Receivables represent one of the most liquid current assets on the balance sheet, following cash and short-term investments. They are monetary claims on others and arise primarily from the sale of goods or services or through the lending of money. Receivables are classified as accounts receivable, notes receivable, and other receivables. Those that arise from the sale of goods or services are referred to as trade receivables. Because of their significance to the financial position and operations of a company, proper valuation and disposition of receivables are important. There are risks associated with accepting receivables from customers and individuals; receivables might not be collected. Companies must assess the future risk of collectibility and ensure that expected uncollectible amounts are reported within financial statements.
At A Glance
- Accounts receivable, notes receivable, and other receivables are classified as receivables. Accounts receivable arise from business/trade transactions. Notes receivable arise from written promises to pay a specified amount at a specified time. Other receivables arise from nonbusiness and nontrade transactions.
Receivables may become uncollectible for several reasons, including a company's insolvency or a company's refusal to make payment when required.
- The direct write-off method expenses bad debts at the time specific accounts are determined uncollectible.
- Under the direct write-off method, accounting for the write-off and subsequent collection of specific accounts receivable requires three journal entries.
- The allowance method reports bad debts based on estimates of uncollectible accounts. The allowance method is required for financial reporting purposes when a company's bad debt write-offs are significant in amount to the financial statements.
- The percentage-of-sales method is one method for estimating bad debts under the allowance method and involves computing bad debt expense as a percentage of net credit sales estimated to become uncollectible.
- The aging-of-receivables method is another way to estimate bad debts under the allowance method and involves computing the estimated end of period balance in allowance for doubtful accounts by analyzing accounts receivable by length of time accounts have been unpaid.
- Two main differences between the direct write-off method and allowance method of recording bad debts are the timing of the bad debt expense recognition and the use of actuals or estimates to determine bad debt expense.
Notes receivable represent formal promises to pay and are usually evidenced by a credit instrument known as a promissory note. Features of these include face amount, date of issue, due date, term, interest rate, and maturity value.
Accounting transactions involved in the reporting of notes receivable include issuance of the note, accruing periodic interest earned on the note, receipt of payment on the due date of the note including interest earned, and dishonor of the note when not paid timely.
- Presentation of receivables on the balance sheet as well as in the notes to financial statements includes identifying each major class of receivables, classifying receivables as short-term or long-term, and disclosing any significant concentrations of credit risk.