hho8e_ch08_sg - 64817_08_ch8_p223-268 11/6/08 8 11:14 AM...

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Receivables 8 W HAT Y OU P ROBABLY A LREADY K NOW You probably already know that if a friend borrows money from you, there is a chance you may not be repaid. You would not loan a friend money if you didn’t believe that he or she is creditworthy and will likely repay the debt. However, until the money is received, there is no guarantee. If the friend asks to borrow more money before repaying the original loan, you may be more likely to refuse your friend because your risk of nonpayment is increased. There has been no history of successful repayment yet. If the friend never pays, you have incurred a loss equal to the amount of the loan. The same concerns exist for a business. Sales on account are made only after a company has been approved by the credit department. Despite the most thorough investigation, there will always be some customers who may not pay the amount due. The uncollectible accounts receivable results in a reduction to the asset and to net income. Learning Objectives/Success Keys Define and explain common types of receivables. The two most common types of receivables are accounts receivable and notes receiv- able. Accounts receivable are amounts to be collected from customers from sales made on credit. Notes receivable are more formal and usually longer in term than accounts receivable. Design internal controls for receivables. An important feature of a strong system of internal control is to separate responsibility for custody of assets from the accounting and operating departments. The individual handling cash should not be granting credit, nor should he or she be accounting for receivables.
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224 Chapter 8 | Receivables Use the allowance method to account for uncollectibles. The allowance method matches the sales revenues with the uncollectible accounts expense. An estimate of the uncollectible accounts expense must be made in the period of sale using either the aging of receivables or the percentage-of-sales methods. The entry required at the end of the period is: The Allowance for Doubtful Accounts is a contra-asset account. This account is credited, rather than Accounts Receivable, because it is unknown on the entry date which specific customers will eventually not pay. When it is determined which customer’s receivable is uncollectible, the Allowance account is reduced (debited) and the specific customer accounts receivable is reduced (credited). Carefully review “Accounting for Uncollectibles (Bad Debts)” in the main text. This can be a challenging concept. Understand the direct write-off method for uncollectibles. The direct write-off method is simple to employ, but the method is not in accordance with GAAP. No estimate of the uncollectible accounts expense is recorded. When it is determined which customer’s receivable is uncollectible, the following entry is recorded: X X Uncollectible accounts expense Allowance for doubtful accounts X X Uncollectible accounts expense Accounts receivable Check out “The Direct Write-Off Method” in the main text. Report receivables on the balance sheet.
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hho8e_ch08_sg - 64817_08_ch8_p223-268 11/6/08 8 11:14 AM...

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