Understanding Accounts and Notes Receivable: Recognition, Valuation, and Disposal

Posted on Mar 30, 2025 in Accounting and Finance

Understanding Receivables: A Comprehensive Guide

This document outlines the key aspects of receivables, including accounts receivable (A/R) and notes receivable (N/R), focusing on recognition, valuation, and disposal.

Three Types of Receivables

  • Accounts Receivable: Customer owes the company on account.
  • Notes Receivable: Written promise with collection of interest.
  • Other Receivables: Nontrade receivables, including interest loans, advances, and income taxes.

Key Issues with Accounts Receivable

  1. Recognizing
  2. Valuing
  3. Disposing

Recognizing Accounts Receivable

A merchant records A/R at the point of sale (POS) on account. When they sell goods:

Debit A/R and Credit Sales Revenue.

Store Credit Card

When a customer makes a purchase using a store credit card, the store:

Debit A/R and Credit Sales Revenue.

At the end of the month, adjust the entry to record interest revenue:

Debit A/R and Credit Interest Revenue (I/R).

Valuing Accounts Receivable and Notes Receivable

Companies report A/R on the Balance Sheet. Credit losses are recorded as:

DEBITS to Bad Debt Expense and CREDITS to Allowance for Doubtful Accounts.

Allowance Method for Bad Debts

This method involves estimating uncollectible accounts at the end of the period. It provides better matching, and receivables are stated at Cash Realizable Value, which is the net amount the company expects to receive in cash.

This method has 3 steps:

  1. At year-end, the company ESTIMATES uncollectible A/R: Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts.
  2. Write-off Account: Debit Allowance for Doubtful Accounts and Credit A/R. Companies debit every bad debt write-off to the allowance account and not the Bad Debt Expense.
  3. Customer pays a written-off account: Company re-establishes the account. Debit A/R, Credit Allowance for Doubtful Accounts, then Debit Cash, Credit A/R.

Estimating the Allowance

Percentage of Sales: Emphasis on income statement relationships.

Example: If 1% of net credit sales will be uncollectible, and the net credit sales for the year are $800,000, the adjusting entry is:

Debit to Bad Debt Expense $8,000, Credit to Allowance for Doubtful Accounts $8,000. This emphasizes matching expenses with revenue.

Disposing of Accounts Receivable (Same for Notes Receivable)

Two major reasons companies sell receivables:

  1. Receivables are the only reasonable source of cash.
  2. Billing and collection are time-consuming and costly.

Credit Card Sales

  1. Recorded the same as cash sales.
  2. The retailer pays the card issuer a fee for processing transactions.

Example: A customer uses a credit card for a $1,000 purchase at a restaurant. The bank charges a service fee of 3%. The entry is:

Debit to Cash $970, Debit to Service Charge Expense $30, and Credit to Sales Revenue $1,000.

Promissory Notes

A promissory note is a written promise to pay a specified amount of money at a certain time.

  • Maker: The party that borrows the money (note payable).
  • Payee: The person who gives the note (note receivable).
  • Maturity Value: The amount due as of the maturity date. Equals principal (face value) + interest.

Interest = Face Value x Annual Interest Rate x Time in Terms of One Year

Recognizing Notes Receivable

Debit N/R, Credit A/R.

To Honor a Note

Example: W Company lent H Company $10,000 for a 5-month, 9% note. Interest is $375. Maturity value is $10,375. W Company’s entry to record the collection is:

Debit Cash $10,375, Credit N/R $10,000, Credit Interest Revenue $375.

Accrue Interest Receivable

Debit Interest Receivable, Credit Interest Revenue.

To Dishonor a Note

Debit A/R, Credit N/R, Credit I/R. If there is no hope of collection, Debit Allowance for Doubtful Accounts.

Statement Presentation

  • Balance Sheet: Identify notes in each major type of receivable. Short-term receivables are in current assets. Report both gross amount and allowance for doubtful accounts.
  • Income Statement: Report bad debt expense and service charge expense as selling expenses. Report interest revenue under other revenues and gains.