Accounts Receivable & Allowance Method | Robert Steele | Skillshare

Accounts Receivable & Allowance Method

Robert Steele

Accounts Receivable & Allowance Method

Robert Steele

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20 Lessons (4h 38m)
    • 1. Receivables Course Overview

      7:30
    • 2. 10 Receivables Introduction

      15:23
    • 3. 20 Accounts Receivable Journal Entries

      10:05
    • 4. 30 Accounts Receivable AR Subsidiary Ledger Explained

      9:00
    • 5. 40 Direct Write Off Method

      19:57
    • 6. 50 Allowance Method Accounts Receivable financial accounting Accounting%2C Financial

      30:37
    • 7. 60 Allowance Method VS Direct Write Off Method

      20:37
    • 8. 70 Allowance Method % Accounts Receivable vs % Sales Method

      19:00
    • 9. 80 Notes Receivable

      24:26
    • 10. 90 Interest Calculations

      20:18
    • 11. 100 Note Receivable Example

      20:24
    • 12. 10 Discussion Question Receivables

      10:26
    • 13. 20 Discussion Question Receivables

      7:23
    • 14. 30 Discussion Question Receivables

      9:47
    • 15. 40 Discussion Question Receivables

      7:51
    • 16. 10 Multiple Choice Questions Accounts Receivable

      10:17
    • 17. 20 Multiple Choice Questions Accounts Receivable

      6:59
    • 18. 30 Multiple Choice Questions Accounts Receivable

      7:12
    • 19. 900

      11:28
    • 20. 900

      9:14
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About This Class

We will discuss receivables, focusing on accounts receivable and notes receivable, reviewing the accounts receivable cycle, the journal entries for recording accounts receivable, and related subsidiary ledgers. 

We will discuss bad debt and valuing of accounts receivable using two methods, the allowance method and the direct write off method. The accounts receivable account represents money owed to the company but there there will be times when the company cannot collect on the account receivables. 

Under the direct write off method, we write off the accounts receivable as we determine they are not collectible. The direct write off method does not do a good job of representing the accounts receivable account's true value and does not do a good job of conforming to the matching principle, matching up expenses with the related revenue it was used to generate. 

The allowance method does a better job of valuing accounts receivable and conforming to the matching principle and is the method preferred. The allowance method is more complex, however, and requires the use of estimates. 

We will also discuss notes receivable, the journal entry for recording notes receivable, and for receiving payment on a note receivable. We will cover detailed methods for calculating simple interest. 

In addition to instructional video, this course will include downloadable

•    Downloadable PDF Files

•    Excel Practice Files

•    Multiple Choice Practice Questions

•    Short Calculation Practice Questions

•    Discussion Questions

The PDF files allow us to download reference information we can use offline and as a guide to help us work through the material.

Excel practice files will be preformatted so that we can focus on the adjusting process and learning some of the basics of Excel, like addition, subtraction, and cell relationships.

Multiple choice example question helps us improve our test-taking skills by reducing the information into the size and format of multiple choice questions and discussing how to approach these questions.

Short calculation questions help us reduce problems that have some calculation down to a short format that could be used in multiple choice questions.

Discussion Question will provide an opportunity to discuss these topics with the instructor and other students, a process many students find very helpful because it allows us to see the topic from different viewpoints.

Who will we be learning from?

You will be learning from somebody who has technical experience in accounting concepts and in accounting software like QuickBooks, as well as experience teaching and putting together curriculum.

You will be learning from somebody who is a:

•    CPA – Certified Public Accountant

•    CGMA – Chartered Global Management Accountant

•    Master of Science in Taxation

•    CPS – Certifies Post-Secondary Instructor

•    Curriculum Development Export

As a practicing CPA the instructor has worked with many technical accounting issues and helped work through them and discuss them with clients of all levels.

As a CPS and professor, the instructor has taught many accounting classes and worked with many students in the fields of accounting, business, and business applications.

The instructor also has a lot of experience designing courses and learning how students learn best and how to help students achieve their objectives. Experience designing technical courses has also benefit in being able to design a course in a logical fashion and deal with problems related to technical topics and the use of software like QuickBooks Pro. 

Content Includes: 

  • Account receivable and note receivable characteristics
  • Accounts receivable cycle
  • Accounts receivable subsidiary ledger
  • Accounts receivable valuation
  • Allowance for doubtful accounts method of accounts receivable
  • Direct write off method of accounts receivable
  • How to estimate bad debt expense under the allowance method
  • Components of a note receivable 
  • How to calculate simple interest
  • How to record a note receivable

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Related Skills

Business Accounting

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Transcripts

1. Receivables Course Overview: if we are a business owner who would like to run our business better by better tracking receivables owed to us by customers or a business professional who would like to advance our career by better understanding the concept of allowance for doubtful accounts and how to write off accounts that are no longer collectable or an accounting student who would like to better understand accounting concepts related to receivables, accounts, receivables, loan receivables and how to calculate simple interest as well is how to work through problems related to these topics much faster. This course is a course for us. What will we learn? This course focuses in own receivables, both accounts receivable and notes receivable, looking at the specific problems for those specific accounts and how to deal with them, including subsidiary ledgers. This will be a review of subsidiary ledgers. Those being the ledgers that will support the accounts receivable in order by customer will talk about the direct right off method that has to do with the evaluation of accounts receivable. There's a couple different ways to value accounts receivable and deal with the problem of what happens if someone doesn't pay us for those receivables one method is the direct right off method. The other is the allowance method. The allowance methods gonna be a bit more complicated. Where we're going to spend most of our time is the method that would be preferred under accounting standards, including generally accepted accounting standards. Then we'll talk about notes receivable on the difference between notes receivable and accounts receivable when we might use a notes receivable as compared to accounts receivable . We'll talk then about interest calculation as it relates to notes receivable, including simple interest and different ways that we can do the same interest calculation. Interest seems like an easy concept, but when we start to calculate it and we look at other people calculated and we look at the different formats for calculating it, including the calculator or excel or ah, formula or different formats for the formula, it could be a little bit confusing. So we'll go through some different options for calculating simple interest. And then we'll take a look at the accounting cycle, always taking a step back because note here, what we're doing in this course is zooming in on accounts receivable as we do that we could lose sight of the big picture and start to get this feeling of Why are we doing this? What's the point of this? How does this fit in to the major goal? The goal being to create the financial statements in order to get a sense of how everything fits in As we zoom in and work with the specific accounts, we also want to take a step back as well. Do it the end of the course with a comprehensive problem and go through the full accounting cycle. Seeing how what we're learning here will apply to and fit into the overall picture. Why choose this course? Although this course will have a lot of instructional videos, it will include more than just instructional videos, including PdF files. Pdf files that can be downloaded can be used as a reference can be used to follow. Along with the instructional videos will have Excel practice files, Excel practice files that will be pre formatted but will really give us a chance to apply in practice. Practical application of the concepts that we will be learning will learn some excel as we do this, including the critical components of Excel, which is addition subtraction cell relationships. But the worksheets will be pre formatted for us, so we really can just maneuver and focus in mainly on the accounting, applying the accounting to application and picking up some of those critical Excel skills. We will also include practice test questions, both in the format of multiple choice questions and short calculation test questions. It's important to practice test questions because this is the format that we will typically be tested on and when we have test questions, they're usually in a compacted format, meaning the information has been compacted down. We don't get to see a trial balance. We don't get to see the big picture, and therefore they can be more difficult in some ways. And we also need to be careful of the terminology used so that we can recognize it as we answer multiple choice test questions. These will be in the format of an instructional video, so we'll just talk through the test. Questions will go through multiple choice test questions and go through the the answer and how we might go through a thought process to get to. Those conclusions, will also have discussion questions which are designed to be more open ended discussion questions to facilitate discussion with other students as well as the instructor. So we can see different perspectives and how different people would think about these topics. Think through these topics and work through these problems. Who will we be learning from? We will be learning from a practicing certified public accountant, someone who has practical accounting experience, as well as teaching experience and design experience in accounting courses and other business courses. Someone who has experienced putting together curriculum curriculum that typically it needs to be in some structured order. Some structured fashion in such a way that students can get from it what they want. Someone who is a charter global management accountant, someone who has a master's of science and taxation, someone who is a certified post secondary instructor and a curriculum desert development expert. Someone who has experienced putting together courses in a logical fashion, courses that we can go forward through, go back in practice, the skills that we have learned and get from the course what we want. How will we be taught through viewing and then doing we will have the instructional videos that will go through the new concepts, and the new ideas will have PdF files that can be downloaded and printed out. If we would like to use them to help, take notes or as references, then we'll have those Excel file problems, which will include an instructional video toe walk through how to go through these step by step learning these practices, putting the practices into a conceptual framework into excel learning. Some excel as we go, but they will be pre formatted worksheets, the pre formatted worksheets typically having a tab that will show the answers to them and having a time that we can work through the problems so we can go back and we can figure out how Excel works. If we want, we can figure out how the problem is working and then go through the instructional video and do the same things ourselves and work through the problems we're gonna have. Those practice tests questions. These will be in video format just going through the test questions, but you can use them as a proactive Teoh. Answer the test questions as well as practice, test taking skills and those discussion forms that will help us to facilitate discussion with open ended questions with other students so we can look at the conceptual frameworks of what we're talking about often time when we think of accounting, we think that there's just an answer, which is like two plus two is four. But a lot of times there is a lot of conceptual framework behind what we're doing. Why are we doing this? Why do we have certain types of vestments? How are we gonna apply those estimates? What if we have different options between two estimates? Which one should we use and why? These are all questions that are great for discussion, and many people will have different ideas about them. Please join us for financial accounting receivables and the allowance versus direct right off methods. It will be great. 2. 10 Receivables Introduction: this presentation, we will take a look at receivables, the major two types of receivables and the ones we will be concentrating on. Here are accounts receivable and notes receivable. There are other types of receivables we may see on the financial statements or trial balance or chart of accounts, including receivables such as rent receivable and interest receivable. Anything that has a receivable and it basically means that someone owes us something in the future. We're gonna start off talking about accounts receivable that's gonna be the most common, most familiar, most used type of receivable. And that means something someone, some person, some company, some customer, typically always this money for transaction happening in the past, typically some type of sales transaction. So if we record the sails transaction, that would typically be the way accounts receivable would start within the financial statements, meaning if we made a sale, we would credit the revenue account will call it sales. If we sell inventory, it would be called sales if results something else that might be called fees earned or just revenue or just income. Increasing income with a credit and then the deputy not go into cash. But go into accounts receivable. This is a transaction that should be fairly familiar. That's gonna be a transaction that happens fairly often. We made a sale on account and of course, if we made that sale on account and it was inventory, then under a perpetual system, we have the second component to that which would be cost of goods sold. The expense related to the inventory we sold some amount less than the receivable and the inventory going down, the assets going down. So we, of course, are focusing in on here this receivable amount and talking about what that means for us, what it means to the company. And are there sometimes of problems with receivables that we will have to deal with and one major problem with receivables and one that many people see when we start to learn the accrual accounting, we start to say, Hey, we recorded a receivable here. We're talking about balance sheet accounts. We say, for example, we have cash and we have total receivables of 45,000. Well, the cash is pretty concrete. We have that in the bank and therefore there's not much question about the cash. Cash is cash. However, the receivable Many of us start to question the accrual principal, especially when we start to first learn the accrual principle and say, Hey, is that really fair for us to record this receivable of 45,000 when we have not yet gotten the cash? Were recording it as an asset, a current asset almost equivalent to cash in some ways in the same section of the balance sheet as an asset. When we don't have the cash yet, what can we do? Something about that seems like we might overstep state the financial statements. And that's the question here. Will we be able to collect on This is the question with the receivable, the problem with the receivable just because we made the sale just because we earned the revenue by doing the work completed in our case, giving the merchandise in order to complete the sales process and earn the revenue and therefore be entitled to the receivable? It is the fact and the case that some receivables won't be paid, and it'll differ from industry to industry. So that's what we'll talk more about as we go through future presentations. How can we value this one way to do it is to have an allowance method and say, Hey, this is people that, oh, it's money. How much is owed to us? We're gonna estimate how much of that is not going to be collectible. We cannot write down the receivable directly because we don't know who's not gonna pay us yet. But it would be reasonable to tell our readers that someone's reading the financial statements. They would want to know the receivables. We gotta put it on the books. We can't remove it. We can't be that conservative in that. In that we're gonna take it off the books and not recognize any assets at all. 45,000 of what is owed to us is significant readers to financial statements. Want to know that number, However, in order to be, it's fair as possible on the balance sheet side, we would also want to say, Hey, we know that based on past history, that it's likely that a certain amount of these receivables would not be collectible and therefore the net receivables is what we really think should be recorded as an asset and so we cannot write down the receivable directly. We don't know who's not gonna owe us, but we can make this Contra account, and that's what we'll talk about in the allowance method. There's also a problem related to the receivables on the income statement side of things. And whenever we talked about receivables, we talked about the debit to accounts receivable, and the other side of that is, of course, sales. When we record the revenue and the and the receivable and we have the same question or similar question on the revenue side, did we really earn this money? Is this sales of this revenue that we recorded as earned when we made a sale on account for a certain time period? Is that really sales that we can record? In other words, it's not exactly a sale, even if we delivered the goods, if we're not going to get paid in the future, and we need to question this on the income statement side, which again is another area where a lot of people, when we learn accrual accounting, we start to really question this. This question comes up a lot as to Well, how can we record a sale? Aren't we recording the sale that we may not actually actualize and therefore the overstating sales. And the same thing is if the case here that we have to record the sales because the readers of the financial statements do want to know that we earned the revenue by completing the work and therefore earned the revenue. However, we also need to tell a reader that, hey, some of the sales possibly will not be collected on and therefore do a similar type of fashion on the income statement side not only increase in the sales but also decreasing it with the amount of those sales that we believe are gonna be uncollectible, something we typically called bad dead expense. So this would be dealing with the matching principle so that the net income effect here, we think, should be something netted out between these two. In order to be as fair as possible under the allowance method, this number here and this number here are just gonna have to be estimates, which is another area of problem in and of itself, because estimates are estimates. There's a range and there's there's guesswork that we have to do there, but you can see why we would need to do these things because we need to record the receivable. We need to record the sale because those are important to the readers. The financial statement. We cannot eliminate it. We can't go to a cash basis and not record sales on account or accounts receivable. However, it would also be useful for us to try to look at past experience and give the actual number that we think is receivable on the on the balance sheet and that we think was actually earned on the income statement. And that will take a bit of guesswork. The other type of receivable we have is notes receivable, so a note receivable is gonna be different from accounts receivable in that it's typically ah, bit longer. Term in time frame usually has a larger dollar amount and therefore is often put in writing and often has interest than attributable attributed to it. So in accounts receivable may not have the formal note documentation. Teoh record the transaction and the note, whereas the note receivable were typically gonna have the formal notes transaction because of the longer time period, the bigger dollar amount and probably having the interest being charged on that. When we're considering notes receivable, we're gonna consider notes receivable of time, periods that are typically shorter than a year when we're talking about our receivables here. They could happen for a couple different reasons. We might make a sale, and we might have the period be a longer period and or more money and therefore want a more formal documentation and or charge interest and therefore make a note receivable rather than running it through accounts receivable. When we have a notes receivable, we're not gonna put it into account receivable and track it in the subsidiary Ledger to accounts receivable were typically going to have possibly our own account on the trial balance for each note that we make for each individual customer or will have a notes receivable account on the trial balance. And then we'll have the supporting documentation tracking the note receivable as well as the interest that will be generated from it. So a note receivable document will have something like this will have the amount of the note receivable on on the note receivable, the date of the note receivable, the date it was generated. So if we will have the due date, so the due date might be formatted. Such ads 90 days after the gate of the note, I promised to pay to the order of and then we have the payee. So that's gonna give the terms of the note, which is gonna be 90 days in effect of the new date of the note, and then it's gonna be paid to the order of the pe E. Then we're gonna have ah, 1000 no sense dollars for value received with interest at the annual rate of 10%. So, in other words, were typically gonna have the principal amount that will be dio in some time period 90 days , in this case, from the date of the note to the PAYEASY. And then we're gonna have the interest rate in this case being 10%. Then we're gonna have the maker of the notes signature here. So when we think of the note, remember that the maker is gonna be the one that you can think of as creating this note. If we had a business transaction, say we that company sold something to a customer, then the customer would be the signer as the maker of the note. Now, of course, we would probably be that one as the business generating the note for the customer to then sign in that circumstance. But note that this is, in essence, a promise to pay. So you can think of this actually being written out by a Nen Vivid Jewel making a promise. And that would be the person purchasing something would be writing out the note, saying You're giving me something of value on purchasing something from your store. I'm going to write you a note here saying that I'm going to pay you 90 days from this time period, pay you the pay ee Ah, the amount of 1000 plus 10% interest and then signing the note as the customer then gives the note to the company of the store that is providing the good or service. So if we go through the terminology of this one more time, we could see that the amount here is gonna be the principal. So when we consider the amount of a note, we typically consider it to components of it. When we get paid at the end of the time period, we're going to receive the original principle, and that's what we gave the customer in value. So if the customer purchased something for $1000 the sticker price of what they purchased was 1000 and they didn't give us money. They gave us a note this note receivable. And therefore the principle of this notes receivable is the 1000. We're gonna get more than that because we loaned them that money. We, in essence rented them the money and therefore are gonna also generate interest. So the final payment we will receive can be thought after of as having two components of it won a principal component and to an interest component. And then we're gonna have the due dates. Now, this is the date of the note up here. The due date is actually this item, which is the promise to pay within 90 days. And that does provide a bit of a complex city because wing notes air worded this way, we do need to figure out when exactly that is one of 90 days up and make sure that we get the correct due date on the note and then we've got, of course, the pay ee the pay is the person who's going to get paid. And in our case, we're going to say that that's gonna be the company where the company making the sale, Receiving the note from the customer again. Obviously, if you go in somewhere and you are, you purchase something on account that you're going to get financed and you go through the financing process. That company will typically help out with a financing process and be the one that generates the note. But you can think about this note clearly being a promise from the purchaser, the purchaser, the customer to the store, the seller in order to purchase something, a promise to pay. And so that means that the Payeasy is going to be the person paid the store, providing the good or the service who is going to be paid the principal plus interest at the end of the note term. So this one course will be the interest amount, the interest amount of being the 10% note what we have to do here with the note receivable . It's saying what the principal is it saying with the interest rate is, but it doesn't say specifically one what the actual due date is just says it's 90 days will have to figure that out. And that's like the case with many notes, the way the note will be formatted and written. And that's when, for one reason, it makes it easier to formal formalize a note or make it a standard note copy. If our standard note is 90 days, then it's easy for us to just say 90 days from whatever date the signature happens. And therefore we can have just a template of the note for that type of sale and make it pretty easy to Dio. And the interest rate will be the same type of concept. If we say that whatever the interest rate is typically 10% then you know, whatever the dollar amount weaken basically have the interest rate there were not generating here. Isn't is an amortization type table or a table to show us the calculation of interest that will be due at the term or the end of the note. Ah, it also note that we could have many different types of notes set up. This is gonna be a fairly simple type of note where we're gonna pay simple interest out and the principal at the end of the term period at the end of the 90 days, we could make a note as complexes we want we could make a note that pays monthly type of note weaken, have the compound in of interest be different. So note that the complexity of a type of note can differ greatly. But at the minimum, we're gonna need these components typically in a standard note in order to create a standard note. And oftentimes, when you look at the note, it doesn't give the total amount that will be due at the end of the no term. It only gives you the interest rate, it gives you the principal, and it gives the time frame for the note. And therefore we're probably gonna want to go through the process of figuring out what is actually going to be due at the end of the note, which, of course, will be the principal amount plus some type of interest. Now then, of course, the maker of the note once again is gonna be the person who is promising to pay. So this is the person who is signing the note and therefore promising to pay for services rendered or goods rendered. So if we purchase goods and worthy customer, we purchase goods. We got something of value of $1000 in terms of goods and services or making this promise to pay back that amount some point in the future. 3. 20 Accounts Receivable Journal Entries: Hello. In this presentation, we will be recording that journal entries for business transactions related to accounts receivable. Otherwise no one as the revenue cycle. We will be recording these using debits and credits. At the end of this, we will be able Teoh list transactions involving accounts receivable, record transactions involving accounts receivable, using debits and credits, and explain the effect of transactions on assets, liabilities, equity revenue expenses and net income. We're gonna be recording these transactions up here on the left hand side, constructing those journal entries in accordance with our thought process, our list of questions to most efficiently construct the journal entries. We will then be posting them not to the General Ledger, but to this worksheet here so that we can see the quick calculation of the beginning balance and what is happening to the individual accounts as well as account types in that we have the accounts categorized, as is the case for all trial balances accounts being in order that order being assets in this case in green that liabilities in orange of the equity light blue and the income statement accounts of revenue and expense type accounts. First transaction performed work on account for $10,000 1st question, we will always ask. Is cash effected in this case? No, we didn't get cash. And the key term here is on account. Be aware of that key term in real life. We would know what would be happening here. Meaning we did work for a bookkeeper. We did the bookkeeping, and then we sent out the bill. Have not yet received the cash in a problem that's in a book. They have to indicate that in some way often a very generic type of thing here, where we're just a service company and we did work. And the key term being on account on account will mean either accounts receivable or accounts payable when working with the accounts receivable or sale cycle. As we are here, the account, when you see on account, will be accounts receivable. Some books might use the term on credit, and in practice you might hear the same term credit. The reason many books avoid that term is because we don't want to confuse it, or the book doesn't want to compute it. Confuse it with the idea of debits and credits, mixing up the meaning of what a debit and a credit is. But when you hear that term in real life, you gotta know what the distinction is when someone says they're gonna have something on credit versus Debuting or in crediting the account within a journal entry. If cash is not affected, then we're gonna ask, What did we received? And what we got in this case is an IOU. We got people owing us money. We got a promise to pay at some point in the future. That's gonna be our accounts. Receivable accounts are second favorite asset account, not as good as cash, but we like people owing us money. Eight therefore, because it's an asset has a debit balance. We need to make it to go up because people always more money. So how do we make an account to go up? We do the same thing to it as it's normal balance it being an asset. Having a normal debit balance means we will do the same thing of another debit. So we're gonna debit the accounts receivable, and that means we're going to have to credit something for the same amount. Why're people gonna pay us 10,000 in the future because we did the work today. We performed the work today in their four earned revenue or income, the credit going to revenue or income. We already know that if we know that it's gonna be revenue or income, that we will be crediting it because we debited the accounts receivable. But we want to think through that. Remember that revenue is an income statement. Account revenue and expenses being the income statement accounts and income statement accounts on Lee go in one direction. Revenue accounts going up in the credit, the direction. Therefore, we're going to do the same thing to it, which in this case, is another credit. Also note that according to the revenue recognition principle, we're recording revenue here when the work was done. Although we have not yet received the cash and typically this would be like an invoice transaction. The transaction would be recorded wind invoicing the client, as is shown here. So if we post this out, we're going to say that the Accounts table goes from zero up in the debit direction by 10,000 to 10,000. The revenue starts at zero, goes up in the credit direction by 10,000 to 10,000. Remember here that we are representing debits and credits in two columns and the credits with brackets on the journal entry. But when posting, we're showing the credits as bracket numbers on Lee, not in a separate column and debited numbers without brackets. This will save a lot of room when we post to a worksheet like this, and that's why we will be working with this in practice. It will save a lot of time. If you're working with Excel, which I highly recommend doing, then it will save a lot of functionality in the formulas as well. The effect on the accounting equation. Assets increasing as cash goes up, liabilities remaining the same and equity going up because net income is going up. Net income going up because revenues going up. Net income calculated as revenue minus expenses. Net income Increasing equity. Here we see that that net income is increasing due to revenue increase in net income, starting at zero going up by that 10,000 calculated as the 10,000 minus zero minus zero. Remember that that brackets does not mean negative number for us when considering this in the format of debits and credits. It represents a credit. It represents revenue over the debits, the credit of revenue over the debits of expenses by net income of 10,000. Next transaction received cash on account 10,000. First question we're gonna ask Is cash affected? We're gonna say yes. We're gonna say received cash. Is it going up or down? Up keyword received. How do we make something go up? We do the same thing to it as it's normal balance, which in this case would be a debit to an asset account which has a debit normal balance, increasing cash. Now, when first seen this many times when we start working with journal entries, we started to think, Wait a sec. Is cash really affected in this? Because I also see the key term on account. And I start to think that when I see on account and that means cash isn't affected, it means that some other accounts receivable or payable thing is happening here. And when we are purchasing something on account, that will be the case because we purchased in the last example we purchase something on account or in this. In that case, we did work on account, and therefore the on account was affected rather than cash. But in the second half of that transaction, what's happening is we're gonna receive cash for the the amount that was over to us in this case, what was in the on account account of accounts receivable? So bottom line, don't let that throw you off. If it says received cash, then we received cash. Think about that first, and then we'll think about why did we get cash? We got a credit. Something. What are we gonna credit? We can't credit revenue because it says on account. And that indicates that we didn't do the work at this point in time. That indicates that we did the work sometime in the past. And if we see this this transaction without having first seen the prior transaction, we've got to be able to look at this and say what? What? What must have happened in the past? What must have happened in the past is that Trump prior transaction. That's how the accounts receivable works. We do work on account. We invoice the client. We put that money into this account called or that receivable that I owe you into this account called accounts receivable. It represented here with this 10,000. Now, once we get paid, that 10,000 needs to decrease. So the credit is going to go to that accounts receivable. It's going to reduce that 10,000 back down to zero. So if we post this out, we see the 10,000 debit to cash increasing cash from zero up by 10,000 to a 10,000 accounts receivable. Then going down were they credit it being a debit account? We do in the opposite thing, crediting it, bringing that balance down 20 The effect on the accounting equation. Assets going up, however, as it's also going down one asset increasing one asset decreasing. In essence, we're getting a better asset and losing the worst. Harass it. We're losing the fact that people owe us money and getting the fact that we have now got the money. There's no effect on the liabilities and no effect on equity for look at the net income, no effect on net income. Note that although we got the cash now, we already recorded the net income in the past and therefore in the current transaction in the middle column. Nothing's happening to net income, and we are remaining at 10,000 representing net income calculated as revenue minus expenses . We are now able to list transactions involving accounts receivable, record transactions involving accounts receivable, using debits and credits, and explain the effect of transactions on assets, liabilities, equity revenue expenses and net income. 4. 30 Accounts Receivable AR Subsidiary Ledger Explained: Hello. When this lecture, we're gonna talk about the accounts receivable subsidiary Ledger, the subsidiary Ledger being the ledger that will be backing up the account of accounts receivable showing on the trial balance with 27,000 in it in this case accounts receivable . Being that accounts, that represents what is owed to us. If we were the owner of the company, we might ask our accounting department How much money do people owe us? In this case, it would be 27,000 would be the reply. Next follow up Question would most likely be who owes us that money and have we called them when we're going to get paid that money? In order to answer that question, we cannot look at the normal backup balance for all accounts that being the General Ledger accounts, if we look at the G l, we do get some detail in terms of the activity of that has happened. However, that activity is not going to be in terms off. Who owes us the money? It's in terms of date, so every account has the general ledger, which does give very good detail, but not the detail we need in this case. What we will then need is that information broken out by customer, which will be in terms of a subsidiary ledger such as this. For example, it might say that Smith those is 5000 and Ryan knows is 15,000 and Adam's owes a 7004 a total of the 27,000 the accounts receivable subsidiary Ledger matching the general ledger matching the trial bounce, which, of course, would match the balance sheet. It's important to note that this information is all put together using the same data. So the General Ledger and is often thought of as how we create or put together the information which the end result will be reported in terms over the trial balance. We could put that same data the same General Ledger data into the subsidiary Ledger. That's what we'll do in this process. Also important to note that because of that relationship, when we look at the end result meaning the accounts receivable account in terms of the trial bounce or the balance sheet weaken, sort that data and back up that data in terms of a general ledger or a subsidiary Ledger. Let's take a look at some transactions. First transaction is a familiar one. We've seen it before. We're gonna invoice the clients. So we're going Teoh do work on account. Therefore accounts people is going to go up. The IRA is gonna go up with a debit and we're gonna credit the income account. I'm gonna post out the income account. I'm not gonna post it to the General Ledger account. It would have won, but we want to focus in on the G l for that receivable. So if we post out that income, first income would increase increasing revenue for that time period. When the invoice was issued. Accounts receivable. We're gonna first post to the General Ledger. So the general ledger for accounts receivable increasing by that 35,000 which would then increase the total in the accounts payable G L to 35,000. And of course, the same would impact on the trial balance increasing The trial bounced to that 35,000. We can see then that after this journal entry, we have 35,000 in accounts able, we have 35,000 in the general ledger. But we also want to see that information in terms of who Rose is the money. And in order to do that, we have the subsidiary Ledger broken out by client by customer, and we want to post the same information that same 35,002 the information by customers. So it's the same as the G. L accept. It's a bit more detailed in that it's by customer and then by date. And if we post that out, we see the 35,000 is owed by Smith. Now, we have a total in the subsidiary ledger 35,000 total in the general ledger of 35,000 as well as in the trial bounce. And what would be on the balance sheet of that 35,000? That relationship always has to be there Next transaction. We're gonna assume that we paid. So the customer then paid us. We're receiving cash. Cash is going to increase, and we're gonna credit the accounts receivable, not revenue, because we didn't do the work. We did the work last time or crediting the receivable. So one as it's going up, one assets going down, I'm gonna post the cash first cause I don't want to focus on cash we're not going to be looking at the Geo for cash is going to say cash is gonna be a debit increasing the cash, and then we'll focus on the receivable, which we will post to the General Ledger. So that's gonna bring the balance down. We can think of that in two ways. One, the running balance. 35,000 debit minus the new activity, which is a credit bringing the bounce down to zero or summing up the debits. 35. Summing up the credits. 35 debits minus the credits would then equal zero same activity. Same thing would happen to the trial bounce bringing the tribe balance down to zero. Meaning trial bounce now zero General Ledger now zero Subsidiary Ledger Need that same information. So we're just gonna post that same information of the Geo. It's the same thing that is, will be impacting the accounts table subsidiary Ledger. However, it will be there by client or customer bringing that ballot down. We're back down to zero on the Subsidiary Ledger for a R and the General Ledger for A Are and the trial balance for a our new customer were saying new customer, We're gonna invoice a new customer. We did work and voice goes out. That means debit accounts receivable. Credit the revenue account. We're gonna post the revenue first again because we're not really focusing on revenue. So although it has a general Ledger account, like all accounts do we're just gonna posted to the trial balance, increasing revenue. Then we're going to focus on the receivable. We're gonna post that out to the Geo. What would that do to the Geo debit to the G L the General ledger? Four accounts of people going up by that 14 that would bring the balance up to 14. Calculated in one of two ways we could say it. Zero running balance was zero before, plus a debit bringing it up in the debit direction. Or we can say the debits. 35 plus 14 minus two credits of 35. Bring us two of the 14. Same thing. What happened to the accounts? Evil up here. So we're seeing a counselor before the trial bounces going up to 14,000. Now we see that we have 14,000 in the trial bounce for a council table. We see we have 14,000 in the General Ledger for accounts receivable, and we need to post that same 14,000 of this. Same 14,000 needs to be posted to the subsidiary Ledger, but by customer in this case, and that customer being Adams here. So Adams is going up by that 14. Now we have zero plus 14 plus zero brings us to that same 14 the subsidiary Leisure time out to the General Ledger tying out to the trial balance. Then we're gonna have another invoice. Were invoicing another customer? Same thing we did work in voice in the customer accounts is Table's gonna go up with the debit over that 27,000. We're gonna credit the revenue again. I'm gonna post the revenue first, not to the General Ledger, although it doesn't have a General Ledger account. But we're not focusing on the Geo for this particular count, but revenue within increase in the credit direction. Now we'll post out the receivable. It's gonna be another debit to the receivable in this case, increase in the receivable. We can think of that two ways. The 14 prior balance plus the 27,000 current activity brings it to the 47 or 35,000 debit plus 14,000 debit plus 27,000 debit. That total, minus the 35,000 credit total, would also bring us to that 41,000. That's the T account for Matt, and this is the running balance format free posted out to the trial bounce. We see the same activity the 14 plus 2 27 bring us to that 41 1000. We can see that then about 41,000 on the trial balance is equivalent to the General Ledger account for accounts table 41,000. We need to post that same 27,000 to the accounts receivable subsidiary Ledger, but by a customer, that customer bringing Ryan in this case bringing the balance up to 27,000. Now we have, ah, balance of 41 total, including the 14,000 atoms. Zero for Smith because Smith paid off the balance and 27,004 Ryan Point being that subsidiary Ledger is the same data, in essence as the General Ledger. It just posted in a bit more detailed of a fashion. We want to be able to know that relationship so that we can one build the trial balance. And also we need to know it so that if we are using software, we know that we can sort this data one by geo by date, but also by customer and then date. And that's also why much of the software when we work with accounts receivable, will require a customer. Every time we posted the receivable that the salt were saying, Hey, I can't make a subsidiary ledger unless you assign a customer. Therefore, we're not gonna let you both to the to the receivable account unless you assign a customer . 5. 40 Direct Write Off Method: In this presentation, we will be discussing the direct right off method that direct right off method as it relates to accounts receivable. Quick summary of accounts receivable accounts receivable is a current asset. It's an asset with a debit balance. We are going to be a writing off certain amounts four accounts receivable that will become not do or not collectible at some point in the future. There are two ways to do this. One is called the allowance method. The other is the direct right off method. We will be using that direct right off method here. The non generally accepted accounting principles method being this direct right off method . However, a method that is typically much easier to use therefore win considering whether or not to use an allowance method or direct right off method, we want to consider one. Do we have to use an allowance method due to the fact that we need to make our financial statements in accordance with generally accepted accounting principles? Or are we able to choose between having and allowance method or direct right off method? If we choose to have a direct right off method, it's probably because we're thinking that the receivables that will be written off or not significant. In other words, they're non material to decision making. So if we had our accounts receivable here, that's what people owe us. We want that on the books to represent the fact that we do have an asset. We do have people owing us this money. However, if there's a significant amount that we believe will not be paid to us, then we want to note that if we don't, we're overstating our assets, and we're also distorting our net income on the income side of things. So the deciding factor, then, is gonna be one. Do we have to use an allowance method that will be a general accepted accounting principle ? If we have to make financial statements in accordance with a strict, violent, generally accepted accounting principles, then we would typically need an allowance method unless the amount was in material. If we're not required to be recording our books with regard to the allowance method because of generally accepted accounting principles, that question then is should we be recording the allowance method? Is it better for decision making that decision basically again, coming down to whether or not it's gonna be material to decision making. How many of those receivables we believe will not be collectible As we go through the direct right off method, we always want to compare it to the allowance method to see the differences between the two methods. We have this account here, this red account that will not to be used as we go through this direct right off method but there to show us what would be there if we were to use an allowance method to compare and contrast as we go through this process. So first we're gonna say that a customer C W. Is not gonna pay us the accounts receivable of 9000. For whatever reason, at this point time, we've decided we're not going to get paid and therefore we're gonna have to decrease our accounts receivable and the d creates is gonna be a credit to accounts receivable. Accounts receivable is a debit balance acid account. We're gonna do the opposite thing to it to make it go down because we're not gonna get paid . Therefore, our journal entry will be a credit to accounts receivable that will be the same under the allowance method or the direct right off method. The other side is what will differ under the direct right off method. We will write it off to bad debt expense. This is probably what seems most natural at this point in time because it's not getting paid, So we're going to write it off to bad debt expense. What actually happened here? How did that accounts receivable get on the books in the first place? We debated accounts receivable, and we credited revenue when we made the sale. You would think then that we would decrease revenue At the point in time that we discover that this sale $9000 worth is not valid. We're not gonna get paid that $9000 but we don't typically reduce revenue one, and therefore we're gonna make this other account. That's gonna kind of be like a contra revenue account because we never really earned revenue, bad debt expense. So it's gonna be an expense were really kind of taken away revenue that we had recorded in the past. Now, the problem with this method, of course, is that when we record this expense, we will be reducing net income at this point in time, when really the sale that happened, that increased revenue happened in the past. So it's a timing problem that we have not so good time in in terms of the direct right off method here. Let's see if we post this, then we're gonna post this to the General Ledger accounts here. Then we'll record it to the subsidiary Ledger. So we're going to say that the bad debt is gonna go up. Is the General Ledger is the two accounts were not going to show all the accounts for the General Ledger. Every account here on the trial balance would, of course, have a general ledger accounts showing the detail by date, that means it's gonna go up from zero by 9000 to 9000. That's gonna be the new balance here, the accounts receivable. It started at 1,000,200. There's the 1,000,200. What was 1,000,200 before this. Now we're gonna bring it down by the 9000 to 1 million won 91. There's the one million won 91 now on trial balance. After this transaction has happened, we also need to record this to the accounts receivable subsidiary Ledger. So we know that C. W. Is the individual that didn't pay us. We note that the accounts receivable over here on the trial balance and here on the General Ledger Show who owes us money, How much is owed to us? The G l gives us detail, but only by date. The subsidiary Ledger would then give us detail about who owes us this money. We're just going to show the account for C W here. But in a subsidiary Leger, we would be having all the accounts owed all the customers owing us money and if summed up , then it would add up to the amount on the trial balance. So in this case, C W Roses that 9000 were going to say that they're not gonna pay us. We're gonna take it out of the subsidiary account, and that will bring it down to zero Note. The major problem and difference here between the two methods is that under this method, the direct right off method we brought net income down. By this 9000 we had revenue 3 78 minus this 9000 we just recorded bringing net income, the subtraction of those 22 6 3069 369,000 Under the allowance method, we would have recorded that through the allowance account that we would have already set up , not decreasing that income at the point in time that we determined that something will not be do but having already done so or estimating what the decrease will be trying to match up the bad debt expense to the revenue that it was actually incurred in rather than waiting. And so we determine when something is uncollectible. Note that we have a lot of control over net income in some ways, if we're able to then decide when we think something is going to be a bad debt, because we can write things off at certain times or wait and not write them off, and that could have a significant influence on the net income. On the other hand, if we are forced to basically make an estimate of how much we think of this, revenue will be uncollectible then, where at least have to give a guess as to what we think a fair number would be that would be uncollectible related to the revenue earned during this time period. Next transaction were going to say that G company had a payment of 20,000 but over just 30,000. In other words, of this receivable, this one million won 91,000. G company owes us 30,000 but they're going to go bankrupt or something happened. We're only going to get 20,000. We're not gonna get the rest. We can imagine they grow in bankrupt. We're gonna get 20,000 in the bankruptcy. The 10,000 is something that we're not gonna get. We're gonna write it off. Therefore, we can say, OK, Cash went up just like a normal payment on account Cash is a debit balance. We're gonna make it to go up by doing the same thing to it's another debit 20,000. Then we're gonna credit the accounts receivable. The account here, of course, saying that they owe us money. It's gonna go down because they don't always money anymore. This is a debit balance account, and therefore it goes down with the opposite of a debit or a credit. However, we're not gonna credit the 20,000 but the 30,000 the total owed to us so that we totally removed the amount that's owed to us off the books our debits do not equal are credits. Now we need a debit of 10,000 that then it's going to go under the direct right off method to bad debt expense. This is what will differ under the two methods of the direct right off method. It goes to bad debt expense. Under the allowance method, it would be going to the allowance for doubtful accounts. So this is gonna be the same type of transaction we had before. Only difference being that we received a partial payment. So don't let that throw you off. If you see a partial payment, then we still gonna go through with normal transactions were going to say, Is cash affected? Yeah, we're gonna increase the cash. Then just note that you have to take the receivable off, but not for the amount received, but for the entire amount, because we're not going to get the rest. Therefore, needing to remove the full amount owed by this cups customers so we don't show that they still always 10,000. They don't know it was anything anymore because we gave up on the other 10,000. Then we have to decide how we're gonna even this thing out. We do so with another debit. If we then post this to our general Ledger accounts over here and our subsidiary lead room and then we'll take a look at our Indian trial balance. We're gonna say that cash is going up from 100,000 by this 20. So we post after the geo account, increasing the GL 2 120,000 That, of course, will now match our trial balance. After we post that, then we're going to say the accounts receivable this 30,000 credit, we had one million won. 91 here is going down by 30 to 1 million won, 61 That then matches what will be on the trial balance, then the bad debt here, the thing that will defer the bad debt changing as we determine that something will not be collectible going from 9000. Here's that 10. Here's the 10 going up by 10 to 19,000 that then the amount in the bad debt on the trial balance. Note once again that the revenue is going on? Well, the net income is going down. Bad debts going up is bringing net income down. That's gonna be a difference that the major difference between the direct right off method and the allowance method under the allowance method, this journal entry would not be affecting net income. Net income would only be affected when we make an estimate about what the bad debt should be, not based on when it is becoming bad. But they saw him matching it to the revenue in the same time period. And we could do that with two different methods will talk about in a later point. But remember that the allowance method should have a better matching principle between the revenue and the bad debt happening in the same time period. Then we have the accounts receivable subsidiary Ledger. Remember that the accounts receivable here represents how much is owed to us, but doesn't give us any more detail than that. The accounts receivable here gives us detail, but only by date of transaction. We need the detailed by who owes us money. That's gonna be the accounts receivable subsidiary ledger. We're only gonna look at this particular customer here this customer G company. But all the customers remember would be included in the Subsidiary Ledger. If we added up all customers, it would then add up to the accounts payable on the trial balance. And on the general Ledger, we're going to say we told the same thing. That's 30,000 goes here, and that's gonna bring the balance down to zero. So that's critical. We know that G company doesn't always any more money. They paid us 20 even though they Otis 30 we took the entire 30 off the books, not leaving that 10,000 still owe to us because we gave up on it and therefore need to take the entire 30 off the books, bringing them down to zero. Next transaction, we're gonna say, received a payment from C W. After writing it off, this is gonna be a typical book type transaction. Not so typical when we have a real life situation, because if we wrote off the bad debt, we totally gave up on it. So we gave up on the bad debt and then on that doesn't normally happen until we go through a pretty significant collection process. And then after we gave up on it. We're not calling anymore. We're not actively trying to collect on it. It then gets paid at some point in the future. How do we deal with that? That's a great book question, because it really emphasizes the difference between the two methods. And how are we gonna kind of reverse this transaction? It was gonna be the trickiest thing that we have here because typically, if we got paid, you would think that we would debit cash. And then we were credit What we are. We know we wrote it off the bad debt. So you would think, OK, I wrote it off the bad debt. I could just credit bad debt. So typically we would go through our questions. Is cash affected? Yeah. I debit cash, and then the other side can't go to receivable cause I wrote it off. Well, where did we write it off, Teoh? Bad debt. So we could debit, cash and credit. Bad debt, however, were not going to do that. And this is kind of an exception to the rule of dealing with cash first. And that is because if we do that, we bypassed the accounts receivable and we don't have a record showing us that in the receivable account in the subsidiary Ledger for this customer that they actually paid it. What we want to do is put them back in good standing on the receivable account and then write it off, as we normally would. Therefore, we're gonna do this with two transactions, two entries. We're gonna put him back on the books were going to say that receivables gonna go back up. We wrote off the receivable. We're reversing the right off and then we're gonna put the other side. Too bad, that expense meaning. When we wrote it off, we credited the receivable to take it down and under the direct right off method, we put the other side to bad debt expense. We're just reversing that. Now. We're gonna put the debit to accounts receivable and the credit Too bad jet. Just reversing the right off. That happened because it didn't really happen because they actually paid us. So we gave up on them too soon. Note that this bad debt expense is part of the reversal and part of a difference that would be between the two methods under the allowance method, this amount would have been written off to the allowance and therefore would be reversed now to the allowance. Once we do that, then the second piece is is easy because it's our normal transaction. We got paid on account. They accounts receivable is back in good standing. Therefore, we're gonna say it's cash affected. Yeah, it's a debit. Were increasing cash with a debit. So the debit to cash and then we're decreasing that receivable, which we just increased by 9000. So again we could simplify this transaction. You can look at this and say, Hey, we're duplicating information. I mean, I've got accounts receivable here and I've got accounts receivable here, and it's just doing the same thing. Once being debited once being credited, I could eliminate those two. We just eliminate these two. We would be left with a debit evict checking account and a credit to the bad debt. The problem once again, is that we want to see the paper trail in accounts receivable. We want to be able to go to the council seyval subsidiary Ledger and say, Yeah, this person paid us. We're willing to do business with them in the future. We can't to see that if we don't reverse the transaction and then put it through the Subsidiary Ledger, let's take a look at recording this. Then we're gonna say first the accounts receivable is going to go back on the books that we took him off the books here in the Subsidiary Ledger, back on the books in the receivable Increase in the amount Teoh One million, 170 here, other side on. But that's all that's there right now. Other side. It's going to go to the bad debt. That debt is being reversed here. So here's the bad debt that we wrote off incorrectly. We gave up on it too soon. We are reversing it here at this point in time, bringing the 19 down by the nine to the 10,000. Then we're gonna record the second piece, which is just the normal transaction for a receipt on account receiving money for the accounts receivable for something that we did in the past. So here's the cash going up. Here's the cash going up, and that brings the balance from 1 20 to 1 29 and then the other side of it is gonna be the accounts receivable here. It's gonna be the credit. Here's the credit. So note what happened? We started before this process in the Receivable General Ledger at 1,000,001. 61. And then we brought it up, putting them back in good standing and back down to bring us back to that same spot. 191 61,000. We'll see that same process in the subsidiary Ledger, the subsidiary Ledger for CW. Remember, we had 9000. We gave up on them, wrote them off left, leaving us at zero and then ignore this 9000 here. We're at zero at this point in time, and then we have the other side of it is gonna be a debit to the accounts receivable. So the accounts receivable is going up with this 9000 putting them back on the books. So we took him down to zero, put him back on the books at 9000 bring it back up to a 9000 balance that's from this transaction, and then we're just gonna take it right back off the books for the accounts receivable for C w. Here. So cw another 9000 bringing the balance back down, Teoh zero. So if we look at the subsidiary Ledger, remember that this would be a subsidiary letter with every account for every customer. However, we're just looking at CW's subsidiary Ledger. They had 9000 owed to us. We wrote it off in the past prematurely. We should not have done so because this was still a good customer. They just paid late, very late, apparently. And so we brought it down to zero. And then we want to see that we put them back in good standing here so that we can see the paper trail, bring them back up to only US 9000 and then we record they paid us. If we look at this payment, then it still brings us down to zero. But we can look at this payment say, Well, how did we get paid and see that they actually gave us money. Whereas if we looked at this transaction, we just left it here and we didn't record the other two. We would drill down on that transaction and say, Well, they didn't pay us, and that would probably stop us from doing business with them in the future. We want to say they're back in good standing and they paid us here. Therefore, we can still do business in the future. Note the effect here is gonna be on the bad debt. The bad debt is now going down, and that's gonna be a difference between the allowance method and the direct right off method where the allowance account would be the account affected. They would mean no effect to the net income or the income statement accounts at all under the allowance method. Whereas under the direct right off method, of course that debt is affected and it would then bring bad debt going down, bringing net income up. 6. 50 Allowance Method Accounts Receivable financial accounting Accounting%2C Financial: Hello. When this presentation will take a look at the allowance method, which is, of course related to the accounts receivable account, we will be able to define the allowance method record transactions related to recording bad debt, recording the receivable account that have been determined to be uncollectible, recording every syllable count that has been collected after being determined that it was uncollectible. So we're gonna take a look at some different transactions, the most common transactions when dealing with the allowance method and see what those look like and why we used the allowance method. We're gonna work through a problem. So what we're gonna have here is we've got our accounting equation. Of course we have our trial balance. I do suggest working problems to take a look at a child mounts because it can give you the context in which to work problems. So here's what we have. We've got the assets in green. The liabilities are going to be orange. The light blue is the capital account and with the equity section, and then we have the income statement, the darker blue, which is gonna be the revenue and expenses we can see in this example, we have net income. The net income is going to be chocolate as a revenue minus expenses. We don't have the expenses at this time. We're just gonna note this revenue numbers so that when we work through the problem, we can see what the effect is on net income. Note that we're representing debits with positive numbers or non bracketed numbers and credits with bracketed numbers of that allows us to have lesser Collins and uses quick worksheet to calculate the balancing of the debits and credits by having the debits minus two credits equals zero. So that's what we have here. We're gonna be focusing in on the receivable section, of course, and we're gonna post transactions to this trial balance to see the adjustment in relation to the trial balance. Then we'll also look at the accounts related to the receivable account. So often, times will take a look at the General Ledger. There's gonna be a general ledger account, of course, related to all types of accounts. All accounts on the trial bounce will have a general ledger account, which will be in order by date. We're only gonna look at the two General Ledger accounts that we'll be working with in this problem being accounts receivable and the allowance account. So this is the two we're gonna look at, Of course, that just keep in mind that there's gonna be other General Ledger accounts for all of the accounts on the trial balance. Then we're gonna take a look at the accounts receivable subsidiary Ledger. So remember that the subsidiary Ledger is going to give the same detail. That's basically in the General Ledger. However, instead of just breaking it out by date, it's gonna break it out by customer. Who owes the company money to remember the questions that will happen in relation to the receivable we're gonna ask for who goes? Do people with money? Yeah, people with 1,000,200 who owes us money For that? We go to the receivable account, so we just have these generic names. These are customers. G Company D Company. Geos is 30. B d. Oes is eight CBO's zero k t O's of 3000 m o za four c w. Owes nine CEOs of 67 and all other vendors note that this thing, our customers, all other customers know that this thing could be very long. This subsidiary Ledger could be very long on. We could have a professional accounts receivable, employees just tracking this information, which would be dealing with this report a lot. All other customers add up to one million won 39 3 And that means that if we add all those up, it adds up to one million. Two. So note that the receivable subsidiary Ledger ties out to the General Ledger ties out Teoh the trial balance. Now the new account we have here will be the allowance account here. So now we haven't allowance account. Note that it's still green. It's an asset account, but it has brackets, meaning it's a credit balance account. So it's a contra acid account. It's an asset account that has a debt credit balance, which is contrary to the norm, which is normally a debit balance in asset accounts. So the question many times when I teach accrual accounting to new students, they often think that the way we recognize revenue is overstating revenue under an accrual basis, because when we do work on account, we're gonna increase revenue, and we increase the assets by increasing debit in receivables and credit in revenue. And if we haven't received the money, there could be a valid argument to say, Well, yeah, we did the work, and you can say we earned it, but it could very well be that we never get the money. And if we're recognizing revenue at the point of sale before we get the money, then isn't it true that we're probably gonna be overstating revenue by those revenues that we're not going to receive in cash? And isn't it true that the accounts receivable is gonna be overstated by the amount that we're not going to get your reporting? This asset of 1,000,200 on the books. Pretty large asset. Are you sure you're gonna get all that? Aren't we overstating? And isn't there a general accepted accounting principle that basically says that we want to be error on the conservative side, Meaning when we talk about conservatives conservatism? In this case, we don't mean political conservatives, and we mean that we rather air on the side of looking kind of worse meaning assets being understated and liabilities being overstated rather than the other way around, because from a journal accepted accounting principle. These statements are being geared towards outside users being stockholders and creditors, and we don't want to overstate our position to them. So you could see from a regulatory body. They would rather bust, uh, err on the side of understating the receivable, and it would seem that the accrual method does the exact opposite. And it's not tell this point that we can kind of talk about how the journal accepted accounting principles, deals with that. And the way they deal with that is, they say that we need to account for that. We need to say, Hey, you know what? Yeah, people with 1,000,200. But we believe that in this case 40,000 is going to be uncollectible. How do we know that we're gonna talk a bit more about that towards the end? But the general idea of the general principle will be that we need to tell our readers that we we believe that certain amount is going to be uncollectible. So if it's gonna be significant if the amount is significant, the General accepted accounting principles requires us to use the allowance method rather than the direct right off method. The allowance method is this method we're looking at here which says that we're going to have to report the amount of the receivable that we think is going to be uncollectible. So under the direct right off method, by contrast, what would happen is, for example, if this individual CW company could not pay CW company went bankrupt or whatever. We determined that this company is not going to pay us when they come to us and tell us, okay, we're not gonna pay us. We're gonna look at their accounts receivable and say All right, Yeah, they always 9000. We need to make that go down. So the receivable accounts going to go down when that happens under, under either method we use, we know we got to take it out of the receivable because we have now determined we're not gonna receive it. Therefore, we're gonna credit the receivable. Where should the debit to go? And if you think about it, what really happened? If we're not gonna get paid by a client or customer, it means that we overstated revenue at some point in the past. In the past, we overstated revenue because we increase revenue by a sale. That's not really gonna happen. And really, it's not really a sale if we're never going to get paid for it. So you would think that the debit would go to revenue, which would reduce revenue because we overstated revenue. There's a couple problems without, However. One is that we don't like to decrease revenue directly and remember that revenue basically always goes up. And we almost never debit revenue. So and so therefore, we make another account what that other accounts gonna be called bad debt expense. So the expense is going to go up, which brings down net income. So under the direct right off method, that's what would happen. We would take it out of the receivable, and we would record the expense. When it is determined that the clients not going to pay us and we wouldn't have this allowance account at all, we wouldn't have it here, and that would be a fairly simple method. That's the easiest method to do. If the receivables are in material in decision making, then we can't use that method. But if the receivables are material, there's another problem here, and that is that note that If we write off this 9000 that we we wrote into revenue last year, it was part of revenue last year and were writing the expense related to it or the reduction in net income this year. Then we're violating the matching principle because we're reducing it in relation to this income. But the 9000 isn't included in this income. It's not included in this 3 79 3 78 because it was earned. We recorded an income last period and we already closed that out to the capital retained earnings account. So that means that that's the problem. So under the accrual method, what we want to do is match the expense with the revenue. So we want to look at the same time period and say, OK, I'm going to say that this amount is going to be uncollectable in relation to this revenue , and that's gonna be an estimate. So we had to make an estimate and do that. We'll talk more about how the estimate will work later, but just note that at the end of last period we made an estimate and we said OK of the 1,000,002 that is outstanding. We believe that 40,000 is not going to be collectible. And now when someone comes to us and says that they're not gonna pay us the 9000 then instead of debit in the expense at that point in time, we're just gonna debit the allowance so it would look like this. So under the allowance method, when someone a customer is determined that they will not pay us, then we're gonna reduce the receivable with a credit. The debit will go to the allowance account. What will that look like in terms of the trial balance? Well, we can see here that the receivable is gonna be credited, so that's gonna go down. So obviously that has to go down, and all we're gonna do on the other side is we're just going to debit the allowance. The allowance has a credit balance. We're gonna debit doing the opposite thing to it, which will make it go down. Notice that the book value of the receivables the net value is going to be unchanged because it was before one million to minus the 40. That's the net value. And now receivables went down and so did the allowance. So therefore, now it's the 9 1,000,091 minus the 30 the 31 so noticed there's no effect on net income down here. And that is because we basically already wrote off this 9000 included in the 40,000 last time period when we when we created the allowance account. And we'll do that again at the end of this of this presentation. So you can see if if we go through a series of questions, then we're gonna ask, What do people owes money? Yeah, The trial balances that people with one million won 91. Well, who wills? It's a money. Well, if we look at the G l account, it doesn't tell us that if we look at the geo account, it just tells us by date that we had 1,000,002 and it went down by nine. If we look at the Geo account for the allowance, we could see that That's basically telling us that this wasn't enough. That was not paid. Uh, and we had to write it off even though we were not paid for it. And then So we're gonna have to look at the subsidiary ledger, which is an order by customer. So if we look after the customer in this case, we're going to say that C. W is the one that we are writing off. So this nine here is also recorded here, and it's also recorded here. So this is the same information that is now recorded in terms of customers. And then if you take that off now, CW owes us zero. If we add up all the customers, then it adds up to one million won 91 of those people that owe us money that ties out to the General Ledger that ties out to the receivable account here and note that we have 31,000 vet. We do not believe it's collectible. We cannot apply that 31 to any of the actual customers because it's just a estimate. We don't know who is not gonna pay us. We just believe that certain amount of folks aren't gonna pay it based on prior experience . So now we have a G company, made a partial payment and went bankrupt, is determined that we will not receive the balance. So we're gonna receive 20,000 of cash and then we're not gonna receive the other 10. So if we look at G here and we could see that they company owes us 30,000 they're gonna go bankrupt and within the bankruptcy, assuming they paid off who they could, which they paid off us 20 and then they're not gonna pay the rest because they went bankrupt. So that is what's happening. We go through our series of questions then and we can say, Well, is cash affected in this case? It is. We got 20,000 so we're gonna increase cash going to go up in the debit direction by 20. Normally, when we get paid, the normal credit will go to in this case receivables because that's why they paid us. They paid us to pay off the receivable so that receivable has a debit balance. We're gonna make it go down by crediting it. However, we're not gonna credit it by the 20. We need to credit it by the entire amount owed, which is the 30. And the reason for that is because if we only accredited by 20 then we would show that G owes us 10 still and they don't or they're not gonna pay us, so we got to write that off. So therefore, we have a difference, and we're gonna need another deputy. Where will that deputy go? That is gonna be the uncollectable portion, which we're gonna put into the allowance method. Remember, Under the direct right off method, that debit would go to the back dead expense. At the time it was uncollectible or determined to be uncollectible under the allowance method. We already have this 31,000. We already we already estimated that that 10,000 wasn't going to be collectible. We just didn't know who was not gonna collect it. We already wrote it off in the prior period to match it to the income vet with generated in the prior period. And now we're just going Teoh, take it to the allowance journal. Entry would look like this. We have the debit to cash. Cash is going up by the 20,000 were going credit to receivable for the entire 30. And then the difference is going to the allowance to debit. Here we can see that the 20 plus 10 equals the 30 that debits equal the credits. Also note that I would put it in this order because this is the order that when I think through the journal entry, that's the order that works best for me to think through its. However, if you're gonna post this to something, it's gonna grade you on having the debits on top. You might want to put the two debates on top. If it helps you to audit or something like that and go back to the information and look at it, then I would record it in whatever way helps you to think through the process. All right, So if we're gonna record that in terms of the trial bounce, it would look something like this. The cash is gonna be debited, so it's going from 100 plus. That's when it's gonna go up. We're doing the same thing to it. So we're debuting a debit balance, accounts increasing its their receivable is going to go down. So we have the debit here we are crediting it, doing the opposite to it's bringing the receivable down by the 30. And then that difference is going to go to the allowance and noticed the allowance is a contra account, meaning it's an asset with a credit balance. We're debit in it, doing the opposite thing to it, bringing it down. So then, if we think of our questions, do people always money? Yeah, people. It was 1 1,000,061 who owes us money? Well, if we look at the General Ledger, it tells us detail. But it only tells us the activity by dates that we had people of this one million to then we have this 9000 that it went down by and then we have the 30 that it went down by normally, that would be from payments. In this case, it went down because we were not paid. And we were or we weren't paid on all that we got. We got 20 out of the 30 on this one, but some of them were due to writing it down. We also have the allowance here showing this activity. Here's where they 10 is being posted to the allowance. Here's of course, where the 30 is being posted to the General Ledger. Now, if we want to know who owes us money, we would have to go to the subsidiary Ledger. So in this case, note that this 30,000 is being recorded in Giza counts and they Otis 30 now they paid us 10 and we wrote off. I mean, they paid us 20 and we wrote off the other 10 because we determined it was not gonna be collectible. That's back down to zero. If we add up all customers, then it will add up to one million won. 61 of that ties out to the general Ledger of that ties out to the trial. Balanced of that, we still have this estimate of 21 that will be that not collectible. So the reason it went from the prior balance and when we started this, which was 40 and now it's going down is because we're now know who is not gonna pay us. So this was the estimate, and we didn't know who wasn't gonna pay us. Now we have determined that these amounts are uncollectible and we're writing it off against that 40,000 and then applying it out to the correct customers which are now determined to be uncollectible. All right. Next item received payment from CW after we had assumed the bad debt uncollectible had been written off. So in this case. What we're saying is that this is an unusual case, but it's good to look at because it kind of shows us what would happen if someone came in the door and said, Here I am. I'm gonna pay you now. And we had totally wrote them off in the past because we didn't think that we were gonna get paid from them. So in this case, you remember that the C w company Otis 9000 we determined, were not gonna get paid that we wrote off the 9000 to the allowance account here, So we wrote them off, and now they came indoors that, you know, showed about a nowhere. I've been returning our calls and whatnot, but here I am, and I'm gonna pay you the ninth out. That's great. So how would we record that? I'm gonna tell you the way not to do it first, and I'm gonna tell you why it doesn't work that way. So one way that it would, you know, it kind of works, but it's not. The way we're gonna do it is that we can think it throughout our transactions and say, Well, it's cash affected Yeah, we're gonna debit cash cause we got cash from the client and we would normal credit receivable. However, we cannot credit the receivable now because we already wrote the receivable off. Where did we write the receivable off to? We wrote it off to the allowance account. So therefore, since we already wrote we could see this 9000 was written off to the allowance account. Why don't we just debit, cash and credit the allowance account, which would cancel out this 9000 that we wrote off here? That would work and that works in terms of journal entries. However, it doesn't really work in the system because if we then look, analyze the receivable account, it looks like this payment was not paid. It looks like the customer is kind of like a deadbeat eso if they came to us again. We don't have an audit trail in their subsidiary Ledger showing that they actually paid us . It looks like they never paid us. So what we want to do is record this activity in the subsidiary Ledger and have an audit trail on it. Therefore, instead of doing that, that we're going to kind of break the rule of thinking about cash first. And in this case, we're going to say, Well, let's reverse what we did last time. As of today, we're not gonna We're not gonna go back in time and do it. We're gonna say, As of today, we're gonna reverse the prior journal entry, putting this customer back in good standings on the subsidiary Ledger, and then we'll do the normal transaction, which would be to debit, cash and credit receivable. So that would look like this. So we're gonna reverse the what we did last time, which was to write off the receivable. We're gonna put the receivable back on the books by debuting the 9000 to put the receivable back in Good standing here and then we're gonna credit the allowance account so we've reversed what we did last time. Now we're in our normal circumstance. Now we're back to the norm. And now we can then debit the cash like we normally would when we get money from a client and credit the receivable reducing the receivable so it would look like this. That cash is going. The receivable is going to go up by the 9000 and then the allowance is going to be credited by the 9000. Then we're gonna debit the checking account by the nine and credit receivable by the nine Note, the net difference in the receivable is zero. It went up and down. Therefore, in terms of journal entries, we could simplify the journal entry. Ah, lot by just debit in cash and crediting the allowance you'll note. In essence, that's what we did here. That's what happened. But why don't we do that? Well, let's look what happened on the General Ledger and that is that the receivable went back up here. We debated the receivable here, and then we credited the receivable. So we put the we put it back in good standing, and then we took it off and kind of a normal process. On the allowance account, we can see that we reversed the allowance account here and then on the subsidiary Ledger. What happened for CW is note that we put the 9000 back on the books as being owed to us, and then we wrote it. We wrote it off here. So the reason for that is if we look here than the audit trail will basically show us that . Yeah, we wrote it off, but then we put him back in good standing. And then this 9000 If we you know, if we check the audit trail on that from the subsidiary Ledger, it'll show a payment. Whereas if we didn't do these two transactions and we just looked at this item and we checked the audit trail, it would show that, uh, there was no payment. We wrote it off. So that audit trails pretty much the reason why we would do this reversing process instead of just having a simple journal entry that would just be half as long. All right, so then we determined that P company and D D company would not pay us the amount owed. So two more companies we've determined maybe at the end of the period at the end of the year or so that they're not gonna pay us, we're gonna probably analyzer receivable counts periodically and see that companies will not pay us. And if we look at P company here, we're gonna write them off. So that's 67 is gonna have to go down. And B D company is gonna have to go down. That's the receivable accounts. So those of amounts it will go down by therefore, the receivables gonna have to go down by that. And that's gonna be a credit. And then what are we gonna debit? Once again, we're gonna debit, uh, the allowance account. So that would look like this. We're gonna debit the allowance account for the 14 7 and credit the receivable. And once again, that adds up to the two clients. See a company, P company and B D company the amount that they owed. And therefore we're gonna debit the receivable. I mean, credit the receivable so the receiver is going to go down, has a debit balance. We do the opposite thing, do it to make it go down. And then we are going to debit the allowance account, making it go down. Note that there once again, no change in the net receivable because the net receivable here was a debit of the receivable of one million won 61 minus the credit of the allowance that would be the net receivable. And then they both went down. Therefore, at the new net receivable is now one million won 46 3 minus 2 15 3 So if we look at the activity, then the questions being to people with money Yeah, people always one million won 46 3 Well, who owes us the money? The G l just tells us, by date, what has happened? So what has happened? It went It went down by nine and went down by 30. It went back up by now and it went down by nine. And then we have this. 14 went down by that. The allowance shows us the activity for the accounts that were uncollectible. Then the subsidiary Leisure breaks it down by customer or client. So here's what happened. There's that 8000 here, as well as the BB and T the 67 That's what adds up to this 14 7 So we had to break that out between the two customers that don't pay us. If we add up all the receivables, then in the subsidiary Leisured adds up to one million won 46 3 of that times out to the General Ledger that ties out to the trial balance, and we still have this estimate of 15 3 that we determined was uncollectible. So now we're gonna say it's at the end of the period if it's at the end of the period now and, um, we're done with with a year and we need to then determine what the allowance account should be at the end of the time period. There's a couple ways we can do this if we think about this. What we're saying here is that the revenue account here off 33 78,000. If we made all those sales on account, we need to think about the amounts that will be uncollectible. So part of those sales are going to be uncollectible, and what we want to do is write off that uncollectible portion this period we don't want We don't want to close out the books and then write it off next period because then we'll write off the bad debt expense. Teoh. The next period, we want a match up the uncollectible accounts to this period. Now we don't know who's not gonna pay us. That's the problem. We know that we made a bunch of sales. We don't know who is not gonna pay us, but we can make an estimate of that and under general accepted accounting principles, we have to because if we don't, then we're gonna be overstating the revenue or the net income that we have earned in this time period and will be overstating the assets. So we have to make some kind of estimate. And that's controversial because any time you make an estimate that you know it's just a estimate and you can be off on on an estimate not exact. But in order to to fix the matching problem in order to present our financial statements in the most fairway and not overstate them on estimate is better than but not having an estimate. So how could we make an estimate? One. We could look at the revenue side here and we could say, Well, if we made all these sales on account, then based on past experience, we could take some percentage of the revenue and say that based on past experience, we have learned that this percentages uncollectible. Therefore, we can write off the bad debt expense debit in the expense, increasing the expense for that percentage portion of the revenue the other way, we that we could do it, which I'm going to show here, which I think is probably to me. It's more exact to do because it seems like you can come up to a better estimate in this ways to actually look at the balance sheet accounts. And that would be the receivable account here. And then try to find a way to break down what portion of the receivables are gonna be uncollectible. And so that's oftentimes you're gonna look at something like an aging account in order to do that. So if we have this at 1 1,000,046 3 if we break that out, that one million won 46 3 in terms of an account stable, aging, which could look something like this. A lot of software's will have this, and stuff like QuickBooks or something can generate this report. If we have something that's 30 days past Teoh, we could have to, you know, we might say that 2% is uncollectible. If it's between us 30 and 60 past due 4% perhaps 60 and 90 10% perhaps, and over 90 maybe there's, ah, very high chance that it's gonna be uncollectible and this way we can break it down by how old the debt is, which is usually a fairly good indicator if it's old. If the thing is older and we've been calling people forever and there and they haven't gotten back to us, then at some point we can say that there's a higher likelihood or probability that we're not gonna get paid on that one. So where do we come up with these percentages? We would have to get those on past experience and again, that's something that, in a problem the book would have to give you in real life, we would have to do some careful analysis in terms of how we would come up with that. But if we multiply that out, then we're gonna say this times this we would come up with these numbers and that would say that OK, of the one million won 46 3 we think based on this estimate, that 4 50,037 will be uncollectible. Therefore, we still have 15 300 in the allowance account here, and that's because we basically overestimated. Last time we thought that we weren't going to get, I think it was 40 at the beginning yet was 40 here last time. And we're still left with 15 3 at the end, meaning that we didn't write off his. Maybe not many people came and said they were not gonna be collectible as we thought. Therefore, in order to get this 15 3 up to the 50 we would do a subtraction problem. And the difference being 35 1 37 is what we would need in order to bring that amount up to the estimate of 50,000. So if we posted this so if we took the 15 1000 minus the 15 3 we come up with the 35 1 37 So now if we post this out, then were crediting the 35 1 37 to the allowance. So that's gonna take the 15 3 up by 35 1 37 to the 3 50,047 which matches the 3 50,047 here . Then the other side is finally going to go to the bad debt expense. So now we're gonna debit the bad debt expense by the 35 that's gonna bring it up to 35. And then if we look at what the effect is on net income. We're gonna say of this revenue here, 35 of it, we believe, is going to be uncollectible, meaning we're never gonna get paid on that. And we make that estimate kind of liken adjusting entry as of the end of the time period so that as of the date when we create, the financial statements were showing a a net income of the 3 42 8 63 instead of the 3 78 So we're recording the fact we're representing the fact that of these sales, we believe this amount is going to be uncollectible on the balance sheet side were also saying, Yeah, we have revenue. We have receivables of one million won 46 3 However, we believe, based on past experience, that 4 50,037 will be uncollectible. We want to disclose that to the readers. We want to be as fair as possible and not be overstating our value. However, it's also just an estimate and we could collect more. We could collect let unless that's our best guess. So we are now able to define the allowance method record transactions related to recording bad debt, recording a receivable account that has been determined to be uncollectible recording receiving account that has been collected after being determined to be uncollectible. 7. 60 Allowance Method VS Direct Write Off Method: in this presentation, we will take a look at a comparison between the allowance method and the direct right off method. When considering both the allowance method and direct right off method were considering the accounts receivable account. Remember that the accounts receivable account represents money that is owed to the company , typically from sales made in the past. On account haven't yet received the funds for sales made in the past and therefore the company is owed money. We see this amount on the trial balance. In this case, one million won 91. We then want to know information about that, including who owes us that money? We can't find that typically in the G l, as we have a geo for every account that geo only giving us the information by date. Typically, we want to see that information also broken out in the subsidiary Ledger saying Who owes us this money? A problem that we have is that the accounts receivable represents funds we have not yet received and may not receive. If there is some problem with some customers, we might not get the funds. The question then is, should we be writing off this amount at the point in time that we believe we're not gonna be able to receive it. Should we be estimating how much we think is not gonna be collectible or waiting until the end of the time period until we determine that something will be uncollectible? That generally accepted accounting principle the principle that we should typically be using if, under Gap Channel accepted accounting principles would be an allowance method, meaning that we would be writing off or matching up with the accounts receivable and allowance accounts. That would be an estimate showing us what we think or believe based on past experience will be uncollectible on the balance sheet and that would write down the accounts receivable and not overstate the accounts receivable. And we would also be writing off the bad debt expense then at the point in time to match it up with the revenue at the same point in time. The other method is gonna be the direct right off method which, typically, if not a general accepted accounting principles method, unless the amount of the uncollectable receivables is substantially small and therefore not material to decision making. Otherwise, if we're if we're a smaller company and we're not publicly traded. We may not have to be regulated under the same type of rules and may not be restricted to the method we use and therefore we need to make a decision. Do we want to use one method or the other? The direct right off method has the benefit of typically being easier to use because we can just wait. There's no estimate happening. We can wait until we believe something is not gonna be collectible and then write it off. I note that that does distort the income statement in some ways because we're writing it off at a later time period and therefore not matching it up with the revenue earned in that time period. It also gives us an ability to distort net income in some ways because we can make a decision at the end of the time period to write it off or not. Maybe we wait until the next year or not, whereas if we use an allowance method of estimating method, then we have to make some type of reasonable estimate eso those going to the pros and cons between the book. The two methods will go through and look at them both. So here is gonna be the direct right off method where we are going to say that this customers not going to pay us 9000 that we've determined it at this point in time and therefore work a debit bad dead expense and credit the receivable at this point in time, the difference here being the bad debt expense which brings down net income at the time when we determine its uncollectible. If we post this to the General Ledger, we're gonna say that bad debt is going to go up from zero up to 9000. By this debit, that 9000 then represented here on the trial Mallon's the accounts receivable is gonna go down because they don't always any more money or we've given up on it. The receivables gonna be credited. Here's the G l account 1,200,000 going down by the 9000 to 1 million won 91 that then being represented on the trial balance as well. We can see that on the trial balance that we have the return of the revenue is now going down by the bad depth. The net income then being decreased. At the point in time, we determine that the bad debt would be uncollectible. We also want to see that the information that would back up the accounts receivable that would be on the accounts receivable. Subsidiary Ledger Here's the C W company owned US 9000 Were writing that off, bringing the balance down down to zero after that point in time after we write this off. So now it's down to zero that would be owed to a certain Remember that the Subsidiary Ledger would include all people that always money all companies in people and that always money. And if we added them up, it would tie out to what is on the trial balance as well as what is on the General Ledger. If we contrast that to the allowance method, we have the similar journal entry decreasing their receivable here but the other side not to go into bad debt but instead go into the allowance account. So now we have the same accounts receivable result. It's starting at 1,000,200 going down by 9000 to 1 million won 91. However, now we're using this allowance account, which we weren't using before. We just had it as a demonstration, and we had already estimated that there's 40,000 that was made in the prior period, the prior year or the prior month that we rode off in the prior period to match it up to the revenue in that period. And we created this allowance account, and now we're just gonna write down that allowance account no effect down here to bad debt at this point in time, no effect in that income. At this point in time, we at the end of the period will make an estimate based on the revenue and or the accounts receivable to determine how much of this revenue we think is gonna be uncollectible and therefore be matching up with the matching principle. So in this case, when we write it off, there's no effect on the Net income accounts. It's just affecting this allowance account, which we had set up prior, and we still have the decrease from the 9000 down by the 9002 0 in the accounts receivable . Same activity in the trial balance. I mean, the General ledger in terms of accounts receivable back to that one million won, 91 1 million won 91. If we take a look at a side by side comparison, here's the bad debt. Ah, the direct right off. And here's the allowance method. So here we're not using the allowance account into the direct right off method. It's just there to show what account would be used under the allowance method. It's not being here used under this side. The direct right off it is being used over here. We can see that we have the one million won 91. Nothing in the allowance it's not. It's not a relevant account under the direct right off method. Over here, we still have the one million won 91 but we have this. 31,000 which was there prior, was created prior to this time period when we wrote off the bad debt related to the prior time period. So this 31 is still left over that we think could be uncollectible or become uncollectable at some point in the future. Based on an estimate on the income statement side, we decreased net income by that 9000 so they 3 78,000 minus. This 9000 is the 3 69 on the allowance method. Know right off the bad debt. At this point in time, we won't write it off until we make an estimate at the end of the time period based on either revenue or our accounts receivable. Next transaction, G company payment 20,000 of 30. This is gonna be the direct write off half of this. So we're looking at the direct right off. We're going to say that we did get cash, so we debit the cash, it's increasing. Then the accounts receivable is going off the books for the 30,000 the entire amount owed. We're not going to get the added 10,000 the difference. Then it's gonna be the 10,000 we have to put it somewhere. This will be the difference between the two methods. Under the direct right off method will write it off to the bad debt expense under the allowance method. Asked me, We'll see in the next slide, it would be going to the allowance for doubtful accounts. If we record this, then cash is gonna go up to 100,000 plus the 20,000 to 120 we can see the accounts receivable is gonna go down. We're at 1 1,000,091 down by the 30,000 to 1 million won. 61. This matching up with what's on the trial balance down the one million won 61 the 120,000. And then we have the bad debt, which is going to go from the 9000 up by 10,000 to 19,000. That, of course, over here on the trial balance as well. Note that we are increasing that debt expense at this point in time. That being the difference that then affecting net income net income going down. We also want to remember that we will be recording something to the subsidiary Ledger. This company, this particular company owes us 30,000. We're gonna decrease it down by 32 0 Meaning they're not gonna always anything anymore. Even though they only paid us 20. We're not gonna leave the 10 there that they still owe us. We gave up on it and therefore are gonna write the entire thing out down to zero, contrasting that with the allowance method. We still got the cash we still got the receivables going down to zero. But instead of the 10,000 going to bad debt now it goes to the allowance for doubtful accounts. So we have the same effect on the accounts receivable. One million won, 91 down by the 30,000 to 1 million won 61 Same effect on the allowance for same effect on the subsidiary Ledger, the company going down to zero in terms of the subsidiary leisure 30,000 minus the 30,000 20 The difference being that there's no impact on the income statement. Bad debt not being affected, no effect on net income. What is happening is we have this allowance account which was at 31 prior to this now going down by that 30,000 to the 21. Remember that this 31 was there prior to this time period. It was their created from the prior time period based on an estimate, and we created the bad debt expense based on either the revenue or the accounts receivable . And then we closed it out. Of course, that's why there's nothing in bad debt expense because it got closed out the end of the year or the end of the month and therefore is at zero. And we're writing off the uncollectable receivables here that has already hit the income statement in our estimate. We estimated it prior to this wrote it off in the prior pine period. It then rolled into the capital account in the closing process and therefore is not on the income statement for this time period. And we're just writing off the bad debt to the allowance account. We will have a bad debt won't happen, However, until we make an estimate at the end of the time period. If we compare and contrast the two, then this is the bad debt. This is the allowance method. This is this is the director head off method. This is the allowance method. We have no allowance for doubtful accounts is just there for demonstration. We're not using it under the direct right off method. We have 19,000 of people that we have determined will not be collectible and therefore wrote them off decreasing net income. By that 19 the 3 78 minus the 19 bringing net income to net income of 3 59,000 we have the same receivable over here. But then we have the S allowance account. It's now going down to 21,000 because that's where we rode off the people that we have determined that would be uncollectible new effect on bad debt expense. No effect on the income statement from writing off these accounts thus far. Next one, we're going to say to receive payment from C W. After writing it off. So this is that unusual one. It doesn't happen all that often. Real life. We're gonna first take a look at the direct right off method. This is really good example problem, though, because it allows us to see the difference between the two methods. And what would happen if we if we had to reverse our right off. And so it makes us think kind of backwards, which is great for testing and our knowledge on this type of stuff. So we wrote CW off. We said, Hey, they're not gonna pay us to 9000. And then they came in, even without our collection actions. We gave up collecting the money and they came in and paid us, and that's great. So you would think that we were debit, cash and credit, some other account. We couldn't credit accounts receivable because we already wrote it off. We wrote it off in this case under the direct right off method to bad debt. So you would think we can just debit, cash and credit bad debt, but if we did so, we wouldn't have it run through the receivable account. And if we looked at the at the Receivable subsidiary Ledger, it looks like this 9000 is due to them not paying us. And we want to show that they did pay us. And therefore, under either method, we do need to reverse what we did prior to give us a paper trail that this client is good. So therefore, we're going to reverse what we did last time under the direct right off method. We credited accounts receivable and we debated bad debt. We're gonna reverse that. Gonna put them back on the books, increasing the accounts receivable looked by the 9000 decreasing bad debt. Unusual account here, bad debt and expense typically only going up with debits. This is an exception to the rule. We are reversing it under the direct right off method. This being the difference between the allowance and direct right off under the allowance method, this would be the allowance for doubtful accounts account. Once we do that, then we can just do our normal transaction. That would happen if a company came in and paid us on account. Debuting the checking account, increasing the checking account, crediting accounts receivable, decreasing accounts receivable. Note between these two journal entries. Here's accounts receivable. Here's accounts receivable. Debit credit doing the same thing. If we eliminate those two were left with a debit to the checking account credit to bad debt so we could shorten this from just a technical standpoint to just this with one journal entry. But that doesn't give us a good paper trail. Therefore, we don't do that. So we both this and we're gonna say accounts Steve was gonna go back up by the 9000 Teoh this and then we're going to say that the bad debt is gonna go down here is the 9000 here. We're now eliminating it, and that brings us to the 10,000 down from 19. And then we have the cash account which is going to go from 120 up by the 9000 Teoh 1 29,000 And then we're gonna have the second component, which is gonna be this item here, the accounts table going down, bringing the one million won 70 down by 9000 to 1 million won. 61. That's where we're at now on the accounts receivable in the trial balance. And then we got the subsidiary account and thats went from zero. It's going up by 9000 to 9000 and then we're taking it back down again, down by 9002 0 So the accounts receivable subsidiary account went from, uh, 9000 credit back to zero. Then we debated it by this 9000 here, bringing it back up to 9000 and then we credited it by 9000. This looks really repetitive because it just this is where we started and then it went up, and then it went back down. But this gives us a paper trail. This item, if we were to drill down on it, would show that we got paid here. Whereas this item, if we drill down on it, which showed that we gave up on the customer. So that's the important difference between reversing this rather than just recording a debit cash credit toe that dead expense. If we look at the allowance method, same type of activity, we're gonna reverse what we did. And then we're gonna record the normal transaction. The only difference here being this item. When we first recorded the right off, we debated the, um we debited with the allowance for doubtful accounts and credited the receivable. Now we're just reversing that. So we debit accounts receivable, just as we did under the direct right off. But instead of crediting the bad debt now crediting the allowance, just reversing it, then we're back in good standing. And we could do the same thing that we did in the direct runoff method or the same thing we would always dio when we receive cash on account, debit and cash and increasing cash and decreasing with a credit accounts receivable. So note here no effect on the net income. The allowance account then is gonna go back up from 21 up by the nine Teoh the 30,000. And that's because, of course, this individual did pay us. So we're not taking it. Taking that down the accounts receivable. I count on the General Ledger, went back up and then went back down so we could see it just went up down. Same thing. We put it back in and took it back out. If we look at the C W account here, this is where we started. Same thing his subsidiary Ledger account for this customer goes back up by nine and back down. Everything is the same, except for this allowance account being the reversing account were using, not affecting the bad debt expense. And the way to think of this is just the thing about what did we do before and reverse it. If we look at the comparison, here's the direct right off. Here's the allowance method. Direct right off. I'm showing the allowance account here, but it's not used. It's not being used here, So that's why it's red. It's not gonna It's just a place holder, and what we did was change the bad debt expense to write off or reverse what happened and then record are normal, increasing the checking account and receivables. Under the allowance method, we have the same thing except no effect on bad debt. The adjustment that happened happened here in the allowance method, increasing that allowance back up. We will have the bad debt at the end of the time period when we make an adjustment under the allowance method. These will be the major differences when recording the normal transactions for a an individual or customer that is determined to be uncollectible and when they pay us after we wrote them off going forward. The allowance method will then have an adjustment in order to record the allowance for doubtful account based on either the revenue method here in terms of how much revenue was earned, taking a percentage of that to determine what the bad debt would be matched up against that revenue. Or use a balance sheet method, taking a look at the accounts receivable and determining how much of the receivable is gonna be uncollectible. Either way, it's better in terms of the matching methods. So the next step on the allows method would be to determine in some way what the bad debt expense is not in the case, not buying knowing or finding out who is not gonna pay us this time period from sales made in the past, but instead making some type of estimate in terms off of this revenue made this time period . How much of it will not be paid, thereby matching up the expense to the related income in the same time period? That estimate once again could be made either by looking at revenue, taking some kind of percentage or some type of estimate based on the revenue earned this time period this month this year. Or look at the balance sheet account. And seeing how much of this we believe is gonna be uncollectible. That then get into the same number of bad debt but doing it in kind of a reversed type of way. Whatever we discern the type, decide it's uncollectible. Whatever we have to adjust this allowance account to be, the difference will be the bad debt expense here that will be matching up revenue and expenses 8. 70 Allowance Method % Accounts Receivable vs % Sales Method: in this presentation, and we will be taking a look at the allowance method four accounts receivable, focusing in on the calculation of the allowance for doubtful accounts. There are two methods that can be used in order to calculate the allowance for doubtful accounts accounts one being the percentage of accounts receivable. The other is the percentage of sales we will take over. Get them both and look at the pros and cons of them. First, we're gonna look at the accounts receivable method. We're going to start off with the percentage of accounts receivable method for a few different reasons. One. It's the one that's most often tested. And two. It's the one that maybe most often used in practice, often making the most sense to people that are looking at the two methods. It's also a bit more complicated. So when we're looking at test questions, they typically would focus on this method in order to have a bit more complicated process to do the calculation. It's important to note, however, that there is another method that's gonna be the revenue method or the percentage of sales method that we want a beautiful compare and contrast those two, we can ask a lot of theory type questions in terms of what are the pros and cons between the two methods. And there are pros and cons between the two methods. Remember that the overall goal here is to say, this is our accounts receivable account. We're recognizing that there's gonna be a significant amount of these receivables that will not be collectible. And therefore, we need to tell our reader that we need to tell a reader that for two different reasons one being a timing issue which is gonna be on the income statement and the other being a balance sheet issue a point in time issue, which is the balance sheet on the balance sheet side, which is where the accounts receivable method will be focused. We have this receivable, this asset on the books showing that people are less this amount of money and we're telling people the reader of our financial statements. Hey, look, we're gonna get this much money and therefore, you know, make decisions based on the money we're going to receive on these financial statements. However, we know that we're not gonna get some of it, so it's our responsibility then to show our reader Hey, look, based on past experience, we believe that this amount is not gonna be collectible. That's gonna be one objective of the method here. Either method is to show the allowance for doubtful accounts, which will match up against the accounts receivable accounts receivable. Being a debit here, the allowance being a credit, that difference between the two, the net receivable, the amount that we actually believe that we will collect based on prior experience. That number then, should be more accurate in terms of what our true assets are in the company, as we do. This will also be looking at the income statement side and writing off the bad debt related to the revenue. And this is the part that's a bit more confusing when using the accounts receivable method us than focusing in on the balance sheet, focusing in here on what we think is uncollectible. The byproduct of that tends to be what the bad debt will be, but they're both important because the bad debt is going to be an expense related to revenue happened in the same time period that will be decreasing the net income for the amount of this revenue during this month this year that we think is going to be uncollectible based on past history. This concept, the income statement concept, makes more sense when we look at the revenue method, which will take a look at later that method, then focusing here on the bad debt and matching principle of the current time period. Whereas the allowance method tends to focus more on the balance sheet, where we are to a certain point in time, how much of the current receivables are uncollectible under the balance sheet method? There's a couple different ways we can do this, but what we need to do is just them. How much of these receivables are not going to be collectible? One common way to do that is to look at something like an aging account and try to a list out these receivables in terms of how old they are and then go through past experience and say The older accounts, of course, are less likely to be collectible and try to figure out some type of percentages that would be reasonable. That would be uncollectible based on past experience. So if we say that, here's our total. Here, here's our total. We're gonna break that out between 30 between 30 and 60 60 and 90 and over 90 days that something is either current or or still do within 30 and in 30 and 60 past due in 16 90. Some type of break out in terms of time frame that we believe these accounts are past due by and thereby not judging people based on who the customer is, but just by how old the accounts are as to whether they'll be collectible or not noticed. We don't have any names here. We're just recording them in terms of how old they are. So if we take this and we say Okay, if we go through all these accounts and we were able to break this out and of course software can do that's very easily for us. Give us an agent account. We're going to say that 30 with either current or past due for 30 days, are going to say it's his current, I guess, and then we're gonna say between 30 and 60 this is how much of this amount this one million won 46 3 belongs here 60 to 90 were saying is this amount of here of the accounts receivable falls into the 60 and 90 range. And then over 90 days past due, we're gonna say it's the 22 9 26 point being is that we broke this out. If we add up the 9 17 40 the 1 71 9 45 in the 34 3 89 and the 22 9 26 we get to the total one million won 46 300 broken out in terms of how old this debt is, then we're going to come up with some type of reasonable estimate based on how old the debt is to calculate how much will be uncollectible. So if this is current, or if this is 30 days past, Dio, we're going to say that 2% of it, we think it's gonna be uncollectible. If its current, then we're saying not very much of it will be uncollectible. We're hopeful that we're gonna collect most of it. So we're gonna say that of that, the 9 17 40 times 2% is 18 3 41 between the 60 and 90. How old that the aging is we're going to say, Well, these are a bit older and therefore we're gonna say that 4% is not collectible because we haven't been able to collect it yet. We're past the collecting date due date, and therefore we're going to say that 8 6078 is going to be not collectible. And again you could ask, Well, where do we get this? 2% in this 4% it's an estimate. We have to come up with some reasonable estimate based on past experience and or industry standards, and then we're gonna see. Of the 3 34,089 10% is uncollectible based on past experience industry standards, though, So this times that equals the 4 3039 and over 90 we're gonna say it's very unlikely we're gonna collected. And so if we take the 22 9 26 times in 95 we get the 21 7 80 Now you might be saying, Well, you know, you can question these percentages or what dot but they would be based on industry standards past experience. They should be reasonable in accordance with the industry, based on past research if we then had these up 18 3 41 that 6008 78 4 3039 and the 21 7 80 we get to the 4 50,030 seven. This number, then, is what we believe of this number receivables. People owing us money will not be collectible. We don't know who know names here. We just know that we believe that that much will be uncollectible. It's a complete estimate, and this is kind of disturbing to some people. They say, Well, it's just a estimate. Um, and we don't really know. There's no certainty. However, it's more reasonable to do this. We This is obviously a very significant number on the receivables. We need to tell our reader that people owe us money because that's important to decision making, and we can't wait until people don't pay us. That would be unfair to readers of the financial statements, because we wouldn't be matching it up at the proper time period. We be overstating the receivable, so although this is an estimate, it's much more fair representation as long as the estimate. It's fair than either not recording receivables or not recording how much we believe it's gonna be uncollectible. So we have to come up with some type of reasonable estimate in order to make them as fair as possible. Now, Newt, that under this method, there's already something there in the in the allowance account. So we can't just use this number to make our journal entry. We have to determine what we need to do in order to make this account that number. We want to make this number that number. So we can't just use what we came up to here. That's common error on test questions. To use this number in the journal entry, we have to do a subtraction problem. Why is there something here already? Because it was just an estimate from last time period and it's never gonna be exact. It's just a estimate. So we're just updating what this allowance account should be based on our our best guest. We think it should be that therefore, the adjusting entry. If we take out the trusty calculator, it's gonna be the 4 50,037 minus the 15 300. That's how much it needs to be increased by now. It's possible for this account before we start to actually have a debit balance. And why would that happen? That would mean that in the prior time period, we estimated that we had so much that would be uncollectible and mawr happen to be uncollectible than we had estimated, flipping this account to a debit balance. That doesn't happen too often. But if it does, and we need to get to this 50,000 and this was a debit, then we would have to credit it by something to get it back to zero and then add another 50,000 to it in the credit direction. In other words, if this say was a debit balance of 15,300 we have to take the 15,300 plus the 4 50,037 Do you get it to the credit balance of 4 50,037? If this is a credit balance, then that means that we had less people that would actually be uncollectable in the prior time period. Then we had estimated probably the normal case, that being the normal case and therefore we have to do a safe traction problem in order to get this up to 50,000. We need to increase this in the credit direction. So if we record the journal entry, then we're gonna record the bad debt expense A dead it here. And we're gonna record the credit of that 3 35,078 Here we see that recorded out. Then we see that the 35 3 78 and that amount is gonna be on the allowance account, bringing the 15,300 up by the 35 3 35 1 78 to 50,004. 37. That then, on the trial balance on the bad debt, we'll bring the balance up it started. Actually, it started at zero here. Should have started at zero up by the 35 1 37 to the 35 1 37 That amount here. Now note. What's happening here is we are recording on the revenue side the expense bringing down net income. So this is the point in time that we bring down net income and this 35 1 37 should be matching up to this revenue account. It's less intuitive here to know that that's the case. but by us making the accounts receivable correct in terms of the allowance account than the other side of it should be matching up the revenue and bad debt. This will be more apparent when we focus on this side and focus less on the balance sheet in the sales method. On the balance sheet side, under the allowance method, it seems very straightforward and very useful, the balance sheet being as correct as possible by us looking at the receivable, analyzing the receivable in a logical way, determining how much of the receivables that are due to us will not be collectible 4 50,037 and then showing that on the financial statements. So the reader could say Okay, this is how much is owed to the company. This is how much they believe is not gonna be collectible based on a reasonable estimate of this number, and therefore, the net of those two is how much we are going to collect. This makes good sense under the receivable method, this side is more confusing under the receivable method, cause we're not focused in here. So now we'll look at the other method, which is gonna be the percentage of sales method. And we're just gonna focus then on the receivable side again, not showing as often because one it's an easier method. So therefore, textbooks don't focus on it to Ah, lot of people probably intuitively look more on the balance sheet here and have the income statement kind of full out. That kind of say, If I if I make the balance sheet right that make the receivable in the allowance method right, then the the income statement will fall out and it'll make itself work and whatever problems will happen, well, then roll out into the equity section after we close out the temporary accounts and will be good going forward. So probably most people focus more on making the balance. You correct. But this is gonna be a valid method to the sales method, and it focuses more on the income statement showing the income statement, analyzing the income statement accounts and making sure the bad debt is right and letting the allowance aside fallout and just be correct. Now, one way to do it, a simple way to do it would typically just be. Let's take a look at the revenue and take a look at a percentage of the revenue based on past experience that we believe is not gonna be collectible now. Ah, lot of textbooks will basically say Ah, in practice. Say, we need to look at the revenue on account. We need to look at those sales that we made not for cash sales, but sales on account or the text might just say that we make all sales on account and therefore we can take the entire revenue amount. So that's gonna be a slight different that you might see based on different textbooks or different situations in real life. How would you want to do it in real life? You probably want to look at those sales that are on account and then try to like it past history and see of the ones that were made on account, meaning we didn't collect sales revenue at the time of the sale. We collected it. We're gonna collect it and some other point. Therefore, it's in receivables. So how much of those sales that we make on account where we don't collect cash at the point of sale? Do we think our uncollectible based on past history And then if we say that it's 3% we're gonna just take that member of the 3 78,000 times. 3% 30.33% 0.3 gives us the 3 11,040 that's it. That's straightforward calculation. And we're going to say that the bad debt then should be that number. So the bad debt, it's gonna be the 11,340 then the other side just falls out. We're not focusing on the side here. The allowance. We're just gonna make it Whatever it needs to be in order to make what we think are bad debt should be in order to have a correct matching principle for this time period. So note here that we're focused on this number and we're really making net income as accurate as possible by focusing on this current revenue, whereas when we focus on the accounts receivable, we're really focusing on things. Everything that's happened up to this point in time, where we stand at this point in time and therefore when we used the allowance, the accounts receivable method were kind of fixing possible errors that might have happened in the past and re looking at everything that's happened in the past to make receivables correct and this number than falling out on the income statement side. We're focusing on this time period only, and the side that falls out then will be the balance sheet side. So this would give us more focus. And it's easier to see in this method that we are indeed following the matching principle. We're trying to look at this current revenue and see how much of that current revenue is not going to be collectible based on some type of reasonable estimate and therefore right off the bad debt. Not bad debt for sales made prior period prior month, prior year. But the sales that were made this year, that's gonna be the point, and therefore net income for this time period, we would think is as accurate as possible note. However, it still achieves that the goal of making the allowance account what we think it should be . It just falls out differently if we did this correctly throughout the entire period than the allowance accounts should fall out correctly and be correct as well, meaning the accounts receivable. What is owed to us minus investment. What we think is uncollectible should still give us a reasonable estimate of what the Net receivables should be. We're looking at a comparison between the percentage of ah accounts receivable and the percentage of sales method note that they're almost never gonna be the same. So we didn't make an example where they happen to come out the same here because it just doesn't happen. Typically so And here we have a different type of allowance account under the two methods, um, and and it could beam. Or it could be less. Just depending on what, What time? Period? We are using eso. In other words, the allowance account here could be higher or lower. Under the accounts table method versus the sales method point being, it will typically be different. And the bad debt, same thing. It will typically be different. Under the two methods, it could be higher. It could be lower depending on what our focus has under the two methods. So notice they are estimates these air both gonna be estimates. They're not going to be perfect. And but they are better than not estimating there better than waiting until this is gonna be uncollectible and therefore better than not showing the accounts receivable at all, because the reader's tip riel obviously want to know what the accounts receivable is, how much is owed. And they want some type of estimate of what is not gonna be collectible. Also note that once we have a method here because we are using some type of estimating method, we want to be consistent with that method so that we have comparison from time, period of time, period. So if we're using a percentage of accounts receivable, we typically want to use that next time period next month, next year as well. We're using a sales method. We typically want to be consistent. Our goal here is to have consistency is to have a matching principle that we could compare time period to time period going forward. 9. 80 Notes Receivable: in this presentation, we will take a look at notes receivable. We're first going to consider the components of the notes receivable, and then we'll take a look at the calculation of maturity and some interest calculations. When we look at the notes receivable, it's important to remember that there are two components to people to parties, at least to the note that seems obvious. And in practice it's pretty clear who the two people are and what the note is and what the two people involved in the note our doing. However, when we're writing the note or just looking at the note as 1/3 party, that's considering the note that has been documented or if we're taking a look at a book problem, it's a little bit more confusing to know which of the two parties are we talking about who's making the note? Who is going to be paid at the end of the note time period? We're considering a note receivable here, meaning we're considering ourselves to be the business who is going to be receiving money at the end of the time period, meaning the customer is making a promise the customer is in essence. We're thinking of making a note in order to generate that promise that will then be a promise to pay us in the future. So in essence, you can think of a note as a type of promise. We are the business. In this case. We're providing a service, and therefore the customer is making a promise in order to pay us at one. At some point in the future, we're asking for a bit more commitment of the promise than we would typically have under an accounts receivable situation. And typically the reasons for that would be that the amount of the sale was greater, possibly so. The bigger dollar amount that we want a formal, documented promise to pay us and or we're gonna charge interest on on the loan that we're making here. Now, remember that although we're thinking of it as a promise from the customer, it's probably the case that we asked. The business who deal with these type of documentations and promises all the time are probably the one that are going to generate and print out the formal type of documentation as part of our business that the customer can then sign as the promise to pay in the future . But from a conceptual standpoint, we can think of it as the customer, basically documenting or making this filling out this promise in order to pay us in the future. Couple critical components that will typically be, in any note receivable, even a fairly simple note receivable, which we will typically have documentation for and have a formal written document win. It's a larger dollar amount, and we're charging interest. There's a larger or longer timeframe involved than the normal 30 days or 60 days, possibly of an accounts receivable. So we're typically gonna have the amount we're gonna have the amount of the note. That would be if we sold something as the business. Then we maybe had a sticker price of whatever we sold of $1000 therefore our are owed $1000 . There's gonna be a promised by the customer to pay us for what they purchased. Then we're gonna have the date of the note. Typically, the date that the transaction happened purchase happened, then we're gonna have the due date, and oftentimes the due date is gonna be written something like this. 90 days after date of note, I promised to pay to the order of and then we'll have the name of the Payeasy, and that's for a couple different reasons. Note that this isn't just doesn't just have a date at some point in the future. Typically, a lot of times the note will be written in wording such as this, and part of that could be that it it makes it easier for us. If we're the business who are generating this note for the customer to sail and we do this often, then it could be a pretty standard way for us to just say 90 days from any point of the date of the note. And that makes it easy for us to make, like a template to make the note. But for any in any case that the terminology will off to be like 90 days, 30 days 120 days for the note, we're gonna be dealing with notes here, typically, ah, shorter terms, meaning less than, ah year when we're considering the notes that will be working with now, it's important to keep straight that they pay ee, as you can see from the wording of the note is who we are promising to pay. So that's in essence, us. That's the business. That's who we're going to get paid at the end of the time period, the principal amount plus the interest. So the other component then will be the interest. We're gonna pay 1000 and dollars for value received, with interest at the annual rate of 10%. So that's how much is going to be paid. Note. How much is going to be paid then in terms of two components? One the principal component. This is kind of like the loan that we gave. We didn't give him alone in dollars. We didn't loan out the dollar amount, but we sold something with a sticker price of 1000 didn't get paid yet at the point of sale and therefore are, in essence loaning this money, renting the money out to the customer. And we're gonna get paid that money at the end of the loan term 90 days typically greater than a normal accounts receivable term, and we're going to get paid interest on top of the loan. Note. What's not being said here if we don't have an official in date. We have 90 days from the due date, so we'll figure out when that will be. When is this actually do And we don't have the actual amount that we're going to get. We know we're gonna get $1000. That's the sticker price. And then we gotta figure out the 10%. This is typical and many notes. So if you read a note, often times it's not gonna give you liken amortization schedule or an interest type of calculation not required to have that in the note because you can figure it out and eso oftentimes it's not included, but you're probably gonna want to figure that out, and we'll take a look at that. We'll need to know that in order to make the payment at the end of the time period, and then we've got the maker of the note, and remember that is gonna be in our case, the customer were imagining the customer is the one that's making this promise. So that's the thing that's often confusing. When we think about these notes, who's who? It seems obvious, but it could be a little bit confusing in terms of who's the pay ee And who is the maker? Although we as a customer when we go and finance something, don't think of ourselves as writing out this little promise. But you can think of it as making this promise as if we're riding this out. We're saying, Hey, give me a piece of paper. I don't have the time right now. I don't have the money right now, but my you know my word is good. Give me a piece of paper and I'll write out your little promise. Little formal promise here, Right here is the date. Here's the amount I promise to pay it within 90 days. And I promised to pay you not only the principle, but 10% interest for giving me the service of loaning me this money for a certain time period and then the person making the promise. The customer in this case, the maker, signs the note. Of course, in practice, the person who has this document made formally made would probably be the business than being a person who is used to making this documentation, then allowing the customer to read it and go through it and sign it as well. So if we look at the components, remember that the principle is up here. We were gonna break out these two components of the payment of the note at the end of the time period in to pump components one the principal, the amount of the original loan to the interest. Then we're gonna have the due date, which is here 90 days from the date of the note, which will have to figure out Well, when will that actually be? Then we've got the pay ee who's going to be paid at the end of the time period. It's going to be paid the 1000 plus the interest. Who's going to get that payment at the end? We have the interest rate in this case being 10%. And the maker of they note the person who signed the note, the person who made the promise for the note. Okay, so then we're gonna figure out the maturity date. This can be a little bit more confusing than you would think, because if we're saying it's a 90 day note and that were saying that due date was 1 15 Well , we really gotta think Well, now I mean, each month has a different number of days in it. So it's actually a bit a little bit confusing to go through and figure out when the actual date of maturity is. And this is actually a common problem. Of course, the computer can help us out well when we generate this and will typically give us the duty because it could be computer generated. But note that when you're working problems and when you're figuring this stuff out when you're trying to just say from what's 90 days from this due dates, it's a little bit more confusing than you might think, and you want to have a system. If you're doing a test question, T be able to figure that out. And if you're in a system where you're figuring this out all the time, you know, have some computer I system or just note that it might be a little bit more confused that he would think at first so we can think about that by saying that, Okay, we're gonna count up. 90 days is about 30 days in each month, but it's starting on January 15th so we could start off with a kind of a little subtraction problem. We can say, Well, there's 31 days in January and we know that the note date is as of the 15th so 31 minus 15 means they're 16 days left. Now, be careful because it depends on whether or not we're gonna be counting the day of the note term like this 15th day. So the question is, does that count in the in the term of the note and you're gonna have to be kind of careful on that. So if you're off by basically a day of a problem of a computer problem or something like that or on multiple choice problem, it may consider the fact that, well, is this 15 day included or not? If it is, then we'd have to add to that one more for this day, for the 15 were taking the difference between the 2 31 minus 2 15 which would start at the 16th. You can count on your fingers or at 16 17 18 up to 31 16 days. Then we can count up from there were No, we're doing around three months because it's 90 days. So we're gonna say the days in February. We're gonna say it's 28 in this year and then we're going to say the days in March are 31 and then we're going to consider what we need to be at 90 days so we can just figure out where we're gonna live in. At the end of this, we're going to say, Well, 16 days engine that are left in January plus 28 days plus 31 days. That gives us 75. We need to get up to 90. That's not going to complete a full another month. So how many days then are we gonna need in April, it's gonna be 75 minus 90 or 15 more days. So this last piece, we're gonna say days in April or the due date is going to be April 15th. So, in other words, if we calculate this one more time, we're going to say we have 16 days in January, plus 28 days in February, plus 31 days in March. Quest. The 15 days, 15 days in April, and that gives us our 90 days. So that means the due date is gonna be here on April 15th. So just be aware that due date calculation can be a little bit tricky. Okay, so when we record the note, it's a pretty easy thing to do to record the note, but often very confusing for people. When you see this, now you see this. Know what you say? You know, man, there's there's a principal amount. There's an interest rate of 15%. There's the 90 days of the due date. And so what? You would think that when I record the note, it's gonna be a fairly confusing, But really, when we record the note, all we need is this 1000 and so it's deceptively easy. Teoh record the note, The interest of the note and the due date doesn't come into play until time passes. We haven't earned any interest as of the day of the note. If we sold something for $1000 they gave us a note saying they will pay us in the future, then all we have to do is record the note. At this time period, interest accumulates as we basically rent them money. It's it's rent on the money, so we have no rent on the money when we just gave the note. Set a record. The note. If we sold something for $1000 we would just record the sale of $1000 and then we debit instead of accounts receivable notes receivable. So note it doesn't matter. All this other stuff like I don't need any of this stuff. All I need to know that there's a note. $4000. I don't need to know the interest rate. I don't need to know the terms. I don't need no any of that in order to record the note. So just be aware that you can be really confusing because of too much information to put the note on the books now. Of course, if we made a sale and we sold inventory, we would have the other side of that cost him good sold and the inventory going down. But so this is the same transaction. Just look, This should look familiar for us making a sale on account instead of having accounts receivable, we're now having notes receivable. Typically, because the amount of the note is a larger dollar amount, we want to charge interest on the note. Typically, the term of the note being longer term and therefore having a formal written document. We then will be tracking it not in the subsidiary lecture for accounts receivable, but in a separate note receivable and tracking both the principal and the interest. So same transaction, just replacing accounts receivable with notes receivable and pretty straightforward transaction. Then when we're gonna calculate the interest, we're gonna have to figure this out so that we know how much is going to be paid to us or due to us at the end of the time period. So note at the beginning of the time period, there's only $1000. Do us and that's it. Me. There is no interest yet. There's no interest until time passes after time passes. Then they're gonna os the interest because we rented them money and they have to pay us rent on the money. It has interest on the money. So how much they're gonna have to pay us because of the rent on the money. We'll figure that out. How we got $1000. The interest rate is 10%. So 1000 times 10% and rember fits and a calculator. We're gonna say 1000 times 10000.1 or 10% 100.1. If you move the decimal over to places is 10% that's $100. So that kids, that's the $100. And then I typically think about it this way. Remember that this interest and we'll go over this and more depth later. We'll figure out different ways to calculate the interest. But interest is for a year. So it says it here an annual rate, even if it doesn't say annually. Whenever we thought. Think about interest. We think about it in terms of a year. So just we have to understand that whenever we talk about interest we talk about in terms of a year. Even though the note term is rarely for one year, it's often for a series of months, and we'll have to then break out this interest amount, which would be for a year if the note was out for a year into some monthly amount. So in order to do that, one way to do that is we can take the days in a year are 3 60 and we could take that $100 divided by 360 days or it doesn't come out even and we'll have to deal with this. 3600.2777 right? And so that's gonna be the amount. Now, where did we get the 3 60? There's 365 days in a year. Typically, we're gonna use it a rounding a number to make this an easy calculation for simple interest . Meaning we're just gonna take 12 months times an average of 30 days in each month or 360 days. And they don't give us a nice even way to calculate this simple interest that will be calculating. So once again, we have $100 divided by 360 days in a year. That's about 28 cents per day if we round it. So 28 cents. We need to be careful about this rounding. We cannot get away from rounding. It's always gonna be a situation so we could make problems that come out perfect all the time. And they don't round around how perfectly. But in real life there's gonna be this issue. So if you're off by a couple ah, little bit a couple dollars, it could be a rounding issue. and we always have to be aware of that. So then, if we have the 28 cents per day and the number of days of the note is 90 days, then we can multiply that out. And we get the 25 here again. If you If you do the math here and you say 250.28 times 90 it's actually 25.2. And so that's a rounding issue there. And remember, this wasn't actually 28. It's 100 divided by 360 is actually 27 2.77 point 277 times in 90 is 25. So just if we use Excel and we'll take a looking excel will be able to know how to deal with these rounding issues and make it exact eso. Just note that those are always gonna be something that we have to deal with. Things aren't gonna be perfect in terms of dollars and pennies. We need to figure out how are we going to deal with these round issues? And when we're off by a dollar or so, we need to recognize that. Say, it's okay. Well, it's rounding. We'll figure it out. Okay, so then if we're going to say that the interest is $25 that will be earned at the end, then when we get paid at the end of the time period, we're gonna get paid. Then what's our journalist? You're gonna be well, Cash is going to be received, and the note receivable is gonna come off the books. Now, we'll see this with an example. Problem with a trial balance. It's a lot easier to see if you have a trial balance, but the note receivable we put on the books, remember, by debit of 1000 it's kind of like accounts receivable has a debit balance. We need it now take it off the books because we're gonna get paid. We're gonna get paid more than 1000 1000 plus the 25. But we're gonna take it off the books for the amount that's on the books. 1000 that that 25 is gonna be interest revenue. So it's gonna be revenue that we learned. We earn revenue based on not the sale when we learned the $1000 when we sold it, this is revenue that we earned for renting money. In essence, it's going to increase revenue, increasing an income statement, account revenue, income, statement accounts which will increase net income. And then the cash we get will be the 1025. So I remember we made the note for 1000. When we put it on the books, we only put it on for 1000. Then we had to take it off the books, taking that $1000 off. But at this point in time, we had earned $25 throughout the term of the note, and therefore we're recording more revenue than we had recorded at the beginning of the note because we recorded revenue for whatever we sold at the beginning. Now we're recording revenue due to the fact that we loaned out money, we made interest on the money. We rented money. That's how we earned this 25 increasing net income by the 25 then we got then 1000 principal back plus 25 interest. That's how much is going to be paid to us at the end of note. Now, if the note is dishonored, we have the same kind of problem that what happens if they don't pay the note, then we're still had earned the 25 we're gonna have to revert it to some other components that the due date of the note, we still need to do something. Meaning we need to take the note off the books it's passed to do, and then we're gonna record the interest. We still earn the interest for renting the money and we're gonna have to debit something. We can't debit cash so we could put it back into accounts receivable, tracking it back into accounts receivable so that we can track in our subsidiary ledger this customer, this individual that those of money on and track that they still always that money somewhere. So we're gonna still record the fact that we earn interest revenue. We still need to take the note off the books because the term of the note had ended, and then we can put it back into accounts receivable as a holding accounts to let us know that we still have this dishonored note and we still want to try to collect on it and go through the collection process, for there's also a case that we might have an adjusting entry at the end of the note time period. And that will happen because memory remember that we make financial statements as of the end of the month or the end of the year, and the no term in this case is 90 days. So what that means is that, for example, here we have the notes term. It happened on January 15th and we're gonna make financial statements as of January 31st. Then we're gonna have some days that fell in this month where we earned revenue. We rented money out, kind of like we rented a house out. We earned revenue, but we're not gonna collect the rent until next month after the end of the clothes here. That means that there's there's rental money that was earned, which we should recognize as earned it. We earned it because we loaned out what we loaned out, not a house in this case, but money. And so we should recognize it in this time period. Even though we have not received the cash, that's gonna be an adjusting entry. So to do that, we're gonna have to figure out Well, how much did we earn as of the end of the month. So it's a 90 day note. But how much did we earn in January? We have to figure out what that depends on how many days it was outstanding and the interest rate. So we'll do a symbol. Similar type of an interest calculation. We got the principle we've got. The interest rate is 10% 10% times $1100. Then we've got the days in a year. This would be $100 per year. Remember 360 days, which were saying 12 months times 30 days to make it even straight $6100 per year. Times 360 days is 3600.28 28 cents per day. Again, that's rounded really point to 77 This is the same calculation we had prior. Now we're just gonna make a slight difference. We're not gonna multiply times that term of the of the note, the 90 days, but by only the amount of days that are remaining in the note, which is 16. So if we did this in it in a calculator, remember, What we're saying is there's 31 days in January minus 15. That means there's 16 days left and you have to be careful in terms of Are we gonna count the day of the note or not? So if you if you're off by a little bit, that might be the difference. If we're counting the 15th day the note was created or not. The difference when we calculated here it's 31 minus 15 is not calculating, meaning. If we counted it up on her fingers, we would count, starting with 16 16 17 18 up to 31 would be 16 days. So if we do this calculation and we're going to say we had $100 of interest divided by 360 that gives as 3600.2777 and that's about 0.28 times 16 days, and that gives us 4.44 again. It's not perfect, but it's about $4.44. Now this amount seems minor, and it is so in this suggesting entry. But if we had a lot of these adjusting entries, or if the dollar amount was larger, this could be a material adjusting entry that we would want to make sure that we record in order to represent the financial statements correctly. As of the date we we make them the end of the month, the end of the year, sort of record the adjusting entry. We'd have to say that we have interest receivable of this $4.44. In other words, at this point in time, we have the notes receivable already on the books. When we first recorded this at $1000 and we're not going to record this amount in the receivable itself, we're not going to say the Receivable. It's $4004.44. What we're gonna do is make another account called interest receivable, and that's where we're gonna accumulate the interest, which is related to this note. It's an asset asset at debit balances the receivable. It's gonna go up by doing the same thing to it. Another debit. Then we're gonna record the interest revenue that we learned. We didn't get paid yet. We haven't gotten cash yet, but we did record interests. And remember, that's just the rent on the money that we loaned out. Interest is a revenue account or interest revenues. The revenue account has a credit balance, as all revenue accounts do, we're gonna make it go up by doing the same thing to it. Another credit increasing both the revenue account and therefore net income. 10. 90 Interest Calculations: In this presentation, we will take a look at how to calculate simple interest, a view different ways. As we look at this, you may ask yourself, Why are we going over this a few different ways? Why not just go over it one way the best way and let us learn that well and be able to apply it in each situation? While one way does work in most situations, in other words, we will probably learn one way. Have a favorite way to calculate the simple interest and apply that in every circumstance. It's also the case that when we look at other people's calculations or technical calculation, they may have some different form of the calculation. For example, I prefer away when I think about the calculation of simple interest to have some sub totals in the calculation and have more of a vertical type of calculation, the way we would see if done in something like a calculator. If we see a type of equation in a book, then the idea there is to have the most simple type of equation expressed in as short a way as possible, and that typically is going to be some type of formula, and that formula will often not be showing the sub total. So in other words, a textbook has an incentive to show a very compressed type of format for calculating something and individuals. If we want to go back for Intuit, note what happened in it, then we often will benefit by having some sub totals in the calculations that we work through. That's one type of difference we want to know. Other reason we want to know different methods is just to understand the math a bit better . If we understand different approaches, we understand what we are actually doing a little bit better. Another reason is that different people are gonna have different minds in terms of how they think of things and how they process things. So we want to be able to look at someone else's work and say, Okay, I see what they did here and be able to apply that to ourselves and see what they're doing it again. The more we can understand how other people process things, the better we understand what the material is and how to communicate it to other people. So let's go through a few of these type of ways. We can calculate simple interest. So we're going to start with a A loan of 50,007% interest rate. And it's a 90 day loans going out for 90 days, so we'll start out with the loan amount 50,000. For our first calculation type. We're gonna multiply that times 7%. Note. If we have a calculator, were typically going to do that by saying 50 50,000 50,000 times 0.7 point 07 If we're in Excel, we format the the's X l A p percent. We have a percent. We can use this percent button up here, but I typically use decimal 70.7 If we move the decimal two places to the right, then, of course we would have a 7% and that would give us the 3500. So, in other words, 50,000 times 7% is 3500 1st thing we need to note this 7% means 7% a year unless expressed . Otherwise, whenever we say that something is so much percent, typically we mean percent a year. So, for example, if we say we have a mortgage, we pay the mortgage monthly, but we typically expressed the monthly mortgage rate as a yearly rate. Why would we do that? You know, there's a couple different reasons we might do that. But one main reason that it's a convention for us to do that is if we took 10.7 and said we want a monthly type of interest rate. If we divide that by 12 we get a pretty small number. So it would be 120.58 something something percent, which is pretty small. We don't really that's it's a range. It's more difficult for us to express in. Therefore, we typically express interest rates for that reason and just it's a convention in years. So unless expressed otherwise, just note within a problem with any type of discussion, interest typically means a year, and it's similar to if we're talking about a salary like we say someone makes 70,000 we typically probably mean 70,000 year. Even if not stated, then we're gonna take that amount and we're going to say how many days are in a year now. In this calculation, were taking 362 making even rather than 3 65 which is an assumption of 12 months, times 30 days in a month. Of course, there are 31 days or 30 days or 28 days or 29 days in a month. But if we do a nice even calculation here we get uneven. 3 60 for are simple interest calculation. So that's what we will use at this time. So then we're gonna take the 3500 her year of interest. This is a dollar amount, and this is going to be 360 days. Gives us about $10 a day again, that's rounded. It's really 3500. Divided by 3 60 gives us 9.72222 So I'm gonna use this 10 here just to show it. That's how you'll see an excel if you take the decimals off. But note that we're really gonna be multiplied by that nine something. Just remember when you deal with interest, you have to deal with that. Not everything's gonna run out to the dollar. Not everything's gonna Randall to the penny will have some rounding differences. So then we're gonna take that times 90 That number times 90 days. And that'll give us 8 75 again, not 90 times 10 in this case, because we're using that rounded numbers as we would see in something like an Excel worksheets. He just got a kind of deal with those kind of things. So if it was 10 times 90 it would be 900. What we really have is the 3 60 divided by 3500. Um, do that one more time. What we really had this 3500 divided by 360 or 9.72 which was rounded to 10 taken off the pennies and then would take that and we multiply it times 90 days. That gives us our 8 75 So then, if we take our 8 75 that's how much we would earn then for the time period for the 90 days at 7%. For simple interested, we take the original amount of the loan 50,000 we loaned out at day one. We add to it the 8 75 Then we get 50,000 8 75 that we would then receive at the end of the loan term. This is the way that one of the ways I think is the most easy to see this, and that's if we break it out by days depends on the loan type if we want to break it out by days or months. So if it's less than if it's less than a year, then it might be that we want to use days. If a problems getting very specific, then we'll have to use the actual number of days in the month. She's gotta be careful on the terms of the problem. If it's gonna be ah, longer term problem, then we might just round these two months and use months as the calculation. As we'll see this time, same type of idea will take the 50,000 multiply times 7%. That's going to give us our 553,000 times 7%. They yearly rate gives us the 3500 interest her year. Now we're gonna take that and we're gonna instead of dividing it by 360 days, well divided by 12 giving us the interest rate per month. 3500 divided by 12 So again, if we did that with the calculator were taken 35 divided by 12 NEC is it's not exactly 9 to 92 foot to 91.6666 on forever. Note that even if I put the pennies there, it's not always going to be exact. And we just have to get a deal with that. That's gonna be some rounding issues we will always have. When we when we do these types of calculations, then we're gonna take that amount and multiply it. Times three Where did we get three? Three months, 90 days divided by our convention 30 days per month About gives us three months They were gonna take the this dollar amount per month, times the number of months. Three. Give us that 8 75 Remember, we're not talking about the 1992 92 necessarily will have rounding there. It's a golf by dollar because really, what we're talking about is the 3500 divided by 12 or to 91.6666 on forever times three and I'll give us our 8 75 So just be careful of the rounding it's always gonna be a problem. Doesn't matter how many places we take it out to. Some of the decimals will repeat forever, so we'll have the 50,000 plus the 8 75 getting us to that same 8 50,075 these two ways, the prior weight by day in this way by month are the easiest way for me to think about it. Because it's linear. This is how you plug it into a calculator. This shows just each step and the sub totals. However, if you were to represent it with its short, ah, way as possible than these subtitles aren't something that are typically going to be represented in textbooks because it's nice. Not as neat, not is nice. So when you put things out and you calculate them, I would remember them into this format. This is easier for me to remember than a shorter type of formula, because the shorter formula doesn't make intuitive sense. I can't say, Well, walk through this and say, Well, this is the yearly interest rate. This is the rate per year, and then we're gonna take the rate per per month, times a number of months to get the interest, so I can't really tell the story to myself. The longer story that I can tell is easier for me to remember than a shorter formula, which has no story that makes any sense. So it was bottom line. I would remember one of these two methods and for your dif old method. Okay, so now we're going to it to another method. We're gonna start off with the number of days in the loan 90. We're gonna divide that by the number of days in the year. This, of course, is called a ratio. So we're comparing and starting off with the comparison of the loan term. 90 days divided by the number of days in the year 3 60 which again is 12 times 30 for our purposes, rounding it set of 3 65 3 60 And that's gonna give us points to five or 25%. So here's our ratio. Given us 250.25 Now that we have that ratio, we can take that ratio that 0.25 and multiply it times the interest per year, which was that? 3500 or 50,000 times 35000.7 that 3500 that will give us our 8 75 So note this gets that 8 75 a bit faster. Here. We don't have as many calculations or as many steps. However, I find that most students on myself included. When I think about this, the ratio doesn't make as intuitive sense to me as saying, Oh, here's the interest rate per year. Here's what the interest would be per year and then breaking it out through either a daily or monthly interest rate and then multiplying times the number of months. Same math, same end result. Just a different order of calculations. So just be aware that this because it's smaller, probably often more represented in a textbook or something, we need to be able to see that. So then we got the 8 75 Plus, the 50,000 original gives us the loan that will get back at the end of this time period. We loaned out 50,000 at 7%. Simple interest. 90 days. We should get back 50,008. 75. Next, we'll do the same type of thing. But now we're gonna do this by the number of months in the lone. Remember, this is gonna be 90. Divided by 30 gets us three months in alone. And then we're gonna take that and compare it to 12 3 divided by 12 3 over 12th. That gives us the ratio of 3 to 12. So three divided by 12 will give us that same 25. So no, we're doing the same thing. Of course, because we're doing the comparison of the timeframe. The loan is over over the total time frame. And as long as we use the same measuring tools belongs in this case using months or in the prior case, we used days for both the loan term and the amount of time. Within the year we will get to the same ratio. 0.25 is the percent. So then we're gonna And of course, you can simplify these down, Teoh, and see that the same ratio 3 3/12 If you simplify that down then and you simplify the 30 compared Teoh or the 90 compared to 3 60 you'll get to the same ratios. Right? So there's a 600.25 and they were gonna take that multiply times of 3500 which once again is, of course, the $50,000 loan we started with Times Point has 0.7 point 07 3500 and that will give us the 8 75.25 times 3500 gets us back to that 8 75 So once again, it's quicker method. In the 1st 2 we started off with a little less intuitive in my experience with myself and people I've worked with for most people, understand, I believe, um, total cash received then would be this 8 50,075 next method. Now, we're gonna try to break this percentage out as we saw at the beginning and break it out into a monthly rate, and we'll deal with that. So we're gonna say that we're gonna start with the interest rate this time and say, That's the yearly rate. That's what default by default, that typically is divided by 12 and that will give us the monthly rate. So once again, if I did this when a calculator, we'd say 0.7 That's the 7% divided by the number of months in a year 12 gives us 120.58333 on forever. That's a pretty small number, which once again, is the reason we don't typically do that way. We don't typically represent the interest rate in terms of months because it typically is a small number. And it's just not the convention that we just have out of whatever reason we had come up with conventions for. So that's what we're gonna have if we break it down to a month. Right now, it's important to know this because when you put stuff into Excel or other sites of financial catch calculators at times, then it sometimes uses this monthly rate. So we'll need to know that rate per period. And thats in this case the monthly rate. And so it's important for us to know this type of calculation when we use tools such as Excel, so that will give us 0.258%. Remember, that is not exact here. This is a rounding times. The loan of 50,000 gives us to 92 so once cannot be careful of the rounding all the time, because is this 0.598? You might first think it's 58%. It's not. We gotta move the decimal two places. Teoh the left, which was 20.58 What it really represents times 50,000. But even that's a couple bucks off. Why? Because this is rounded to remember what we had. Its 0.7 divided by 12 gets his 120.583333 And that's what we're used in times 50,000. So again, just be careful. I could give an example that is perfectly even here, or but it's not ID. Rather, given a lesson, perfect example. To show that it's not gonna be perfect all the time. It will be perfect sometimes. So this would be the amount of interest per month. Simple interest per month. Um, now we just need to say that's a dollar sign, by the way. Now they're gonna say, there's how many months in the year we're going to say that in the term of the loan, three or 90 divided by 33 months, so to 92 times three would be 8 75 Once again, that might be a bit of rounding there. If we say to 92 times. Eight times three. We're gonna get 8 76 Why? Because really, what we had remember is 0.7 divided by 12 which is 120.58 And then we multiply that times 50,000. It really to 91.6666 divided. Our times three. That's gonna be our 8 75 And then we take the 8 75 Plus the 50,000 gives us that same 50,008 75 1 more time. One more way, and then we'll stop this. Okay, so we're gonna take that same interest. 7% break it out to a monthly rate. So 7% divided by 12 gives us at 120.87 point 58%. Once again, this is rounded. Same spot we were at last time. We now have a monthly percent percent. Now, we're gonna take that in multiplied times the number of months. So we have 50. We have 90 days divided by 330 gives us three months. So if we take that 30.58 rounded, this is grounded times to three. We get about 1.75 and this thin would be the interest rate. Her the time, period. We're talking about three months or 90 days. So in other words, we take a look at this. We have the interest rates point 07 for a year, divided by 12. Gives us the interest rate per month by move the decimal point over 2.58333 This is rounded . This isn't 58%. Remember 580.58 big difference. And they were gonna take that times the number of months. Three. And that's gonna give us, uh, 0.175 or 1.75%. So this is actually exact now, 1.75%. And they were gonna take that times the loan amount 50,000 and then I'll give us the 8 75 So remember this. What we did here is we broke down in the percent for a three month time period or 90 days and again, that's not usual reading. We don't usually say that. We don't usually say, Hey, we're gonna pay you a simple interest rate of whatever for a three month time period. So just, you know, be aware that we don't typically say that we're gonna pay you 0.58 per month. We typically express things, often times with a yearly rate that yearly rates often being between one and, like 20 and therefore being uninterested rate. That makes more sense to use it within that range. So but when we do financial calculations, this once again might be a way that we could see this within the periods that we're talking about, which in this case, it's a 90 day or three month period. So then we just take that interest rate. Times the 50,000 gets is the 8 75 We add that to the original 50 we get to that same 8 50,075 So again, I hope this wasn't too confusing or more confusing than it was helpful. But note that when you see this types of calculations in a textbook, they're often so simplified they look to be like the easiest way to see, and they are the easiest way to write it, but obviously often times a longer type of calculation. Ah, more vertical calculation rather than a horizontal type of formula, is easier for us to think through. Tell a story in her head remind ourselves what we're actually doing in order to better memorize the calculation for future use an application to other types of problems, as well as to just have a format and be able to understand it better for future use to know what we're actually doing rather than spitting out a number that we think is correct just based on formula, but not having any intuitive realization or understanding what it's for and therefore how we can use it to apply to something. 11. 100 Note Receivable Example: In this presentation, we will discuss notes receivable, giving some examples of journal entries related to notes receivable and a trial bounds so we can see the effect and impact on the accounts as well as the effect on net income of these transactions. First transaction, we're gonna have a 120 day, 7% note giving the company am I an extension on past do A are or accounts receivable of 6200. When considering book problems and real life problems, One of our challenges is to interpret what is actually happening. What is going on? Which party are we in this transaction in? Therefore, how are we going to record this transaction when we're looking at notes receivable? A common problem with notes receivable is the conversion of an accounts receivable to eight notes receivable. So in this case, that's what we have. We have in accounts receivable here that includes an amount due to us by this particular company. Am I So these are our books. We have a receivable. People owing us money for prior transactions, goods or services provided in the past. And they owe us in total all customers oas 41,521. This customer in particular owes us 6200 of this amount in the receivable that could be found not in the general ledger, which would give backup of transactions by date, but in the subsidiary Ledger supporting this amount given us this number broken out by customer in this case showing that this company in my our customer O za 6200 if we were adding up all the customer accounts in the subsidiary Ledger which mailing CD one here, if all of them would add up to the total accounts receivable Now the accounts receivable represents sales that are made that are typically do in, say, 30 days. Uh, and a note receivable, on the other hand, typically has a longer time period. Interest rate involved often has a higher dollar amount, and therefore interest will be charged and want to have that in writing. So in this case, we're gonna say, OK, it was in accounts receivable, But now we're gonna given extension, and because of the extension and the days being greater than, say, 30 days, we don't want to track it in accounts receivable and in the subsidiary Ledger. But create another account and track it in a note receivable and then charge interest on it so we can imagine a formal document being made here for a note receivable. And we then now having to record this. So to record this No, we don't. We don't really need to know the 7% or the 120 all we need to know at this point in time. If that it wasn't accounts receivable and we're transferring it to notes receivable. So Accounts receivable has a debit balance. We need to make it to go down. So we're gonna do the opposite thing to it, which is a credit decrease in the receivable. And then we'll put it into notes receivable, which is another asset account very similar to accounts receivable. And it has a debit balance, and it's gonna go up by doing the same thing. Another debit. Now note here that we're recording the note receivable a different note receivable for each customer. So, in other words, the accounts receivable we're tracking in one account here supporting that account with a subsidiary ledger, which then will track each customer that owes us the money with the notes receivable and this example, we have a different note receivable for each note outstanding, and we'll track the amount owed the principal amount owed here, as well as supporting documentation to be able to track the principal and interest that is owed. It is possible, however, for us to track this with just one account on the trial balance as well, and then have supporting documentation in a similar way as subsidiary ledger for the notes receivable, which would calculate what the notes receivable due to us and the interest that would be do on those notes receivable. I kind of like to see it if we don't have too many notes receivable in this format so that we can check each note receivable when we make the financial statements. Then, of course, we're not gonna list out a bunch of different notes receivable with different customer names. We're just going to put it together in one account called notes receivable. If we record this out, then we could see the accounts receivable started at 41 5 21 It's gonna go down by this 6200. We're recording this accounts receivable, making it go down to 35,003 2141 5 21 minus two. Credit 6200. Giving us the 3 35,021 notice here were representing the debits with non bracketed numbers the credits with bracketed numbers and therefore, if we do some this up debits minus two credits equals zero debits minus accredits equaling zero, meaning that it's equal that credits and we are in balance. Net income is calculated as the revenue, uh, minus the expenses. We don't happen. We're not showing any right here. Simple. Find the chart of accounts all we have a revenue accounts, revenue, interest revenue and a gain in here to get to the revenue, not a loss Revenue or net income. 38,000 to 45. The second component notes receivable started at zero. It's now going to go up in the debit direction by 6200 to 6200. We also need to track this account. This gives us total accounts receivable Oh, to us by all customers. We're gonna track the activity in the subsidiary Ledger for in my company, a particular customer who owed us 6200. We credit the same credit here, similar to as we would do for the General Ledger. But now breaking it out by customer, saying that they no longer oh us any money. So this 35,000 to 3 21 is all made up of customers other than the M I company customer. If we look at the full transaction off all of our accounts at the end of the day, here's where we started. Here's our adjustments. Here's the Indian trial balance. All that happened, one asset accounts goes down. One asset account goes up. No effect on the accounting equation. In essence, assets went up, assets went down. No effect on equity, no effect on liabilities. You can see down here in the income statement accounts, nothing happened. No revenue went up. No. No expenses. Net income is the same after this transaction. Just transferring from one account to the other account. One asset accounts to another asset accounts. Why? Because this asset account will allow us to track not only what is owed to us, but then we'll want to calculate the interest on it. And the longer term of days. Then we're gonna say, OK, what happens at the end of this time period? We're gonna get paid both the principal and the interest, and therefore, we need to calculate what that interest will be. So the principle that amount is 6200 the interest rate is 7% 6200 times 7% is for 34 or 6200 times. We owe 77% 770.7 It's 4 34 Then that would be remember for an entire year. And we're gonna need to break this down to the time period we're talking about, which is only 120 days. There's a few ways to do this. We'll talk more about different ways to do this and a little presentation. But here, what we're gonna do is break it out into an amount per day and then multiply it times 120 days, which I think is one of the most intuitive ways to do this and make sense too many people. So we're gonna say that 4 34 divided by 360 days, is $1.21. So what does that mean? Where did we get the number of days? At 3 60 we're gonna say 12 months times 33. 60. There's really 3 65 But we're gonna round it for simplification purposes. For simple interest calculations, we're gonna take a 4 34 divided by the 360. Meaning 4 34 Interest for an entire year. Divided by 360 days is about a dollar 21 cents. We have to deal with rounding. That's okay, um, for each day. So then we're gonna take that 1 21 multiplied by the number of days in the loan 120 days to give us the 1 45 Now again, remember that if we take the 1 21 times 120 get something slightly different here. Then if we took the rounded number 4 34 divided by 360 gives us really 1 20.555 times 120. And that kids, that still something else slightly different. We're rounding to the nearest dollar, so just be careful of rounding. It's always gonna be an issue. Even if we go to the penny, it's still gonna have rounding issues because we're off by less than a penny. So always gonna be an issue and we'll have to deal with it, no matter how we structured the information s. Oh, here we go. We're going to say that the interest was 1 45 What happens when we get aid, then at the end of the loan period? So now we're at the point where they're gonna pay us. We loaned originally 6200. We're gonna get that back plus interest of 1 45 So the note receivable is gonna have to go off the books. Here's the note receivable. It's easiest to see this when we have a trial balance because we could see Hey, there's a note receivable. We got paid on it. Now that needs to go to zero. It has a debit balance. We need to make it go down, therefore, will do the opposite thing to it. It credit to make it to go down. We're also gonna have the interest revenue. That's this revenue that we generated. It's not included here. We're gonna get cash not at 6200 but 6200 plus the 1 45 Because of the time value of money , the interest that we've earned, that's gonna be interest revenue. It's an income account. Income is going up. Revenue has a credit balance. We're gonna increase it by doing the same thing to it. Another credit. So we'll increase revenue, increase the net income. Note that this revenue is not going up because we made a sale. But because we loaned money, we loaned money and time value past. Therefore, we generate revenue from it. The debit to cash then will be the 6200 plus the 1 45 or 6003. 45. If we post this out, then we're going to say that cash went up. So years cash here, we're gonna post that here. It started at 39 4 29 It's gonna go up in the debit direction by through 3 6045 to 4 39,029 accounts receivable started at this 6200. It's going off the books now, and this is a check figure that we should have. It should go to zero, and that should be intuitively the case. I that it should go to zero because no, what? They no longer owe us money. If we have the trial balance, this becomes much easier for us to think through, construct the journal entry and then post it and see if it does what we think it should. Dio a nice work sheet format is a good way to see this rather than having the G O and posted to the jail. Because this gives us a quick view of these accounts, allows us to stay in balance after we recorded and see what happened here very quickly and easily. Then the interest revenue. We're going to say interest revenue is a revenue account. It was at 1 46 Prior to this, it's gonna go up in the credit direction. We're posting this 1 45 interest revenue by 1 45 to 291. If we take a look at all the accounts, then we can see that the cash is gonna end up here. We got the notes receivable is down, and the effect on net income then is going up by that 1 45 We're recording this entire 1 45 at the point in time, we received the cash because we earned revenue not at that point in time, but throughout the time period, throughout the 120 days. So instead of us recording the revenue that were earning for loaning money out for the interest each day as it accumulates, we're waiting until the end of the term. And then we're recording this at one time. At the point in time that we received the money at the answer, just be aware that under the accrual method, this revenue didn't happen. At one point in time, it happened over 120 days. It's just easy for us to record it at the end of the term when we get paid. Now, if the term goes over the Justin entry date, the end of the month or year, we may have to then doing adjusting entry to recognize the fact that we did earn revenue over time. Not at this one point in time at the end of the time period, and we'll see an example of that shortly. What would happen if, at the end of the time period, they dishonored the note? We didn't get paid? We have a similar journal entry, but of course we wouldn't get cash. Then we're saying they didn't. They didn't pay us. So we would say that the notes receivable. It's still going down. We still have to take it off the books. So it's at 6200. We didn't get paid. It needs to go down to zero. This is a debit. Will do the opposite credit to make it go down. We're still gonna earn the interest revenue. It's not like we didn't earn the money even though we haven't gotten paid on it. We haven't given up on it yet. We're not gonna debit cash yet. We're gonna debit instead accounts receivable representing the fact that they always the money putting it back into account that we can then track them and be able to see if we can have collection action on it within accounts receivable. So this the only difference here, of course, being not cash but accounts receivable accounts receivable being up going up. It started at 35 3 45 going up by 6003. 45 to 6 41,088 the note receivable. It started at 6200 is going down by 6200 to zero, and then the income would still be going up. It had revenue of 1 46 It's going up by 1 45 to that's to 91. We also need to record down here in the subsidiary Leger. We increased the receivable. We need to record that here in M I company on the subsidiary Ledger, increasing the fact that it's not at the principal now. 6200 put the principal plus the interest that is Oh, to us back in receivable now. This is an area that weaken further track how much is owed further, go through collection process and see if we can collect on the amount owed. Once again if we if we see all of the accounts, we can see that there is, in effect effect on net income. Even though we didn't get paid cash, it's going up by the interest revenue recorded here. Remember, this is the income statement part. So we had 20,000 revenue plus this 1 45 increasing and this game down here for revenue. We're not showing any expenses right now because It's a simplified financial statements that we don't have any expenses at this time now. What would happen if we had in adjusting entry notes that we recorded this 1 45 as of the end of the time period? What if we had in adjusting entry? For example, what if we made this loan term as of the middle of the month there, 15 days left in the month, Let's say, the month of December, there's 15 days left in the month and we need to record then the fact that we generated revenue over that 15 days interest revenue, even though we're not going to get the money until next year, next month after the cut off date. So we'll have to do in adjusting entry in that case, so we'll have the principal amount. We're gonna calculate the interest now for that 15 day time period so we can do the adjusting entry principle. 6200 interest is the 7% the same 4 34 we did prior to this calculation, but now we're gonna divide it once again by the number of days in a year. 360 12 months times 30 days. That'll give us about $1.21 interest per day. Ah, And now we just need to multiply times the number of days that this is where we differ rather than having 120 days. We're just gonna multiply times the tent. The 15 days that have passed for this current month that we're in. So 15 days, which will give us $18 in eight cents, and we're gonna round it to $18. So if we did this with a calculator, we'd say, Okay, there's 6200 times 62000.77%. That gives us the 4 34 interest. If it was for an entire year. We only have 15 days that we're looking for. So we'll break it out into a daily total, dividing by the number of days in a year rounding not 3 65 But we're going to use 3 60 12 times 30 rent, divided by 360 gives us 1.20 point five, 1.20555 about 1.21 We'll take this number. The UN round a number, times 15. And that'll give us 18 08 We're going around it to $18 for our calculate for our journal entry. So then we'll do the journal entry here, and we'd have to say, Okay, well, as of the end of the cut off date for our Justin entry, we've got interest receivable of 18. We're not gonna put it into the loan amount. We've got 6200. We could, you could think. Well, why don't we debate the loan? They always now not 6200 but they always 6218 but typically will record it separately and say, Hey, this is the principle. And then we'll record all the interest that we've generated in the receivable amount here and then the credits gonna go to interest revenue. So even though we have not yet gotten paid, we have been generating revenue note. Under a perfect accrual system, you might be saying what we should be recording revenue each day, each second each minute that time passes, cause that's when we earn it. But clearly that that's that's not practical. That's why we're only going to record the revenue that happened over this 120 days at the end of the loan date typically or will record it at the end of the financial statement date at the point in time that we make the financial statements and therefore want them to be as correct as possible for presentation purposes. So recording this out we've had interest receivable on asset accounts going up in the debit direction started at zero by 18 debit to 18 debit. Then we've got the interest revenue started at 1 46 Here it's going up by the 18 to 1 64 Okay, and then if we see all the accounts, then of course, revenue is increasing. Even though we haven't received the money, we do not. We do need to recognize revenue, and this may look in material right now. It's not very material, meaning it's not gonna effect decision making too much in this example. But if there are a lot of notes, receivables or if the dollar amount with larger, this could be something that would affect decision making being material to financial statements. So we're gonna recognize the revenue that has been earned during that time period on the income statement side, increasing net income even though we have not generated the cash because we have earned revenue over that 15 day time period. And we're gonna recognize the receivable that is owed to us. As of the cut off date that $18 we're not gonna get paid until the end of the time period. 120 days and we're gonna accumulate mawr receivable. Asi that time passes for the days that passed. But at this point in time, we have accumulated 18 more dollars on the original 6200 that is due to us. 12. 10 Discussion Question Receivables: In this discussion, we will discuss the discussion question of describe the accounts receivable cycle subsidiary ledgers and allowance method. So we're talking here about accounts receivable and related activities to accounts receivable. If we're given a discussion question like this, an essay question similar to this, we could first start off with what is accounts receivable and then go into the problems related to accounts receivable, which are solved by things such as a subsidiary, leisure and on allowance method. So first accounts receivable. What is accounts receivable gonna be an asset type account? It's typically a current asset type account, more liquid type account or one that we believe will be converted to cash relatively soon, typically within around 30 days. And it's a result from us doing work goods or services on account and therefore being owed something in the future. Typically, money were typically owed money in the future due to something happening past, usually us earning money through providing a good or service. Therefore, the accounts receivable is an asset, but it's not something really tangible. We don't have it yet that money is not with us yet. We expect to have it soon. It's a claim to future assets and therefore it does have a value. However, there could be problems with it now. We might want to start with the journal entry as well. How would that happen? Well, the accounts receivable would happen if we made a sale. If we didn't work or service, we would debit the accounts receivable and we would credit some type of revenue account, whether that be out, something called revenue. Adjust the revenue account or income, or we sell goods or services. Then, typically, it would be called sales. If we if we sell services and not goods, it might be called fees earned, so that would be the normal transaction to increase accounts receivable. If we're selling inventory along with that on a perpetual system, we would debit, cost of goods sold and credit inventory to record the inventory. Half of the sales transaction. Then what happens is we're going to get money, hopefully in the futures. The normal accounts receivable process would then be hopefully within 30 days. The customer pays us we debit cash, increasing the cash, credit, the accounts receivable, decreasing the accounts receivable at the time we received the money. Therefore the accounts receivable should have a pattern. It going up with a debit for every time we make a sale going down every time. There is a payment on sale course at every sale on account meeting sale that we didn't get cash for. It was on credit. So then we can go into the problems with accounts receivable. Well, one of them being how do we value accounts receivable? Isn't it the case that we might not get cash? We don't yet have the cash. Aren't we counting our cash before it's received by recording receivables? And the answer is not really because it is just to receivable with not cash. So we are claiming we have something of value. Ah, promise to pay us. And that's the Receivable. But it is the case that we might not get paid, and we might have some knowledge about those types of council released How many of them will not be paid? That's gonna be one problem. We're gonna have to deal with it. We deal with that with the allowance method under general accepted accounting principles. The other problem is, how do we track who is gonna pay us in order to send them the invoices in order to make sure that we get payment. And that has to do with tracking the receivable by customer, which is typically done with a subsidiary ledger type of account. So let's start with a Subsidiary ledger type of account. We know that the accounts receivable represents in total we're looking accounts receivable on the balance sheet or trial balance. What is owed to us by customers, meaning all customers. Some together, Oh, us, whatever's on the trial bounce or balance sheets We could call that, Um, let's just say that people was 100,000. That's just what it is. But it could be obviously multiple customers that owe us that. And then we need to know who owes us the money so that we can invoice them and try to collect on the money. That would be something done with a subsidiary lecture. This is different than the General Ledger, which every account has a General ledger, which supports the data. By order of up order of date, date of operations date. The transaction happened. Give the activity, in other words, to every account, such as the accounts receivable account by date or in order of date. What we need, though, is another type of lecherous subsidiary ledger, which is going to give us the activity first by customer, so that we can then track who owes this money and has it yet been paid. So you can imagine if we're a company that the first question the owner would happen where the bookkeeper is. How much money do people owe us? If there's 100,000 in on the books we say they always 100,000. The next question is gonna be, well, when are we going to get paid? Who owes is the money? Have we sent them out reminders any time recently? Are we expecting to get paid soon? To answer that question, we need to order things by customer who wills this money by customer that done with a subsidiary Ledger. Next problem to address it has to do with the allowance method, and that's the idea of us. If we don't somehow make some type of estimate for the receivables that we think are gonna be uncollectible, then we're overstating the receivables. We do that with what's called the allowance method and what that means is note that when we put the receivables on the books, we have to do that. If we don't put the receivables on the books and we wait until we get paid, that really distorts the financial statements. Because if I'm a creditor from the bank and I want to see the financial statements to assess whether we give alone or not, all the receivables on the book is something important. That's what we want to know. That number, however, we also want to know how much of that number is not gonna be collectible, which is something we can't know for sure. But we would like to have some type of estimate on that. So that's gonna be something we want to provide on our financial statement. We want the receivables on there, but we also want to know how much of those receivables we believe are gonna be uncollectable in order to represent where we stand on a balance sheet basis as accurately as possible. One way to do that is to try to take the receivables Macon aging type of account and determine how much of them, based on some type of estimate from past experience or related industry will not be collectible, then we're not going to write down the receivable directly. One reason being that we can't take the money. We can't reduce the receivable to the subsidiary ledgers because we don't really know exactly who is not gonna pay us. It's just a estimate. So we can't go in each individual subsidiary ledger account. Say this person is not gonna pay us. We don't know. What we do know is based on an estimate, the percentage or how much of the receivables we believe will be uncollectible. And therefore we can make a Contra asset account, one that has an asset. Captain has a credit balance. Most asset accounts have a debit balances, this one having a credit balance, which will match up against the receivable in a similar way as accumulated depreciation matches up against fixed assets. And it'll reduce the net receivables that we believe that we're going to get. So that's what we'll do In order to deal with this problem of overstating the receivables will come up with this allowance for doubtful accounts, which we could do one of two methods to do that. We can do that with this accounts receivable method. Or we can look at the sales side to try to figure out what that allowance should be. And to understand that it's really we really need to just look at the other side of the equation, the accounts receivable. The account related to it on the income statement is revenue and revenue. We have the same problem that if we made sales on account and it might be overstated, meaning we might have some of those revenue accounts that we recorded, revenue of which we're never gonna actually get the money. And if that's the case, we shouldn't really have recorded revenue. Even if we did the work, um, we're not gonna get paid. So it's not like we really made a sale there because we're never going to get the money. So we would like to match that up in the same time period. If we we would overstate revenue instead of reducing revenue, we want to record the bad debt expense, the amount of that revenue which we don't believe we're going to get paid on in the same time period in which we generated it, and that's gonna be the other side of this allowance method when we fix the receivables will also be fixing in a way, the matching principle on the income statement matching up the amount of those receivables we'd belief will be non collectable. The amount of sales we made on account, which we never think we're going to get the cash for in the same time period, that being better than us, waiting until later time period to decide that we're not going to get paid because we'll be matching up then in that circumstance, the amount we're not gonna get paid with a future revenue and what we want to do is match it up. Whatever rental revenue earned we earned this period this month this year, we want to try to match up the amount of it. We think there's going to be uncollectible. To do that, we'll do some type of estimate, either estimating the type of revenue, their total revenue. We think it's uncollectible or were kind of backing into it by figuring out how much of the accounts receivable is uncollectible and thereby getting the bad debt expense as well. So that would be a pretty comprehensive tax question asking, you know, really many of the major components of the receivables, The receivable being what is the receivable? What's the receivable cycle? One of the journal entries related to the receivable. And then how do we know who we're going, Teoh Bill? Or how are we gonna build that having to do with a subsidiary Ledger? And how do we deal with this fact of the or this problem with the receivables being potentially overstated, that having to do with the allowance method? 13. 20 Discussion Question Receivables: in this discussion, we will discuss the discussion question of discuss what a note receivable is and how to calculate interest. Do so a note receivable is gonna be a type of receivable. It is gonna be an asset in that it's gonna be something owed to us claim to something in the future. Typically, that's something being cash in the future. The note receivable will typically happen due to some transaction in the past, and it represents something owed to us often by customers. So if we're a business, we may have notes receivable from sales that become do or possibly we convert in accounts receivable to a notes receivable. It's often useful when talking about notes receivable to compare them to accounts receivable. What's the difference? In other words, between a note receivable and and accounts receivable, the accounts receivable is going to be the normal type of business transaction that we use in order to make sales. So when we make a sale, we typically on account from making on account. We typically debit accounts receivable and credit sales, and then, if we have sale of inventory at the same time under petrol system, debit, cost of goods sold and credit the inventory. The accounts receivable then represents what we expect to be paid within a normal, probably around 30 day time period. When would we want a note receivable? If we made a sale of something that is larger and nature meaning the dollar amount is larger, or and or we have a longer time period in which we expect to receive payment? And because of those things, we possibly also want to collect interest on it and therefore because it's because of those things, because it's a greater in value because we want to collect interest on it because the time period is longer for which we expect to get paid in. We also typically have a documentation of it. A written documentation, a more formal documentation then we might use under accounts receivable. So under the accounts receivable, then we're gonna track things in a subsidiary ledger we're gonna track who owes his money, track things we're gonna We're gonna track who owes us money in the Subsidiary Ledger, meaning the Genovia balance sheet will show a total of how much people owe us. In the accounts receivable, The General Ledger will show us detailed, but only by date of transactions. To get to that total, the subsidiary Ledger will break out that same information by who owes us money and that will be very useful for a collection, clearly, the notes receivable. Then we're not gonna track in that same subsidiary Leger. We may track in a couple different ways. We might one have a different note receivable for each notes on the trial balance and track the principal, at least on the trial balance. Or we could have one note receivable on the trial balance and then have supporting documentation that will track who owes the money on the note receivable and calculating the interest on that note. Now, because the note receivable is longer typically in dates and due dates more than 30 days, typically then accounts receivable, we might tend to think that it should be, ah, long term acid or not a current asset. And that's not that's not necessarily the case. I mean, if it's over 30 days, it still might be a current asset, but something that's not going to be in accounts receivable so typically will be working with notes receivable here that are less than a year. Still still then, current assets, not non current assets but have a longer time period than a typical accounts receivable. So don't get that mixed up. That's not necessarily the case that is, over a year's time and therefore not a current assets to be a note receivable rather than and accounts receivable. Now, once we have a note receivable, we're gonna have to calculate interest on it. When we first put the note receivable on the books, we don't need to know what the interest rate is or anything we can just debit notes receivable and credit sales or credit accounts receivable. Depending on whether we made a sale for the note receivable or if we're converting accounts receivable and then calculating interest, we need to note that we're gonna be dealing with simple interest. Here s oh, so it's just gonna be calculation of simple interest. So if the interest rates say is 10% were going to say whatever the note was multiplied times, the rates of the note itself was 20,000 times 10%. That will give us the interest. That would be do if the note without for an entire year and That's the key point we want to keep in mind here. Interests typically means, when stated, unless stated otherwise, an annual rate of interest. We don't typically state interest rates in terms of a monthly rate, because just by convention one and two, probably the reason we have the convention is that it would be very small interest rates. We would talk. We would be talking about fractions of percents rather than something that's typically between zero and 100 so the interest would be to a lot smaller that way. So in any case, whenever we hear an interest rate, we typically mean an annual rates. Therefore, we have to break down the annual interest into whatever term it is covering. So, for example, if it was 10% on the 20,000 we have 20,000 times 10% and then somehow converted to the terms. If it was only a 60 day note on Lee out for 60 days or two months, we have to take that yearly amount of interest and converted to um, a amount for just two months. We could do that by dividing by the number of days in the in the year we could round it to 360 which would be 12 months times 30 on average of 30 days per month. And that would give us a daily interest amount. And then we can take that and multiply it times the number of days outstanding in the note , which we said was 60 and that would give us the interest that would be due at the end of, ah, the time period. So then when we collect the money, we should collect the original amount that we issued the 20,000 plus the interest. Then we're gonna credit the note to take it off the books for the 20,000 It not having included the interest yet because we haven't recorded any. And then we're gonna credit interest revenue for the revenue that we've earned. Now there's a There's a bunch of different ways we can do that same kind of calculation on interest, just basically ordering the operations of the math a bit differently. But that's gonna be the basic Savage is the key that the interest is just that simple. Interest still means annual interest that we need to then convert in some way or other to whatever the term of the note is which will typically be, You know, 60 days 100 day, we're gonna be dealing with notes again that are less than a year, typically for the receivables. So it will usually be stated in terms of days. Often days that are gonna be could be broken out into multiples of 30 which would be broken out into even types of months. 14. 30 Discussion Question Receivables: In this discussion, we will discuss the discussion question of compare and contrast the direct right off method and allowance method. So considering the direct right off method and the allowance method, we would need no. First, what are we talking about here? What is this related to? What methods are these four. And they both have to deal with accounts receivable, the evaluation of accounts receivable. So we have this problem with accounts receivable and this is how I would approach this if we were to write this out in a discussion and or essay question till list out the problem that these two methods are trying to solve and then explain how they both solve the method and where the pros and cons of either method are. So we have a problem with accounts receivable, and that problem is one you'll really find if you teach accounting at some point that students, often when you or anybody whose learning accounting when you often say that we're on an accrual method and we're gonna record accounts receivable and sales at the point in time we make the sale rather than the point in time we get the money which will be sometime in the future. It's often pointed out that we're kind of recording the asset on the books as relus the sales before we get any money. And what if we never get paid, which is probably probably happens in time to time. We're going to do some work from time to time, and we're not going to get paid. And therefore we're overstating in those circumstances the assets because the assets are going up by the accounts receivable and the revenue note what we're not doing. We're not overstating cash because we're not recording cash, but we are recording an asset that's a current asset cold accounts receivable, and we're increasing it even though we haven't gotten paid. Therefore, the readers of the financial statements. If we look at this from the reader's standpoint of the financial statement, we have to record it still, because if I'm reading the financial statements and people over the company $100,000 that's important to me. I want to know that it doesn't I recognize the fact that the $100,000 that people owe the company is not the $100,000 in the bank account, which would be preferable in terms of having the better looking financial statement. So but 100,000 still something I want to know about when making financial decisions. So it has to be on there when we want to make the best financial statements for decision makers, however, to make them better for decision makers. We should also tell the readers of the financial statement that, hey, we have some pretty good idea of how much of those receivables are not going to be collectible not based on our current clients particularly, but based on past history and history of related industries, on how how good a payment there is for receivables and on the income statement side. We also want the same issue, which is that if you're recording, you know, 100,000 revenue, we want to know well, if those were all made on accounts, meaning we never got the money for it, it's not really a sale if we never get the money for it. So or at least we should write off the bad debt related to the sale. So we need to be able to record. That makes some type of estimate for the balance sheet side and the income statement side. So in other words, we need to tell our reader how much of the accounts receivable we think is uncollectible and how much of the sales that we made this year, this time period that were reporting that we don't think are gonna ever get paid on. And so there's two methods we can do that we weaken dio the direct right off method and the allowance method. Now they direct right off method is a simplified method. It's not usually ah, method that we can use under general accepted accounting principles unless we believe that the amount will be in material that will be written off, meaning it's not 22 large for decision making purposes, and therefore we can use whatever method we want. Typically the direct right off method being easier. And that's gonna be the pros of the direct right off method, meaning there's no estimate or there's less estimates on the direct right off method. For example, if we make a sale, we're just gonna wait until we are pretty sure they were not going to get paid, and then we'll write off the bad debt. So at some point if we made a sale today and we're not gonna get paid on it. But we don't realize that till five years out. Then we'll ride it out. Five years out will write it off. Meaning will debit, bad debt expense, reducing that income? And we'll credit the accounts receivable five years later after we've tried to collect on it for that time period. Problem with that is that for that five year time period, we had a receivable on the books, which is overstating our assets, and we had, ah, income recorded and year one of that five years, which wasn't really net income was too high because we didn't were not really make a sale because we're not gonna get paid on it. So that's the problem with the direct right off that it's easier that way because there's not as much estimate. We don't have to make an estimate of how much we think it's gonna be uncollectible, but it's not as accurate because it doesn't apply to the matching principle in terms of the income statement side and overstates the assets typically on the balance sheet side. It can also be abused by management. I mean, if we wanted to make our revenue look higher or lower from one of our revenue to look higher this year, we might have bad debt expense that we're pretty darn sure that isn't going Teoh. We're not gonna get paid on. And instead of write it off, the management might, you know, have more incentive to write it off next year and and and under the direct right off method , it's It's more possible basically to do that to basically, you know, determine when you want to write off. And if, if we wanted, for whatever reason, it income to be lower in a term certain time period, possibly for taxes, we might decide to write out. You know, you could say, OK, I've determined now that these bad debt expenses, our uncollectible and lower net income by writing them off during that time period and so there's some arbitrariness in terms of, you know, when is something gonna be non collectible? Whereas if we do the allowance method, we have to make some type of estimate of how much was going to be uncollectible, and you could say that there's there's also a room for abuse there because it's an estimate and we could make a high estimate or low estimate, and that could change net income. However, the fact that we need to make an estimate and it needs to be reasonably done within industry standards and not me made individually based on a client by client basis or customer by customer, he was actually a bit more assured it meaning we can look at and say it Is it reasonable? If you compare this estimate to other industries that that this uncollectible amount would be reasonable might could be arguing that that would be easy to do. But in any case, the direct right off met. That should be better with the matching principle on the idea there is that, Ah, the asset side, the accounts receivable. We think we're gonna figure out how much we think it's gonna be uncollectible during this time period in some way, a couple ways. We can do that one ways to look at the aging for accounts receivable and try to determine based on related industries in past history, how much of it is uncollectible and then set up an allowance account allowance for doubtful accounts, which is a contra acid account. It's gonna be a NASA account with a credit balance. So the net of the of the accounts receivable and the Contra account would then be what we actually think it's gonna be collectible. So now we're telling our reader, Hey, this is how much people owe us. This is how much of it we believe is uncollectible. The difference between those two that it's subtraction of those two is what we think are true receivable is. And that would be that if those could be accurate numbers, that would be the best representation for most readers of the financial statements on the income statement side. We're gonna say, Here's our revenue and here's the bad debt expense, not the bad debt expense that we think is gonna be uncollectible due to, um, we've determined that particular clients are not going to be able to collect it, meaning bad that expense related to revenue that happened in prior periods prior years prior months. But we're looking to try to make some estimate of the bad debt related to the revenue that we actually earned this time period and match it up in that way. That being a better format of the matching principle. So we're going to say we earned 100,000. We think of that 100,000 that so much of it, you know, 5000 isn't gonna be collectible based on past history based on an estimate we have made. So that's gonna be the major difference between the two. Remember that the allowance method is gonna be generally accepted. Accounting principles, typically the method preferred under general accepted accounting principles and a cruel concepts. The matching principle in particular, but maybe allowed for a direct right off method if the amount to be written off is typically small and material to decision making. Or if you're talking about a smaller company which doesn't have as much requirements to use something like an allowance method, a smaller company may say, Hey, it's just it's more confusing to do an allowance method. It takes more time than the added information. I'm benefiting from doing what's typically considered to be a better, more accurate method. The allowance method. That direct right off method might be simpler and therefore, for a smaller company, easier to use and easier to deal with. So it's gonna be the pros and cons between the two 15. 40 Discussion Question Receivables: In this discussion, we will discuss the discussion question of compare and contrast the methods commonly used to calculate bad debt and allowance for doubtful accounts when looking at bad debt and the allowance for doubtful accounts. The first question we're gonna have to ask is, What are these things and what does this relate to? What problem are we trying to solve? Why would we want to calculate bad head expense and the allowance for doubtful accounts? And those two things have to do with accounts receivable. So the accounts receivable is going to be something that represents something owed to us from customers, typically from past sales. It's an asset. It's a current asset, and typically it's gonna be It could be overstated. That's the problem with it, because it could be a fact that we got people owe us money. We're never going to get paid on it. That's always a risk we have of doing business. And what we want to be able to do is tell the readers of the financial statements one how much people owe us, and then two, if we can tell them how much of that is, Oh, to us, we believe is uncollectible. That would be a fair way to report the financial statements, and that's what we call the allowance for doubtful accounts. That's what we use the allowance for doubtful accounts for. So if we see some things that says Allowance for doubtful accounts, that means that we're using the allowance method and not the direct right off method, which is a method that doesn't really do that estimate. It waits until the time period that we're not going to collect to record the bad debt. So here we're gonna assume that we're talking about the allowance for doubtful. Kip counts when calculate both bad debt and the allowance for doubtful accounts. So then how do we calculate the allowance for doubtful accounts? There's two methods we could use to calculate that. Ah, the way I see it in a way to makes intuitive sense to me, and I think a lot of people that I talked to on it usually I think of the of the accounts receivable in the problem with the accounts receivable more than I think of the income statement in the problem with revenue on the income statement, meaning I typically think of well accounts receivable. It could be overstated. How could we fix that problem? And if you think of that, you're thinking about the balance sheet side of things and you're probably gonna take a balanced approach to the problem. But as you fix the balance sheet, the income statement also becomes fixed because the other side of the journal entry you will make will be to the income statement. So if you better, uh, match up or if you better make the more accurate the balance sheet, typically you could be making the income statement more accurate. So, for example, the accounts percentage of accounts receivable method would be in some way to look at the accounts receivable, possibly by looking at an aging account by listing the accounts out by how old they are and then determining by industry standards in past experience. How much you think? Is it going to be uncollectible? Meaning you might take some percentage of the accounts that are past due by 30 days. Some percentage of the accounts that are past due by between 30 to 60 days, some percentage of the accounts probably a higher percent as they become more past due from 60 to 90 and over 90 and that would be one way to to try to estimate they will. The older something is the more likely we're not gonna get collected on it in an old because we tried to collect it for 90 days. So if we've been trying to collect on it for 90 days and we haven't got it yet, then it could be a very more likely that we're not going to get paid on that. And then we can see Okay. Well, then, how much of the receivables do we think are gonna be uncollectible and then will make the allowance for doubtful accounts match what we believe is uncollectible based on that estimate? When we do that, however, we won't be reducing accounts receivable because we don't know who exactly is not gonna pay us. We can't write down any individual account. Say this. Customers not gonna pay us. All we have is an estimate that we believe based on you know, this timing estimate not based on who the customers are, of how much we we thinks not gonna be collectible. Therefore, we will make this other account this current asset account put a contra account on account , an asset account that has a credit balance rather than a normal debit balance, which will then have this amount that we believe is uncollectible. So then we'll have the accounts receivable. What we believe people owe us. What people of us is not really an estimate minus the allowance for doubtful accounts, which is what we believe is uncollectible giving us the net receivables. Now that makes that makes the balance sheet pretty good there. Now we show the reader how much is owed to us and how much we think it's uncollectible and the Net. But the income statement also, it gets worked out, too, because the journal entry is gonna be a credit to allowance for doubtful accounts and credit Teoh and a debit to what we call bad debt expense. The income statement side. Reducing that income, which solves in some ways, have done well. If the income statement side, meaning the revenue we recorded is too high because if we recorded revenue for something that we're not gonna collect on, then it's overstated. And so if we record an expense related to it, bad debt expense that will reduce it now. The other method focuses on the income statement more. We can use the percentage of sales method which it focuses more on the income statement, and then the balance sheet will kind of fix itself if we use that method. So if we're more concerned, our focus is more on the income statement in solving the matching problem on the income statement, the revenue and the related expenses, Then the percentage of sales method makes more sense, meaning if we frame the problem more of a problem on the income statement side, which is that the revenue is overstated because we recorded revenue four sales for which we may not get paid on in the future and therefore should be reducing net income in some way with that debt during this time period. Then we can use the sales method instead of the percentage of receivables method, meaning we can look at the sales we made on account this time period. The sales we made four accounts receivable look at past history or industry standards to see how much of those sales typically become uncollectable and then make a journal entry the same journal entry debuting bad debt expense which would, um, reduced net income expenses, reducing the net income this time period. So we're recording bad debt expense related to this period's sales not related to sales that happened in the prior periods, as would happen under the direct right off method, a non generally accepted accounting principle method. We, in this case matching the amount we think is uncollectible with the revenue earned in the same time period and then the credit going. Teoh once again allowance for doubtful accounts, which will make the balance sheet side more accurate. Hopefully. But by focusing on the income statement side now, these two methods typically won't end up with the same exact answers. Um, and one will focus more on making the balance sheet correct. And one more focus more on making the income statement correct. So it kind of depends on where our focus is as to which method will be preferable, they typically are more. They're both estimates so, and they're typically not going to come out with the same number. Um, and there could be distortions from, you know, period to period, depending on the method we use. What we typically do want, however, is to use some consistency with the methods over time. If we choose one method, in other words, we should probably be fairly consistent with that method and conform to the consistency standard. 16. 10 Multiple Choice Questions Accounts Receivable: In this presentation, we will take a look at multiple choice questions related to receivables. First question. The person who signs a note receivable is a maker be pe e c holder de receiver, e owner. Well, read through this again and see if we can cross off some options with the process of elimination. The person who signs a note receivable is now. I know if we look at a note receivable, you might first start thinking, Well, maybe both parties. There should be two people signing the note receivable, but typically it's only required often times for one individual to sign the note receivable . And for the reasoning of that, we need to know that the notes receivable is basically kind of like a promise. So a note receivable is an individual promising to pay in the future at some point that we can imagine if we have a a debt that is due and we say, Well, I'm not gonna pay you now, but I'll write this little note here and give a formal note telling you that they will pay you in the future. That's what's going on here. So who's gonna be the person who signs it, the one who's making it. So if we look at this aim is the maker and so that sounds good, right? The maker. It seems like a technical term you might not hear or think of the maker of the note, but that's gonna be a technical term. Typically, that looks like a good term to use. That's what it's probably gonna be be is gonna be the payeasy. Now the difference between the payee and the pay or is a little bit confusing. We just have to know that terminology Pay ee and and then the pay or the pay, or is going to be the one that eventually pays the payment at the end of the note term, and then the pay is gonna be the one that's gonna be receiving it. So the payee may sign the note, but not really required to sign the note. The one who's making the promise to pay it's gonna be the one that needs a sign that's going to pay or the holder of the notes. The holder of the note is probably gonna be on the one that is going to get paid at the end of pe e is the one that's gonna hold the notes, and again, they're not the one that really needs to sign it. The one that needs to sign is the one making the promise that is. Get them giving the note to the holder that will then be able to use it for collection at the future. Uh, the receiver. I'm not sure that's exactly technical term there. The receiver of the note, I think. But that sounds more even if it were more of, Ah, the holder of a note. And again, the holder of the note is not the individual that is signing the note per se or is required to sign it. The one that is making it is, and then the owner. It's not really an owner of a note that said the note, Doesn't you know? You could say that the holder has possession of a note, but I don't think that term really applies here, so it looks like the maker is what we're left with. So the person who signs a note receivable is the maker of the notes receivable. Next question. A credit sale results in a a debit to accounts receivable account in the General Ledger and in the customer accounts in the customers account in the accounts receivable subsidiary Ledger. Be credit to the accounts receivable account in the General Ledger and to the customer's account in the accounts receivable subsidiary Ledger. See a debit in the accounts receivable account in The General Ledger and a credit the customer's account in the Accounts receivable subsidiary Leger de a credit to the accounts receivable account in The General Ledger and a debit to the customer's account in the accounts receivable subsidiary Ledger and E. A credit to the sales and a credit to the customer's account in the accounts receivable subsidiary Ledger. Okay, so one more time we'll see if we could go through this with the process of elimination. Ah, credit sale results in. Now this one, Since it actually has a journal entry, we might first want to just record the journalist. I would I would say, Write it down. It doesn't have a dollar amount. You may say that's okay. We can still write down what the debit and credit would be, and that would typically a credit sale. We made a sale and we didn't get cash we got a our accounts receivable so I could just put a dollar sign or something for the dollar amount, or just put an amount of 100 or something like that to show us that that represents some type of amount we don't know. They didn't give us that. That's OK. And then the credits gonna go to something like income or revenue or sales, whatever the income account is. So that's the normal journal entry. Now they're talking about this subsidiary ledger type thing and remember that that really is gonna be supporting backing up the accounts receivable account. So you got the accounts receivable account and then some type of subsidiary ledger, which will give us the same information by order of customer. So a then says a debit to the accounts receivable that looks good account and the General Ledger. This journal entry is gonna be posted to the G L. The General Ledger and a customer accounts in the Accounts receivable subsidiary Ledger. So that would be also a debit to the subsidiary Ledger. That sounds pretty good, because that's really what's happening here. We're debit in both the General Ledger and the Subsidiary Ledger Let's look through the rest of them, though. Be says a credit Teoh to the accounts receivable account in The General Ledger. A credit and we're debuting the General Ledger for accounts receivable. So that's why that one's not right. See, says a debit to the accounts receivable in the General Ledger. So debit to the county level. It's good. In a credit to the customer's account in the accounts receivable subsidiary Ledger. Now, we wouldn't be crediting the subsidiary Ledger. We're basically doing the same thing to it. This journal entry We are, in essence, posting the same. They are debit both to the G L General Ledger and to the subsidiary Ledger, the subsidiary Ledger being the same thing as the General Ledger, except that it's ordered in a different order rather than being just in order by date, it being ordered first by a customer. So then D says a credit to the accounts receivable account, and that's not correct. We're not crediting or debuting the accounts receivable, and E says, a credit to sales and a credit to that customer account in the accounts receivable subsidiary Ledger. We will credit income or sales, whatever that account is sales, but we're gonna debit accounts receivable, which, in essence, is the Subsidiary Ledger and the Geo Ledger. So we're not going to credit the accounts receivable accounts. That's why that is incorrect. So a looks like are correct. Answer. Once again, a credit sale results in a a debit to the accounts receivable account in the General Ledger and a customer account, customers account in the accounts receivable. Subsidiary Ledger. Next question. A promissory note is a investment for the maker. Be a written promise to pay a specified amount of money at a certain date. See and asset to the maker. De an installment receivable E can never be used in payment of an accounts receivable, so we'll go through the process of elimination question one more time. A promissory note is a an investment to the maker. You may have a question on who the maker is, so I'll leave that one for now. I mean, you could think of ah note as a kind of investment. B says a written promise to pay a specific amount of money at a certain date and that that promissory note that sounds pretty good. It sounds like a pretty good definition and then see says an asset to the maker. So once again, we've got this maker term here, so let's let's leave that one for now, D says an installment receivable and not necessarily an installment. Types say, unless it says it was an installment. So I'm gonna cross that, he says. They can never be used in payment of accounts receivable. And it's possible, actually, to do that, we could say, Okay, we can't pay you the accounts receivable. How about we sign a note receivable? And they might accept that because the note receivable would then charge interest. So that might be we could actually, you know, using new receivables payment from accounts receivable. So we're left with A B and C. So a promissory note is a says an investment to the maker. And see says an asset to the maker. Now note that those two kind of cancel each other out. In some ways, they can't both be correct. And even if we didn't know what the maker is, if something was both an investment and an asset, they would both be, You know, if it was an investment, it would have to be on acid typically. So that's one reason just looking at the multiple choice format. We could say from those two Don't look right and we can kind of cross those out. Now Who is the maker? That's the one that is actually signing the note. So the maker is actually the one that is making the promise of the notes. So that's usually that customer. In other words, now that's a little deceiving of a term, because oftentimes the person who writes the note will be the business because that's what they do. They make a standard note, but you can think of the note as a promise being made by the maker, the one that customer is promising to pay in the future. And therefore they're the one that's gonna sign it, as if they made it as that they wrote up the notes, and I'm gonna promise you to pay whatever I owe you in the note and sign it and give it Teoh, the other individual, that being the business. So the maker, then it's not an investment to them. It's get some kind of like a liability to them, and so that's not correct. Here And that's why it's not an asset to the maker. It could be an asset to the receiver or the holder of the note. So be looks like are correct. Answer a written promise to pay a specific amount of money at a certain date. So one skin a promissory note is be a written promise to pay a specific amount of money at a certain date. 17. 20 Multiple Choice Questions Accounts Receivable: In this presentation, we will take a look at multiple choice questions related to receivables. First question. A promissory note received from a customer is recorded as a an equity account. The and accounts receivable account. See always a current asset de always a non current assets or e a current or non current asset. Read through it one more time. Go through the process of elimination. Question is a promissory note received from a customer is recorded as a an equity account. So a promissory note, if we receive the promissory note from the customer, might help by thinking of the journal entry related to that. So if we received a promissory note, typically we might have a sale that we made and we credit sales. And then the debit might be the note receivable rather than accounts receivable. Typically, because possibly the dollar amount with larger large longer term that we have that we're gonna receive the note receivable four, and therefore we want a formal note. So the note receivable then it's typically going to be some type of asset. We made a sale instead of accounts receivable. We have a note receivable, so the promissory note isn't typically going t o deal with equity, although the other side is increasing net income and therefore increasing equity. But the note isn't so. We're gonna say that's not in visas and accounts receivable account. Now we'll leave that It is a receivables, we might say limits of receivable, but I'll leave that for now, SI says. Always a current asset type of account. And, uh, if we read through the rest of these, D says always a non current asset, so note that those two are basically exclusive to each other. So you know, if one of those is true, then the other, you know, they kind of cancel each other out. And then he says, a current or non current asset. So if we look at at these three, they're all kind of related. So if we go through this one more time, a promissory note received from a customer is recorded as either an account receivable account. Always a current assets, always a known current asset or a current or non current assets. Now, whenever ah, question says always want to be careful of that. If it says always Ah, you know, all we need is one exception to make that to be untrue. So e. I'm leaning forward just because of that and the reason for that. We may think that that being the case where the note receivable would always be a non current would probably be the way most people would think of that, because if it were a current, we may think that it should go into accounts receivable and not notes receivable. But the definition of a note receivable really isn't that it's over a year. That's the definition of a current asset, a current asset being something that's gonna be dio typically within the year, making it current and note receivable. Maybe a note receivable not do for more than a year but isn't necessarily so. So the note receivable could be something longer, typically that a normal accounts receivable but still do within a year. So therefore, he's really looking good here because big note receivable could be current or it could be known current just depending on how long the term of the note receivable is, and that really eliminates C and D B, says an account receivable and accounts receivable. It's still a receivable, but it is different. So no conceivable and accounts receivable are similar in nature, but not the same in nature. So it's not be, and it looks like he's our best answer. Once again, the question is, a promissory note received from a customer is recorded as e. A current or non current asset. Next question. The quality of receivables is a the reputation of the cellar. Be the speed of collectibility. See the likelihood of collection D the reputation of the purchaser or e that interest rate . So if we go through this one more time, we're gonna say the quality of a receivable is the reputation of the cellar. Now, if we're talking about reputation and we're talking about the receivable, remember what a receivable is? It's gonna be something do from a customer. So we're not really talking about the reputation of the seller in this case. If we're concerned with anything, it would be the reputation of the person who needs to pay because we're trying to value whether or not the receivable. The quality of the receivable is good. So the asset of the receivable representing stuff that owes is owed to us. Is it good that doesn't deal with the seller's reputation, but the customer be the speed of collectibility now that could be a factor in the quality. So we'll keep that, C says, the likelihood of collectibility. That, too, seems like a pretty good factor in terms of determining how valuable that receivables arm De says the reputation of the purchaser. Uh, and and again, if we're looking at reputation, we would be considering the purchaser more than, ah, the the other side of the transaction, the business. And then he says, the interest rate, the quality. We're not really talking about the interest rate here. That and you know, some receivables if we're talking about accounts receivable, won't even have an interest rate. So we might consider ah, higher interest rate to be better. But that's not really what we're talking about in terms of the quality with regard to most receivables, including accounts receivable which doesn't have an interest rate. So once we got, we're left with B C and D question one more time. The quality of a receivable is be the speed of collectibility. See the likelihood of collection, or D, the reputation of the purchaser and I think of all of those, the likelihood of collection is really the most concerning factor here. Ah, speed might be better if we get it faster. That might make someone you know, some received both more quality than the others. And the reputation of the purchaser may have something to do with whether or not it's gonna be a collectible or not. But ultimately, our major concern is collectibility. So I think see is the best of these answers. Speed is not, you know, the only thing it has that kind of has to do with collectibility in some way and d also is not the only thing we're looking at. We're looking at collectibility, which may, you know, taking account the reputation of the purchaser. So final answer. The quality of receivables is see the likely to of collection. 18. 30 Multiple Choice Questions Accounts Receivable: In this presentation, we will take a look at multiple choice questions related Teoh receivables. First question. The materiality constraint A does not allow the use of the direct right off Method B requires the use of the allowance method. See requires use of direct right off method de permits. The use of direct right off method when bad debt expenses are relatively small or e requires that expenses be reported in the same period as sales they helped produce. So we'll go through this again and go through the process of elimination. The materiality constraint Hey does not allow the use of the direct right off method. Now, if we don't know what the materiality, constraint, materiality, extreme constraint is, we may think that that direct right off method is this is a good answer because the direction right off method is not the preferred method. Now, if we go through some of these, we might be able to use them to have some process of elimination. So, be says, requires use of the allowance method so a says did not allow the use of the direct right off medicine and be says require the use of the allowance method. Now those air basically, you know, there's only two methods typically to writing off the the ah Countess evil. Either we use the direct right off method or the allowance method. So if a says we're not allowed to use the direct right off method, and B says what we are required to use the allowance method, they can't both be right. And so those almost eliminate each other from from. The answers here, See says, requires the use of the direct right off method. So that one just intuitively doesn't make sense. Really, because the allowance method is typically the one that we would think is the preferred method. So if there's gonna be anyone that is required, you would think it would be the allowance method that would be required. So I don't think see. Sounds good, De says permits the use of the direct right off method when bad debt expenses are relatively small, and so that gives a qualification. Here we got we can we might be able to use the direct route method and then, he says, requires that the expenses be reported in the same period as the sales they helped produce and that actually sounds kind of good to write. I mean that I've heard that somewhere. What type of principle is that? So let's read through this one more time. See if we could just use the process of elimination as if we don't really know what materiality is and then see if we can define it. So the materiality constraint a does not allow the use of the direct right off method or B requires the use of the allowance method, which are both of those cannot be right. And they seem to be, Ah, you know, if one's true than the other, seems like it should be true. So I'm gonna say that those both can't be true. And that's basically telling us, um, that it's not requiring the allowance method. And then, D says, permits the use of the direct right off method when bad debt expenses are relatively small . That sounds kind of reasonable, because that would mean that we usually wouldn't need to have two required to use the allowance method unless something happens unless the direct write offs are pretty small. So that sounds pretty good and then, e says, requires the expenses be reported in the same period as the sales they helped produce. And that sounds really good. That sounds familiar to me, but that's on a cruel principle. That's a standard, a cruel principal, one of the main to that matching principle. And it's not really dealing with the materiality constraint here directly. So that's although it probably rings a bell. It's not the one we're looking at here, so D's the one we want. So materiality constraint means that, um, you know, it's something that's small enough that it doesn't affect decision making processes. Then we can use that non preferred method, which is the direct right off method. So the direct right off method does not apply the matching principle as well. But it's easier typically. And if the differences in material because of the dollar amount, then it would be permitted to use. Given this materiality constrained, so once again, the answer. The materiality constraint. DIY permits the use of direct right off method win bad debt expenses are relatively small. Next question and accounts receivable. Subsidiary Ledger is important for all reasons except A. It shows how much each customer has purchased on credit be. It shows how much payment history per customer. See, it shows how much each customer owes d. It helps to generate invoices and e, it tells us, Win customers plan to pay. Let's go through this again with the process of elimination and accounts receivable. Subsidiary Ledger is important for all reasons. Except now, when we think about a accounts receivable subsidiary Leger, we first probably want to define that as we go through these questions and see which ones would apply or not. The subsidy religion is going to be supporting backing up the amount on the general ledger or on the trial balance or on the balance sheet. Now the General Ledger supports that information put, giving the detail by date. What we want to do is give the detail by customer, and that's what we're doing here. We're trying to give detailed by customers so that we know who owes us the money. So a then says it shows how much each customer has purchased on credit. That's typically what we're doing. That's what the subsidiary Ledger is, therefore, so it's not that one. That's what it does for sure, he says. It shows how much payment history per customers should be payment history per customer, and it does show the payment history because it shows how much they bought and the payments that they made, SI says. It shows how much each customer owes. And, um, you know, does show how much each customer owes because it's gonna show the purchases, the payments and how much is still owed by the customers. And the D says it helps to generate invoices. Um, which it shows how much the customers. Oh, so it helps us to collect on the invoice and or to generate them. So yeah, looks good. And then he says, it tells us when the customer plans to pay. So of all this, it doesn't really tell us. E Now it has the term of when the payment is due, But the the customer, of course, could pay any time. If it's due 30 days from now, the customer could pay us anytime within the 30 days. Hopefully, they will pay us by the end of term at the end of 30 days. Hopefully sooner than that, we'd like to get the money sooner, but we don't really. It doesn't really tell us when the customer we can't you know, being the customers head there? We don't know that. So I think he's the correct answer. So the question and answer one more time is and accounts receivable. Subsidiary Ledger is important for all the reasons except e. It tells us when the customer plans to pay. 19. 900: Hello. When this lecture, we're gonna work some smaller test type problems problems that are of a size that could fit into multiple choice questions. We have here company accept all major bank credit cards, many which assess a 5% charge on sales during the card using the card on May 26 company had 6200 credit sales. What entries should companies make on May 26 to record the deposit? So we're gonna make the credit sales, and we're gonna have to account for the charges on those sales. So first thing I would think about is cash affected and we're talking about this credit card kind of like being cash that we're charging it on the credit card, and we're thinking about how much is gonna be automatically basically deposited into our account through this credit card charging system. So in this case, we're gonna say yes, can't. Cash is actually affected on this. It's not going to go into accounts receivable in this case work, considering the point of sale basically kind of like cash. As of the time that the credit card was used in this case, then we're gonna think about Well, what's the credit gonna be? Well, usually it's gonna be if we made a sale to sales or income, and so that's gonna be the credit that we will have. Now we're assuming in this, and it's a little difficult to tell from the wording of the problem. That's one of the problems with smaller type questions. We're assuming that's this. 6002 is the credit sales, basically those with credit sales that are happening and we're gonna have to pay part of those basically as fees for the credit card. So we're going to say that the credit card sales was credit. I'm gonna make it a negative for credit 62 and then we gotta figure out, Well, how much cash are we gonna get after the credit card fees? So that means that if we have a six to that we are would have received if it weren't for the fees and then we have fees of 0.55% of remove the decimal two places over. Gonna go back on that cell home tab numbers group and I could show decimals. It's porno five, or we could go to the percent here we can underline it if we want. We don't need to do this formatting, of course, on a quick question, but it's good practice. So we're gonna say this equals the 62 times 5%. That means, of course, that we are gonna have to pay the credit card company that 310. Therefore, how much cash are we gonna get? We're gonna get this six to minus the amount we have to pay the credit card company. That's what's gonna go into our account. So we can also calculate that a bit faster. And it's useful to know by saying, if we had to six to and we had a 5% that we're gonna have charged on that how much are we going to get? We would get 11 or 100% minus 1000.55%. And if we move the desk from places over home tab numbers, that is 0.95 or 95%. So if we're not gonna get 5% then we are gonna get 95% and that's a bit faster of a calculation, and it's useful in many different areas to know that therefore, that's how much cash we're gonna get. So now we know what the debit is. The Deb. It's gonna be not the six to that we made in sales. It's gonna be the 5890 because we're not gonna get part of that. The part that we're not gonna get is going to be the difference between these two. This minus this 3 10 Or as we already calculated this 3 10 here. And we need a debit to make this work. So I'm gonna put in the 3 10 right there. Therefore, the debits now at six. To equal the credits at 62 And then we got to kind of make up an account as to what we're gonna put this to. And we could just call it credit card fees or something like that, and it's an expense. So whatever that whenever we decided to name that expense something credit card fees or something that's related to the charges, of course, of the credit card. And of course, I built this journal entry, which, in the method that makes most sense to me, meaning I started with cash. And then I thought about the next thing that happens. And then I put in the plug down here the 3 10 which we could also calculated with our plucked formula negative. Some of these two me and that's what we need for the debits equals credits, but toe format it properly. In terms of the journal entry, we could put the debits on top, so just remember that you'll probably see it in the answer key. Of course, like this, it wouldn't make any difference if you put the journal entry into a system most systems in a different way, in whatever the audit trail helps you to put it in the system, I would put it in that way. But in order to put the debits credits on top, you basically would want to see it like this next. One says that company uses the allowance method to account for uncollectible accounts. It's year in unadjusted trial Balance shows accounts receivable of 1 42 500 allowance for doubtful accounts 1045 and sales. And that's a credit. It could possibly be a debit dependent. We over under applied and sales of one million won 15,000 if uncollectible accounts were established to be 9.9% of sales. What is the amount of bad debt expense adjusted. So, in order to set this that we could do this pretty quickly by what it's going to be is it's gonna be the sales times this 0.9%. Why did they give us all this other information in that case? So I mean, we could calculate this is gonna be sales as 1115 times. The 9% will just say point. Remember that if we move the decimal two places over its 20.9 So if we go to the home tab and we increased decimals, its 0.9 or in terms of percent, 9% which would have to add this most again 9%. So I'm gonna underline that and let's go ahead and calculate that this equals the one million won 15,000 times the 9%. And that's the amount that we were put into the allowance. Now let's think through this because there's two methods to do this. We did this on the sales method, which we would just have to do this calculation and then create the journal entry, which would be a credit to the allowance and a debit to bad debt expense at that time. But let's think through the information we have, because the other side of this the other way, they could have asked this was Teoh make this calculation based on the receivable, which in my experience, is actually more common. That's what I've seen more often. So those the two ways we can ask it. So if we think about that the T account for accounts receivable, I'm gonna go ahead and merge This gonna underline this, gonna make our t account here and put this on the left hand side. And I was gonna call this allowance for doubtful accounts. So that's the allowance for doubtful accounts. I'm gonna merge that gonna underline that. Gonna make a line on the left hand side of that. And then the accounts receivable here is at 1 42 5 after debit and the allowance, they say, is a credit. It could be a debit. And if it was basically kind of overdrawn last in the last period, meaning if we had more actual uncollectable debt than we estimated. But we have a credit. I'm gonna represent it with a with a negative 1045 That means the net amount that we believe we're going to get is this. Plus this. Now, why do we need this information? When we we already figured out the answer and calculated this without this information? Well, they're kind of saying, if you were to do it the other way to figure out based on receivables rather than based on sales, what amount should be uncollectible, which is quite common. Then you have to figure out what's already in the allowance for doubtful accounts amount and then adjust it to whatever you think it should be. So that's why this this becomes relevant. So be careful of that. Those two methods on the allowance meth Next woman says that a company borrow 13,000 by signing 100 and 80 day promissory note at 10%. The total interest you at maturity is what we're gonna assume a 3 60 days a year. Okay, so in order to do this, we gotta basically calculate what the interest will be. So obviously we're gonna have the amount we borrowed the principle, and that's gonna be the 13,000 and then we're gonna multiply that times the rate the rate is how I would do it, obviously, and they were just 8.1, and I'm gonna go to the home tab. I'm going to go the number group and make that 10% or 100.10 and then make it a percent or 10%. However, we like to see it, then we'll then underline that, and the key point here is this would be interests for a year. So that's the key point that people have to kind of get in their head this times. This 10%. If we had this loan out for a year, we would be paying 1300. And that's just the standard way we talk about interest whenever we say interest, and we don't basically say any time period. If we don't say interest per month or interest per day will be this, it basically means interest per year. Just like if we said something like, you know, that person earns 100,000 we would kind of assume it means a year. In that case, we have to make some assumption. So that's basically what we're gonna assume. So that means that it hasn't been for you. It's only been for 180 days. How do we account for that? Well, if we're talking about days, we can break down instead of a major in term of use. We could major in terms of days so we can divide by days in a year, which you're probably thinking is 3 65 But the reason they're trying to use 3 60 here is because it makes it a simplified calculation. Meaning what is 3 16 mean? It's It's gonna be 12 times 30 Just if all months had 30 days just to estimate. That's why we get a nice round 3 60 So that would That would mean the interest per day would be the interest per year divided by the number of days in the year. Nice, even number of days 3 60 Gonna go ahead and underline this and see if there's any decimals on that and notice there are. And so that's not a, um around that number continues, so note that when we do it in excel, if we use this number, it'll calculate this number. What it actually is even though we only see 3.61 it's actually going to calculate based on 3.61111 So then, if we take that and how many days were actually in the loan? 180 days. So if we charged 3.61111 times the number of days 1 80 we get the 6 50 So I'm gonna go ahead underlying this and that is our answer. So note that the ratio that we could use if you're looking at a book what they will say most of time they won't do it. Longhand like this as much they'll say 1300 times the ratio of 1 80 over that 3 60 And that almost that always used to kind of confused me a little bit more to see it that way until you know I get more comfortable with that, it it's more comfortable for me. T most light out this way and say, Okay, I got in times for a year, and then I need to make it per day. Remember that that could be rounded me and you could be off by some pennies and whatnot and then most by that times the number of days, and that makes the most sense to me 20. 900: Hello. With this lecture, we're gonna works in smaller test type questions, questions that are other size that they could fit into multiple choice format we have here . A company uses the allowance method of accounting for uncollectible accounts receivable. On May 3rd company wrote off the 4400 uncollectible accounts of its customer on July 10th received a check for the full amount of 4400 from that same customer the entity or entries company makes to record the write off off the account on May 3rd. So they're asking for that first transaction, even though they told us that later on, the customer came and paid it back. So what's happening here? We had a receivable. We made a sale sometime in the past, and then we determined at this point at may 3rd point that this would be uncollectible. We're not gonna get paid by this particular customer. What would be that journal entry at that point in time? What? We know that the receivable is, um, acid and they all with money, and we need to make it go down because they're no longer gonna pay us. Therefore, we're gonna reduce the asset. So we're gonna credit the receivable accounts receivable is gonna be credited. I'm gonna put it way out here for I'm gonna put the credits being a negative. Number 4400 That means we're gonna debit something. And obviously, if we got paid, we would debit cash. But we didn't get paid in this time. We would debit under a direct right off method, the bad debt expense at this point. But under the allowance method in an attempt to match the expense with right off the same time period as the sales, we've already expensed it or estimated what? That expense will be in the allowance for doubtful accounts. And now that this has happened, we're gonna take it out of the allowance for doubtful accounts Allowance for doubtful accounts, usually having a credit balance. We're gonna reduce it now with a debit and noticed there would be no net effect on accounts receivable from this transaction. So here's the transaction to write it off, we're gonna debit allowance for doubtful accounts, and we're gonna credit accounts receivable now. Notice they asked us kind of the easier proportion, even though they gave us all this information which is kind of confusing us because they asked us for the right off and they could have asked us what what would happen. What happens when the company, the customer actually comes in and pays? We thought the customer left town never gonna see him again. Customer comes in and pays. What are we gonna do in that case in what we would do there to journal entries. So if they did ask for what happened at the second point in time in July 10th then we would have to first reverse this. We would say, OK, well, accounts receivables back on the books for 400 Just a complete reversal of this entry. This puts them back into good standing. Put this over here. I'll just say this equals this so that would put him back into good standing. And then we would do the normal transaction, the normal transaction being we got cash so cash is going to go up with a debit of 4400 and we have a credit, and the credit would then in this case, goto accounts receivable. That would be the two journal entries. And this was always used to be really confusing to me when I first learned this, because it seems like we're doing more work than we have to do because we're doing to journal entries and we're debuting and crediting the receivable and from just a journal entry standpoint notice. What we could do to Shortness is is to just do this half to just say OK, the same result would be if we just took this and credited the allowance. And then we debited the cash and the debit and credit would look like that. And what? Why don't we just do that with one journal entry? And instead of this business of basically debuting the receivable and in crediting the receivable, why don't we just do what we need to do to the accounts that will actually be affected or changed in the long run? And the reason for that is, basically, we are reversing what happened last time so that when we see it on her subsidiary, Ledger gives it's kind of an audit trail. So although the in journal entry terms strictly this would be the shortest way to do it, most texts will have us do the reversal and then do the normal process. That would happen when we receive the payment. Next woman says that a company has the net sales of 1,630,200 average accounts receivable of 4 18,000 What is the accounts Receivable turnover. So, in order to do this, obviously we need to know what the accounts people turn over. So they are Come over, is going to be net sales over. I'm gonna flecked off enter to go over and then it's gonna be the average. They are just going to say average a r and then I'm gonna underline that underlying that enter, go back on it and we'll center it. So there's there's the ratio that we need to have and they just gave us those two numbers and this is a bit more simplified than it normally is, because normally obviously from financial statements, we would have to figure out what the average receivable was. And what we would do then is we would see what was the receivable on last periods, financial statements, the end of last period being the beginning of this period. And what was the receivable at the at this period the end of this period on the on the balance sheet, that point in time. Which is, of course, as of the end of the period. And then we would add those together and divide by two kind of giving us what receivable could have been basically any time within that time friends. So in this case, it's just the one 630 two over, both in terms, writing it in the same format, the 418 comma there 00 And if we underline that, we'll just the top when I want to underline just the top one. Then it's that Inter and then weaken center it. And then, if we, of course, do that calculation, this equals the 1630 to 00 divided over the 418000 and enter. Remember that Excel could be rounding here, so we have the ratio and we want to add decimals, the home tab numbers to see if there's any more. So there it is. It's 3.9. Next, we'll insisted on July 9th. Company receives 9101 150 day 12% note from customer as payment on account. What entries should be made on July 9th to record receipt of the note. This one's really just kind of like a terminology thing. We got to see what they actually mean by this. And so what if we interpret this were saying Okay, we haven't accounts receivable out there that this customer owes us money. They can't pay us. So what's happening is we're saying, OK, we will extend the date to 150 days if we make it a formal note and then charge interest on it. And so that being in real life, we would, of course, know that we would know the situation. So in this case, we're saying, OK, they accounts receivable. We're gonna get that off the books and then put on the books the note, which is gonna have an interest rate, unlike the accounts receivable. So the accounts receivable, we're gonna soon we're gonna take that off the books. Accounts receivable is an asset. It has a debit balance. We're going to the opposite thing to it, which is a credit of the 91 and then we're gonna put it back on the books, but not as an accounts is here, but that it's a note receivable and it's still an asset. It's basically the exact same thing, except at this point. The note receivable is a longer term. We're extending the terms, and we're charging interest on it now. We, of course, don't have to worry about the interest yet because no time has passed as time passes. We will then have interest income on the note, unlike what we would have on it in accounts receivable because we don't charge interest on the account. See, because it's usually do within like, 30 days. Next one says that company A makes an 80,090 days, 7% cash loan to Company C Company A's entry to record the transaction. So we loaned out money, I would ask always is cash affected in this case? It is. We loaned out the 88,000 at this point, Teoh, the other company. So we're going to say cash is a dead. It's gonna go down by doing the opposite thing to it, which is a credit in this case. I'm gonna make mine and negative for the credit and put it in the credit column, and then we're going to dip it something, and that debit is going to be in this case, we loaned the money out. We're going to get it back sometime in the future. So it's gonna be something like a note receivable or loan receivable. And, of course, the difference between a note or loan, eyes going to be and accounts receivable. A. Our accounts receivable is that we have the interest, and it's usually look for a longer period of time. Usually there's a formal documentation. Usually it's for a longer period of time, and usually there is interest charged on it. The thing that confuses some people when we see this is it seems like we have more information that we need in that they have two terms of the loan and the percentage on it. Those, of course, are important to the loan to make sure it is alone. And we will need to deal with those at a later point that later point being when time has passed and we have been earned the interest by loaning out the money will have to calculate how much interest we have learned