Your goals for this “receivables” chapter are to learn about:
- The costs and benefits of selling on credit.
- Accounting considerations for uncollectible receivables.
- The allowance method of accounting for uncollectibles.
- Notes receivable and interest, including dishonored obligations.
Chapter 7 reveals that receivables arise from a variety of trade and nontrade sources. Trade receivables relate to sales of goods and services on account. Among the costs and benefits of selling on account is the risk of uncollectible accounts.
If not material in amount, a business might use the direct write-off method, wherein accounts are charged against income in the period finally deemed uncollectible. However, a better matching of revenues and expenses is achieved with an allowance method, wherein an estimated amount of expense attributed to all sales is recorded each period.
A receivable may be evidenced by a formal instrument called a note. Notes receivable often bear interest. Interest may be calculated by multiplying the principal of the note by the interest rate, times the number of periods (Principal X Rate X Time). Accountants must be especially carefully to accrue interest on notes at the end of each period.