Accounting for Receivables Cheat Sheet

Accounts receivable represent amounts due from customers, managed through direct write-off or allowance methods, with notes receivable offering a more formal promise of payment. Efficient management of receivables is key to financial health, measured by turnover ratios.

Core Principles

Receivables include accounts receivable (informal promises) and notes receivable (formal written promises).
Bad debts can be accounted for using the direct write-off method or the allowance method, with the allowance method being preferred for its better matching of expenses and revenues.
Estimating uncollectible accounts can be done using the Percent of Sales Method or Balance Sheet Methods (Percent of Receivables or Aging of Receivables).
Notes receivable require calculation of maturity dates and interest, and their collection or non-collection (honoring/dishonoring) must be recorded.
Receivables can be converted to cash before maturity through selling or pledging them.
Accounts receivable turnover ratio assesses the efficiency of credit management and revenue generation.

Action Steps

Record credit sales by debiting Accounts Receivable and crediting Sales.
When using the direct write-off method, debit Bad Debts Expense and credit Accounts Receivable for uncollectible accounts.
When using the allowance method, record estimated bad debts by debiting Bad Debts Expense and crediting Allowance for Doubtful Accounts.
Calculate the maturity date of a note by counting the days from the note's date to its due date.
Calculate interest on a note using the formula: Principal × Annual Interest Rate × Time (in fraction of year).
To convert receivables to cash early, either sell them (recording factoring fee expense) or pledge them as collateral for a loan (recording a Notes Payable).

Formulas

Accounts Receivable Turnover = Net Sales / Average Accounts Receivable, Net
Interest = Principal of the note × Annual interest rate × Time expressed in fraction of year
Percent of Sales Method: Current Period Sales × Bad Debt % = Estimated Bad Debts Expense
Percent of Receivables Method: Year-end Accounts Receivable × Bad Debt % = Total Estimated Bad Debts Expense
Current Bad Debts Expense = Total Estimated Bad Debts Expense - Previous Balance in Allowance Account (or + Unadjusted balance Dr.)

Key Terms

Accounts Receivable: An amount due from another party, typically a customer, arising from sales on credit.
Notes Receivable: A written promise to pay a specified amount of money, usually with interest, on demand or at a stated future date.
Direct Write-Off Method: A method for accounting for bad debts where uncollectible accounts are written off directly as an expense when they are determined to be uncollectible.
Allowance Method: A method for accounting for bad debts that estimates uncollectible accounts at the end of each period and records them as Bad Debts Expense and an Allowance for Doubtful Accounts.
Allowance for Doubtful Accounts: A contra-asset account that reduces the total accounts receivable to their estimated collectible amount.
Accounts Receivable Turnover: A financial ratio that measures how efficiently a company collects its receivables.
Factoring: Selling accounts receivable to a third party (a factor) at a discount.
Pledging: Using accounts receivable as collateral for a loan.

Real World Examples

TechCom had a credit sale of $950 to CompStore and recorded it by debiting Accounts Receivable-CompStore and crediting Sales.: This illustrates the basic recording of a credit sale, creating an account receivable.
TechCom determined that J. Kent's $520 account was uncollectible and used the direct write-off method, debiting Bad Debts Expense and crediting Accounts Receivable-J. Kent.: Demonstrates the direct write-off of a specific uncollectible account.
TechCom estimated $1,500 of its accounts receivable would be uncollectible and recorded it by debiting Bad Debts Expense and crediting Allowance for Doubtful Accounts.: Shows the initial recording of estimated bad debts under the allowance method.
Musicland had credit sales of $400,000 and estimated 0.6% would be uncollectible, resulting in a $2,400 Bad Debts Expense.: Illustrates the Percent of Sales Method for estimating bad debts.
TechCom received a $1,000, 90-day, 12% promissory note from Julia Browne for a product sale.: Shows the recording of a note receivable at the time of sale.
J. Cook had a $600, 15%, 60-day note receivable due to TechCom. Upon maturity, TechCom collected $615 (principal + interest).: Demonstrates the recording of an honored note, including interest revenue.
TechCom sold accounts receivable totaling $20,000 for cash, less a 4% factoring fee ($800).: Shows the accounting entry for selling receivables, including the fee expense.