Chapter 8: Reporting and Analyzing Receivables – Financial Accounting Study Notes

Reporting and Analyzing Receivables

Introduction

This chapter covers the recognition, measurement, and management of receivables in financial accounting. Receivables are financial assets representing amounts owed to a company, and their proper accounting is essential for accurate financial reporting and effective business decision-making.

Types of Receivables

Classification and Definitions

• Accounts Receivable (A/R): Amounts owed by customers resulting from the sale of goods and services on credit.

• Notes Receivable (N/R): Written promises to repay debt, often including interest and extending beyond typical credit terms.

• Other Receivables (Nontrade Receivables): Amounts not arising from normal business operations, such as interest receivable, loans to company officers, advances to employees, sales tax recoverable, and income tax receivable.

All receivables are considered financial assets and are expected to be collected in cash.

Recording Accounts Receivable

Recognition and Measurement

• Receivables are recorded when services are provided or merchandise is sold on account.

• Initially recognized at the transaction price.

• Reduced by variable considerations such as expected sales returns, allowances, and sales discounts.

• Further reduced when payment is received or merchandise is returned.

Subsidiary Ledgers

Purpose and Structure

• A subsidiary ledger (or subledger) is a group of accounts sharing a common characteristic, such as all receivable accounts.

• The subsidiary ledger for accounts receivable provides detailed support for the total balance in the general ledger.

• The general ledger contains a single control account for accounts receivable, which must equal the sum of all subsidiary ledger accounts.

Accounting for Credit Losses

Recognition and Terminology

• Some accounts receivable become uncollectible, resulting in credit losses (also called bad debt expense or impairment losses).

• Credit loss expense is recognized in the same period as the related sales revenue, in accordance with the matching principle.

Allowance Method

Estimating and Recording Credit Losses

• Estimates expected credit losses at the end of each period.

• The estimated amount is recorded in the Allowance for Expected Credit Losses, a contra asset account with a credit balance.

• The allowance is netted with accounts receivable to determine the carrying amount.

• The allowance is an estimate and does not identify specific customer accounts.

Estimating the Allowance

• Most companies use the percentage of receivables basis to estimate uncollectible accounts.

• Estimation methods:

  • Apply a single percentage to the total accounts receivable balance.

  • Apply different percentages to accounts receivable classified by age (aging of accounts receivable).

Aging Schedule Example

Customer	Not Yet Due	1-30 Days	31-60 Days	61-90 Days	Over 90 Days	Total
Estimated % Uncollectible	1%	2%	5%	10%	20%	-
Estimated Uncollectible Amount	$2,200	$1,800	$1,500	$2,500	$3,000	$11,000

Additional info: Table values inferred from slide image and typical aging schedule structure.

Adjusting Entry for Allowance

• The amount of credit losses to be expensed is the difference between the required balance and the existing balance in the allowance account.

Journal Entry Example:

• Debit: Credit Losses

• Credit: Allowance for Expected Credit Losses

Carrying Amount of Accounts Receivable

• Carrying Amount = Accounts Receivable – Allowance for Expected Credit Losses

Example:

Accounts Receivable	Less: Allowance for Expected Credit Losses	Carrying Amount
$200,000	$11,000	$189,000

Recording the Write-Off of an Uncollectible Account

Process and Effect

• Authorized write-off reduces both Accounts Receivable and the Allowance for Expected Credit Losses.

• Does not affect the carrying amount of receivables.

Example: Write-off of $1,250 owed by a customer.

	Before Write-Off	After Write-Off
Accounts Receivable	$227,500	$226,250
Allowance for Expected Credit Losses	$11,000	$9,750
Carrying Amount	$216,500	$216,500

Recording the Recovery of an Uncollectible Account

Steps

• Reverse the write-off entry to reinstate the account.

• Record the cash collection.

Example: Recovery of $1,250 previously written off.

Summary of the Allowance Method

1. Measuring and recording estimated uncollectible accounts: Use percentage of total or aged receivables; debit Credit Losses for increases.

2. Recording the write-off: Write off actual accounts when determined uncollectible; reduces the allowance.

3. Recording the recovery: Reverse write-off and record collection if previously written-off account is collected.

Account for Notes Receivable

Definition and Use

• Notes receivable are written promises to pay a specified amount of money, often with interest, at a future date.

• Stronger legal claim than accounts receivable.

• Used for longer credit periods, larger amounts, or when settling overdue accounts receivable.

Recording Notes Receivable

• Debit Notes Receivable, Credit Accounts Receivable (when converting an overdue account to a note).

Formula for Calculating Interest

• Interest on an interest-bearing note is calculated as:

$\text{Interest} = \text{Face Value of Note} \times \text{Annual Interest Rate} \times \frac{\text{Time in Terms of One Year}}{12}$

Example: For a $10,000 note at 6% annual interest for one month:

$\text{Interest} = 10,000 \times 0.06 \times \frac{1}{12} = 50$

Derecognizing Notes Receivable

• Honoured: Paid in full at maturity; collection recorded.

• Dishonoured: Not paid at maturity; transferred to Accounts Receivable if collection expected, or written off to Credit Losses if not expected.

Statement Presentation of Receivables

Financial Statement Reporting

• Statement of Financial Position:

  • Short-term receivables reported in current assets, following cash and trading investments.

  • Reported at carrying amount; gross amount and expected credit losses must be disclosed.

  • Receivables due in more than one year presented in non-current assets.

• Statement of Income:

  • Credit losses reported as operating expense.

  • Interest income reported as "other income and expenses" in the non-operating section.

Managing Accounts Receivables

Principles of Sound Management

• Determine to whom to extend credit.

• Establish a payment period; may add interest charges for late payments.

• Monitor collections using an aging schedule.

• Evaluate liquidity of receivables.

Evaluating the Liquidity of Receivables

Key Ratios

• Receivables Turnover Ratio: Measures how many times receivables are collected during the year.

$\text{Receivables Turnover} = \frac{\text{Credit Sales}}{\text{Average Gross Accounts Receivables}}$

• A higher ratio indicates greater liquidity.

• Average Collection Period: Measures the average time a receivable is outstanding.

$\text{Average Collection Period} = \frac{365 \text{ days}}{\text{Receivables Turnover}}$

• A lower period indicates greater liquidity.

Review of IFRS and ASPE

Key Standard Differences

Key Standard Differences	International Financial Reporting Standards (IFRS)	Accounting Standards for Private Enterprises (ASPE)
Allowance for expected credit losses	The allowance reflects the company's expected credit losses, based on historical experience and adjusted for future economic conditions.	The allowance is normally called the allowance for doubtful accounts, based on aging, past loss experience, and current economic conditions.

Summary

• Receivables are key financial assets requiring careful recognition, measurement, and management.

• Credit losses must be estimated and recorded using the allowance method.

• Notes receivable involve written promises and interest, with specific accounting procedures for recognition and derecognition.

• Financial statement presentation and liquidity analysis are essential for effective receivables management.