Financial Accounting: An Integrated Statements Approach, 2nd Edition

SUMMARY OF LEARNING GOALS

372 Chapter 8 Receivables

Most retail companies sell merchandise for cash and on ac-

count. When merchandise is sold on account, an account re-

ceivable is recorded. If accounts receivable increase from one

period to the next, then the amount of revenue shown on the

income statement does not represent the amount of cash re-

ceived from revenue during the period. Instead, part of the rev-

enue includes sales on account (accounts receivable) not

collected during the period. Thus, to determine the cash flows

from revenue activities, any increase or decrease in accounts

receivable must be considered.

For example, assume that Bower Company reports total

revenues of $760,000 during 2008 and that accounts receiv-

able increased during the year from $45,000 to $63,000.

Thus, the amount of cash received from Bower’s revenues dur-

ing 2008 is not $760,000, but rather $742,000. That is, of

the $760,000 of total revenue during the year, $18,000

($63,000$45,000) represents revenue that was created by

increasing sales on account. Likewise, assume that instead of

increasing by $18,000, Bower’s accounts receivable had

decreased by $15,000 (from $45,000 to $30,000) during

2008. In this case, the cash received from revenue activities
      would have been $775,000 ($760,000 $15,000).
      In reporting cash flows from operating activities on the
      statement of cash flows, companies are required to reconcile
      net income with cash flows from operating activities. In do-
      ing so, companies must consider the effect of increases and
      decreases of their accounts receivable on their cash flows
      from revenue activities. As illustrated above, if accounts re-
      ceivable increase, the increase must be deducted in arriving
      at cash flows. During 2004, Starbucks’ accounts receiv-
      able increased by $25.8 ($140.2 $114.4). Thus, on its
      statement of cash flows, Starbucks must deduct this increase
      to arrive at cash flows from operating activities, as shown
      below.^6

(in millions)

Net earnings $390.6

Increase in accounts receivable (25.8)

Net cash provided by operating activities 820.2

Accounts Receivable and Cash Flows

FOCUS ON CASH FLOW

Describe the common classifications of receivables.

The term receivablesincludes all money claims against

other entities, including people, business firms, and other

organizations. Receivables are normally classified as ac-

counts receivable, notes receivable, or other receivables.

Describe the nature of and the accounting for uncol-

lectible receivables.The two methods of accounting

for uncollectible receivables are the direct write-off method

and the allowance method. The direct write-off method rec-

ognizes the expense only when the account is judged to be

uncollectible. The allowance method provides in advance

for uncollectible receivables.

Describe the direct write-off method of accounting

for uncollectible receivables.Under the direct write-off

method, the entry to write off an account debits Bad Debt

Expense and credits Accounts Receivable. Neither an al-

lowance account nor an adjusting entry is needed at the end

of the period.

Describe the allowance method of accounting for un-

collectible receivables.A year-end adjusting entry

provides for (1) the reduction of the value of the receivables to

the amount of cash expected to be realized from them in the

future and (2) the allocation to the current period of the ex-

pected expense resulting from such reduction. The adjusting

entry debits Bad Debt Expense and credits Allowance for

Doubtful Accounts. When an account is believed to be uncol-

lectible, it is written off against the allowance account.

When the estimate of uncollectibles is based on the

amount of sales for the period, the adjusting entry is made

without regard to the balance of the allowance account.

When the estimate of uncollectibles is based on the amount

and the age of the receivable accounts at the end of the pe-

riod, the adjusting entry is recorded so that the balance of

the allowance account will equal the estimated uncol-

lectibles at the end of the period.

The allowance account, which will have a credit balance

after the adjusting entry has been posted, is a contra asset

account. The bad debt expense is generally reported on the

income statement as an administrative expense.

1

2

3

4

6 Adapted from Starbucks Corporation Form 10-K filing with the Securities and Exchange Commission.

Small differences in reported amounts may appear due to reclassifications within the financial

statements.