Accounts Receivable

Key Things to Know 

Key Things To Know


Revenue is “recognized” when:
1) the goods or service has been provided, and
2) the collection of funds the seller is entitled to is reasonably assured (expected)

Sales Returns:
Customer has the right to return merchandise after the purchase
Returns are very common in some industries.
Expected returns must be estimated and recorded during the period the sale occurs.

The amount recorded for sales returns
Sales dollars x historical % expected
Inventory/CGS amount is the gross profit on the expected return sale

Record estimated returns in the period of the sale:

Sales Returns                                           $XX
           Allowance for Sales Returns           $XX

Inventory – Est                                              $XX
              Cost of Goods Sold-Est                         $XX

“Sales returns” is a decrease to net sales.
“Allowance for sales returns” is a decrease to accounts receivable, net.

Record actual returns when the return occurs at the actual value
Record Inventory and Cost of Goods Sold only when inventory is resold

Allowance for Sales Returns           $actual
               Accounts Receivable                   $actual

Inventory                                           $actual
                Inventory – Est                            $actual

Cost of Goods Sold – Est                 $actual
             Cost of Goods sold                        $actual

Accounts Receivable:
Amounts the customer owes to the company for goods or services provided on credit

Accounts receivable is reported:

On the Balance Sheet:

Accounts Receivable
– Allowance for Uncollectible Accounts
= Net Accounts Receivable


Total amount customers owe
– Amount not expected to collect
= Amount expected to collect

The asset reported on the balance sheet, net accounts receivable, must be the amount
expected to be a future benefit.

Uncollectible accounts receivable have no future economic benefit.

Accounts used to record transactions related to accounts receivable:

Sales – represents the amount (price) of goods or services provided

Accounts receivable – represents the amount the customer owes (not yet paid)

Allowance for uncollectible accounts – represents the total amount you do not
expect to collect – it is an estimate, you don’t know who won’t pay or how much

Bad debt expense – the change in the estimate of uncollectible accounts for the current period

4 key accounts receivable transactions to record:

1) Credit sale (increase A/R)

2) Collect from customer (decrease A/R)

3) Write-off an account when you know who and won’t pay and the amount

4) Estimate bad debt expense (to match with current period sales)

Transactions 1, 2, and 3 are recorded during the period at the time occurs.
Transaction 4 is an adjusting entry made at the end of the period.

Journal entries for the 4 transactions:

Sales on credit                                                     Collect accounts receivable

Accounts Receivable                                           Cash
               Sales                                                               Accounts Receivable

Estimate bad debt expense:                              Write – off accounts receivable:

Bad debt expense*                                              Allowance for uncollectible accounts
        Allowance for uncollectible accounts*                       Accounts Receivable

* (or may reverse debit and credit accounts when overestimated bad debt expense)

The accounts are changed by the following transactions:

Accounts Receivable:

Increases when a sale is made on credit
Decreases when the customer pays
Decreases when an account is written off; you know who won’t pay and amount

Allowance for Uncollectible Accounts:

Increases when estimating bad debt expense using % sales method
Increases or decreases when estimating bad debt expense using % of accounts
(adjusting the cumulative estimate)
Decreases when an account is written off

The allowance account represents the total estimate of what won’t be collected.
The company is not sure who won’t pay or exactly how much.
Remove the amount from the allowance account, the accounts receivable list, and the accounts receivable account when the customer and amount is known.

Bad Debt Expense:

Changes ONLY when bad debt expense is ESTIMATED at end of the period

Overestimates in prior periods are reduced in the current period. Underestimates required more to be added.

The 4 transactions change the accounts:


Bad Debt Expense:
Occurs when a receivable is not expected to be collected.

Record in the same period the sale is made.

Always an estimate (based on past history) because the company does not know who and how much will not be collected at the time of the sale

Two common ways to estimate the amount of bad debt expense for the current period:

Income Statement Approach: % of Sales Method:


Used internally for monthly financial statements.
Ignores probably future economic benefit when valuing A/R on the balance sheet

Balance Sheet Approach: % of Accounts Receivable (aging method):


The journal entry for the “plug” amount will either be:

Allowance for uncollectible accounts
              Bad debt expense

Bad debt expense
               Allowance for uncollectible accounts

Use an aging report:

1) Multiply the balance in each aging category x the % given for each category
2) Add all estimated uncollectible amounts to get the total amount not expected to collect
3) The total must be the final ending balance for allowance for uncollectible accounts.

% A/R Method:

The expense for the current period is the change in the cumulative amount not expected to be collected

Considers all sales and accounts receivables (cumulative) in the current and prior periods

When an account written off is subsequently collected

1st Accounts Receivable
Allowance for Uncollectible Accounts

2nd Cash
Accounts Receivable

Record the customer owes and then record the payment to pay the receivable.

Receivables as Collateral for a Loan

The bank is repaid plus interest/fees as cash is collected from accounts receivables

Journal Entries:

            Finance Charge (% fee)
            Notes Payable – financing arrangement

           Accounts Receivable

Notes Payable – financing arrangement
Interest Expense

Factoring Accounts Receivable

The buyer of the accounts receivables collects the receivables and charges a fee for this service.

The seller receives less than 100% of the face amount of the receivable to cover risk

The seller gives up the right to the collect the accounts receivable

Factoring receivables is accounted for as either a sale or a secured borrowing


Account for as a sale when control of the asset is surrendered and each of the following occurs:

1. The asset is isolated beyond the reach of the company that transferred the receivable to the buyer.

2. The transferee (buyer) has the right to pledge or factor the assets it receives.

3. The transferor (seller) does not maintain effective control over the transferred assets; the assets are not going to return to the transferor.

If all of the above does not occur, the accounts receivable continues to be reported on the balance sheet of the seller and the transaction is accounted for as a secured borrowing (a loan with the accounts receivable as collateral).

2 Types of Secured borrowings:

1) Factor with Recourse
2) Factor without Recourse

Sell Accounts Receivable with Recourse:

The seller retains all the risk of bad debt expense and guarantees the buyer (factor) will be paid if the customer does not pay the buyer.

An estimate of uncollectible amounts is recorded as a liability on the seller’s balance sheet (called a recourse liability.)

Journal Entry:

Cash                                               $net cash received
Receivable from                           factor $buyer keeps to cover adjustments
Loss on sale of receivables                 $fee + estimated bad debt expense
             Recourse liability                     $estimated bad debt expense
             Accounts receivable                $total gross accounts sold


Accounts receivable                        $total gross accounts purchased
             Payable to seller                           $potential sales adjustments
             Financing revenue                        $interest
             Cash                                                $net cash paid

Sell Accounts Receivable without recourse:

The company that buys the accounts receivable (the factor) is responsible
for bad debt expense

The fee is higher to cover the potential bad debt expense

Journal entries:


Cash                                                  $net cash received
Receivable from factor                  $buyer keeps to cover adjustments
Loss on sale of receivables           $fee
             Accounts receivable                      $total gross accounts sold

(same debits and credits as with recourse except no recourse liability credit and different terms give different amounts)


Accounts receivable                          $total gross accounts purchased
               Payable to seller                            $potential sales adjustments
               Financing revenue                         $interest
               Cash                                                 $net cash paid

(same entry as a purchase with recourse – different amounts)

Bad debt expense
              Allowance for Doubtful Accounts