)
• Some customers do not pay, and that creates an expense
called a bad debt expense, doubtful debt expense or
uncollectable account expense
• There are two methods of accounting for uncollectable
receivables, namely the allowance method and the direct
write-off method

8/28/2024 205002 & 201081 _ Receivables 5

 1.3. The allowance method
• It is based on the matching principle, which requires that the
bad debts expense is recorded in the same period as the
sales revenue
• The offset to the expense is a contra account called
Allowance for doubtful debts (or the Allowance for bad debts)
• The Allowance account shows the amount of the receivables
that the business expects not to collect and reduces
Accounts receivable

8/28/2024 205002 & 201081 _ Receivables 6

 1.3. The allowance method
• The more accurate the estimate of bad debts, the more
reliable the information in the financial statements
• Businesses use their past experience as well as considering
the economy, the industry they operate in and other variables
• There are two basic ways to estimate bad debts, namely
percentage of sales method and ageing of accounts
receivable method

8/28/2024 205002 & 201081 _ Receivables 7

 1.3. The allowance method
The percentage of sales method: calculates bad debts
expense as a percentage of net credit sales
• This method is also called the income statement approach
because it focuses on the amount of expense to be reported
on the income statement
• Bad debts expense is recorded as an adjusting entry at the
end of the period
Date Account title Dr Cr
Mar 31 Bad debts expense (E+) 300
GST clearing (L–) 30
Allowance for doubtful debts (CA+) 330
Recorded bad debts expense for the period.

8/28/2024 205002 & 201081 _ Receivables 8

 1.3. The allowance method
The ageing of accounts method: is also called the balance sheet
approach because it focuses on the actual age of the accounts
receivable and determines a target allowance balance from that age

8/28/2024 205002 & 201081 _ Receivables 9

 1.3. The allowance method

8/28/2024 205002 & 201081 _ Receivables 10

 1.3. The allowance method
Identifying and writing-off bad debts
When a specific customer account is identified as uncollectible, it is
written off to the allowance account

Date Account title Dr Cr

Jul 15 Allowance for doubtful debts (CA–) 200
Accounts receivable—Andrews (A–) 10
Accounts receivable—Jones (A–) 120
Wrote off doubtful debts.

8/28/2024 205002 & 201081 _ Receivables 11

 1.3. The allowance method
Recovery of accounts previously written-off
Sometimes a customer will pay the amount owed after the
customer’s account is written off.
To account for this recovery, the business must reverse the
effect of the earlier write-off to the Allowance account and
record the cash collection.

Date Account title Dr Cr

Sep 4 Accounts receivable—Andrews (A+) 10
Allowance for doubtful debts (CA+) 10
Cash (A+) 10
Accounts receivable—Andrews (A–) 10

8/28/2024 205002 & 201081 _ Receivables 12

 1.4. The direct write-off method
Writing-off bad debts
• Under the direct write-off method of accounting for bad debts,
the business waits until it decides that a customer’s account
receivable is uncollectable
• Theaccountant then debits Bad debts expense and credits the
customer’s Account receivable to write off the account

Date Account title Dr Cr

Jul 15 Bad debts expense (E+) 200
Accounts receivable—Andrews (A–) 10
Accounts receivable—Jones (A–) 120
Wrote off a bad debt.

8/28/2024 205002 & 201081 _ Receivables 13

 1.4. The direct write-off method
Recovery of accounts previously written-off
To account for this recovery, the business must reverse the
effect of the earlier write-off to the Bad debts expense account
and record the cash collection

Date Account title Dr Cr

Sep 4 Accounts receivable—Andrews (A+) 10
Bad debts expense (E–) 10
Cash (A+) 10
Accounts receivable—Andrews (A–) 10

8/28/2024 205002 & 201081 _ Receivables 14

 Quick Test
1. With good internal controls, the person who handles cash can also:

a account for cash receipts from customers

b account for cash payments

c issue credits to customers for sales returns

d none of them

8/28/2024 205002 & 201081 _ Receivables 15

 Quick Test
2. 'Bad debts' are the same as:
a uncollectable accounts
b doubtful accounts
c neither of them
d both of them

8/28/2024 205002 & 201081 _ Receivables 16

 Quick Test
3. Which method of estimating bad debts focuses on Bad debts
expense for the income statement?

a percentage of sales approach

b ageing of accounts approach

c net realizable value approach

d all of them

8/28/2024 205002 & 201081 _ Receivables 17

 Quick Test
4. Your company uses the allowance method to account for bad debts. At
the beginning of the year, Allowance for doubtful debts had a credit
balance of $1100. During the year you recorded Bad debts expense of $3
000 and wrote off uncollectable receivables of $2100. What is your year-
end balance in Allowance for doubtful debts?

a $1000 b. $2,000

c $3100 d. $3200

8/28/2024 205002 & 201081 _ Receivables 18

 Quick Test
5. Your company uses the allowance method to account for bad debts. At the
beginning of the year, Allowance for doubtful debts had a credit balance of $1100.
During the year you recorded Bad debts expense of $3 000 and wrote off uncollectable
receivables of $2100. Your ending balance of Accounts receivable is $20000. Calculate
the net realizable value of Accounts receivable at year-end.

a $18000

b $19000

c $20000

d $21000

8/28/2024 205002 & 201081 _ Receivables 19

 Quick Test

6 What is wrong with the direct write-off method of accounting for bad debts?

a The direct write-off method does not set up an allowance for doubtful debts,

b The direct write-off method overstates assets on the balance sheet,

c The direct write-off method does not match expenses against revenue very well,

d None of them

8/28/2024 205002 & 201081 _ Receivables 20

 Quick Test
7. What is wrong with the direct write-off method of accounting for bad debts?
a The direct write-off method sets up an allowance for doubtful debts,
b The direct write-off method overstates assets on the balance sheet,
c The direct write-off method does not match expenses against revenue very well,
d The direct write-off method understates asset on the balance sheet

8/28/2024 205002 & 201081 _ Receivables 21

 1.5. Bills receivable
• Bills of exchange are commonly used where foreign trade is
concerned, with businesses selling goods or services in
exchange for bills receivable
• A promissory note is defined as ‘an unconditional promise in
writing, signed by the maker, engaging to pay, on demand or at a
fixed or determinable future time, a sum certain in money, to or
to the order of a specified person, or to bearer’
• A bill of exchange is defined as as ‘an unconditional order in
writing, addressed by one person to another, signed by the
person giving it, requiring the person to whom it is addressed to
pay on demand, or at a fixed or determinable future time, a sum
certain in money to or to the order of a specified person or
bearer’

8/28/2024 205002 & 201081 _ Receivables 22

 1.5. Bills receivable

8/28/2024 205002 & 201081 _ Receivables 23

 1.5. Bills receivable
Identifying a bill’s maturity date
• Maturity date can be a specific date
• Maturity date can be stated in terms of number of months
• Maturity date can be stated in terms of number of days
The formula for calculating interest is

Amount
Interest
Principal Time of
rate
interest

8/28/2024 205002 & 201081 _ Receivables 24

 1.5. Bills receivable
Recording bills receivable
Date Account title Dr Cr
Oct 20

To record sale (ignore the cost of goods)

Jan 11

To record collection at maturity.

8/28/2024 205002 & 201081 _ Receivables 25

 1.5. Bills receivable
Recording bills receivable
A business may, by agreement, draw a bill receivable on a
trade customer who fails to pay an account receivable within
the customary 30–60 days

Date Account title Dr Cr

Oct 1

To draw a bill on account on a customer.

8/28/2024 205002 & 201081 _ Receivables 26

 1.5. Bills receivable
Accruing interest revenue
Date Account title Dr Cr
Dec 31

Sep 30

To collect bill receivable on which interest

has been previously accrued.
8/28/2024 205002 & 201081 _ Receivables 27
 1.5. Bills receivable
Dishonoured bills receivable
Ex: Suppose Thompson Jewellers had a six-month, 10% bill receivable
for $1,200 from D. Hatachi and, on the 3 February maturity date,
Hatachi defaulted. Thompson Jewellers would record the default as
follows:
Feb 3

To record dishonour of bill receivable.

8/28/2024 205002 & 201081 _ Receivables 28

 1.5. Bills receivable
Discounting a bill receivable

8/28/2024 205002 & 201081 _ Receivables 29

 1.5. Bills receivable

Discounting a bill receivable

To discount a bill receivable

8/28/2024 205002 & 201081 _ Receivables 30

 1.5. Bills receivable
Dishonoured bills receivable
• If the debtor of a bill doesn’t pay a bill receivable at maturity, the
debtor is said to dishonour, or default on, the bill
• As the term of the bill has expired, the original agreement is no
longer in force, and no one will buy the bill
• However, the payee still has a claim against the debtor and
usually transfers the claim from the Bills receivable account to
Accounts receivable
• The payee records interest revenue earned on the bill and debits
Accounts receivable for the full maturity value of the bill

8/28/2024 205002 & 201081 _ Receivables 31

 Quick Test
8. At 30 June, you have a $10000 bill receivable from a customer. Interest of 8%
has accrued for six months on the bill. What will the income statement report for
this situation?

a nothing, because you haven't received the cash yet

b interest revenue of $400

c bill receivable of $ 10 000

d both of interest revenue of $400 and bill receivable of $10 000

8/28/2024 205002 & 201081 _ Receivables 32

 Quick Test
9. At 30 June, you have a $10000 bill receivable from a customer. Interest of 8%
has accrued for six months on the bill. What will your financial statements report
for this situation?

a Nothing, because you haven't received the cash yet.

b Balance sheet will report the bill receivable of $10000.

c Balance sheet will report the bill receivable of $10000 and interest receivable of
$400.

d Income statement will report a bill receivable of $10000.

8/28/2024 205002 & 201081 _ Receivables 33

 1.6. Using accounting information for
decision making
• In making decisions, owners and managers use some ratios
based on the relative liquidity of assets
• A measure of the firm’s ability to pay current liabilities is the acid-
test (or quick) ratio
• The acid-test ratio tells whether the entity could pay all its current
liabilities if they came due immediately
• Acid-test ratio = (Cash + Short-term + Net current investments receivables) /
Total current liabilities
• The higher the acid-test ratio, the better the business is able
to pay its current liabilities

8/28/2024 205002 & 201081 _ Receivables 34

 1.6. Using accounting information for
decision making
• After a business makes a credit sale, the next critical event in the
business cycle is collection of the receivable
• Days’ sales in receivables, also called the collection period,
indicates how many days it takes to collect the average level of
receivables
• The number of days in average accounts receivable should be
close to the number of days customers are allowed to pay
• The shorter the collection period, the more quickly the
organisation can use cash for operations

8/28/2024 205002 & 201081 _ Receivables 35

 1.6. Using accounting information for
decision making
• The accounts receivable turnover ratio measures the number of
times the business sells and collects the average receivables
balance in a year
• The higher the ratio, the faster the cash collections
• Accounts receivable turnover ratio = Net credit sales / Average
net accounts receivable

8/28/2024 205002 & 201081 _ Receivables 36

 Quick Test
10. At year-end, your company has cash of $ 10000, receivables of $50000,
inventory of $40000 and prepaid expenses totaling $5 000. Liabilities of $60 000
must be paid next year. What is your acid- test ratio?

a 0.83

b 1.00

c 1.67

d cannot be determined from the data given

8/28/2024 205002 & 201081 _ Receivables 37

 Quick Test
11. At year-end, your company has cash of $ 10000, receivables of
$50000, inventory of $40000 and prepaid expenses totaling $5 000.
Liabilities of $60 000 must be paid next year. A year ago receivables
stood at $70000, and sales for the current year total $730 000. How
many days did it take you to collect your average level of receivables?

a 45

b 35

c 30

d 20

8/28/2024 205002 & 201081 _ Receivables 38

 Summary: Chapter 1
• A receivable arises when a business (or person) sells goods or
services to a second business (or person) on credit
• The two main types of receivables are accounts receivable and
bills receivable
• There are two methods of accounting for uncollectable
receivables, namely the allowance method and the direct write-
off method
• The allowance method is based on the matching principle, which
requires that the bad debts expense is recorded in the same
period as the sales revenue
• Under the direct write-off method of accounting for bad debts, the
business waits until it decides that a customer’s account
receivable is uncollectable
8/28/2024 205002 & 201081 _ Receivables 39
 Summary: Chapter 1
• Bills of exchange are commonly used where foreign trade is
concerned, with businesses selling goods or services in
exchange for bills receivable
• In making decisions, owners and managers use some ratios
based on the relative liquidity of assets
• Common ratios are acid-test (or quick) ratio, collection period,
and accounts receivable turnover ratio

8/28/2024 205002 & 201081 _ Receivables 40

 Tasks in class
Textbook: Chapter 9
• Quick Check
• Starters
• Exercises

8/28/2024 205002 & 201081 _ Receivables 41

 Tasks at home
1/ Homework:
Textbook: Chapter 9
• Problems
• Apply
2/ Self-study:
Key References [2]: Chapter 10

8/28/2024 205002 & 201081 _ Receivables 42

The end of Chapter 1
Receivables