Account Receivable | Financial Accounting | CPA Exam FAR

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These lectures cover trade receivable, bad debt expense, allowance method, cash realizable value, notes receivable, and direct write-off method.

Basics of Account Receivable

Valuing Account Receivable | Bad Debt Expense | Allowance for Doubtful Accounts

Example: Bad Debt Expense

Factoring or Disposing Account Receivable.

Example: Factoring Account Receivable

Accounting for Notes Receivable

Example: Notes Receivable

Account Receivable Analysis

The term receivables refers to amounts due from individuals and companies. Receivables are claims that are expected to be collected in cash. The management of receivables is a very important activity for any company that sells goods or services on credit.

The term receivables refers to amounts due from individuals and companies. Receivables are claims that are expected to be collected in cash. The management of receivables is a very important activity for any company that sells goods or services on credit.

Recognizing Accounts Receivable

Recognizing accounts receivable is relatively straightforward. A service organization records a receivable when it performs a service on account. A merchandiser records accounts receivable at the point of sale of merchandise on account. When a merchandiser sells goods, it increases (debits) Accounts Receivable and increases (credits) Sales Revenue.
The seller may offer terms that encourage early payment by providing a discount. Sales returns also reduce receivables. The buyer might find some of the goods unacceptable and choose to return the unwanted goods.

Valuing Accounts Receivable

Once companies record receivables in the accounts, the next question is: How should they report receivables in the financial statements? Companies report accounts receivable on the balance sheet as an asset. But determining the amount to report is sometimes difficult because some receivables will become uncollectible.
Each customer must satisfy the credit requirements of the seller before the credit sale is approved. Inevitably, though, some accounts receivable become uncollectible. For example, a customer may not be able to pay because of a decline in its sales revenue due to a downturn in the economy. Similarly, individuals may be laid off from their jobs or faced with unexpected hospital bills. Companies record credit losses as Bad Debt Expense (or Uncollectible Accounts Expense). Such losses are a normal and necessary risk of doing business on a credit basis.


Under the direct write-off method, when a company determines a particular account to be uncollectible, it charges the loss to Bad Debt Expense.

Under this method, Bad Debt Expense will show only actual losses from uncollectibles. The company will report accounts receivable at its gross amount.
Use of the direct write-off method can reduce the relevance of both the income statement and the balance sheet.
Under the direct write-off method, companies often record bad debt expense in a period different from the period in which they record the revenue. The method does not attempt to match bad debt expense to sales revenue in the income statement. Nor does the direct write-off method show accounts receivable in the balance sheet at the amount the company actually expects to receive. Consequently, unless bad debt losses are insignificant, the direct write-off method is not acceptable for financial reporting purposes.


The allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period. This provides better matching of expenses with revenues on the income statement. It also ensures that companies state receivables on the balance sheet at their cash (net) realizable value. Cash (net) realizable value is the net amount the company expects to receive in cash. It excludes amounts that the company estimates it will not collect. Thus, this method reduces receivables in the balance sheet by the amount of estimated uncollectible receivables.

Companies must use the allowance method for financial reporting purposes when bad debts are material in amount. This method has three essential features:

  • 1.Companies estimate uncollectible accounts receivable. They match this estimated expense against revenues in the same accounting period in which they record the revenues.
  • 2.Companies debit estimated uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. Allowance for Doubtful Accounts is a contra account to Accounts Receivable.
  • 3.When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.


  • Notes Receivable
  • Companies may also grant credit in exchange for a formal credit instrument known as a promissory note. A promissory note is a written promise to pay a specified amount of money on demand or at a definite time. Promissory notes may be used (1) when individuals and companies lend or borrow money, (2) when the amount of the transaction and the credit period exceed normal limits, or (3) in settlement of accounts receivable.
    In a promissory note, the party making the promise to pay is called the maker. The party to whom payment is to be made is called the payee. The note may specifically identify the payee by name or may designate the payee simply as the bearer of the note.


dishonored (defaulted) note is a note that is not paid in full at maturity. A dishonored note receivable is no longer negotiable. However, the payee still has a claim against the maker of the note for both the note and the interest. Therefore, the note holder usually transfers the Notes Receivable account to an Accounts Receivable account.