Receivables ⢠Must be presented on Balance Sheet at their ...
Receivables
Must be presented on Balance Sheet at their recoverable amount / realizable value. Trade receivables should be separately disclosed from o Related party receivables o Notes receivables
Accounting for Uncollectible Receivables i)
Direct write-off method a. Only account for uncollectible Accounts Receivables with they are identified (as they occur) and record bad debt expense at that time b. Not GAAP c. Only appropriate when uncollectible accounts are very small
Journal Entry to write-off accounts: Bad Debt Expense Accounts Receivables
xx xx
If subsequent collection arises: Cash
xx Bad Debt Expense
ii)
xx
Allowance Method a. GAAP (PEGAAP, IFRS) b. Consistent with the MATCHING PRINCIPLE c. Record the expense of bad debt in same period as year of credit sale d. How: establishing an “Allowance for Doubtful Accounts“ account i. Contra asset account ii. Subtract from Accounts Receivable to arrive at net amount e. Under this method, we estimate bad debt expense and record it at period end as an adjusting entry f. When actual uncollectible account is identified; i. No effect on Income Statement ii. No effect on net Accounts Receivable g. 2 methods to calculate Allowance for Doubtful Accounts i. Sales method ii. Accounts receivables (aging) method h. Sales Method
i. income statement approach ii. aims to record best estimate of bad debt expense iii. Bad Debt Expense = Credit Sales x Estimated Uncollectible Journal Entry: Bad Debt Expense
xx
Allowance for Doubtful Accounts
i.
Example: Total 200,000 Est % no collect Estimated Allowance
xx
Accounts Receivable (Aging) Method i. Balance Sheet approach ii. Aims to calculate best estimate of the Allowance for Doubtful Accounts (so that Accounts Receivable presented is at realizable value) iii. Requires a review of A/R aged listing at report date and estimate which % in each aging category is expected to be uncollectible iv. We calculate the actual Allowance for Doubtful Accounts account, not the bad debt expense. Abrams Co. has an aged A/R schedule that show the following balances at December 31: 0 – 30 111,500 2%
31 – 60 41,400 5%
61 – 90 38,000 10%
91 – 120 6,600 25%
120+ 2500 50%
2,230
2070
3800
1650
1250
E = $16000
Note: If allowance has a debit balance prior to the Allowance for Doubtful Accounts adjustment entry, we must add this amount to the target Allowance for Doubtful Accounts balance calculated to get the required adjustment amount -
If the Allowance balance is too high prior to the Allowance for Doubtful Accounts adjusting entry, we would require a credit to Bad Debt Expense.
Write-offs under the Allowance Method: -
Regardless of the method used to calculate the allowance for doubtful accounts, the entry to write-off specific accounts is the same.
Journal Entry: Allowance for Doubtful Accounts
xx
Accounts Receivable – Specific Customer Account
-
xx
No effect to net realizable value of Accounts Receivables No effect to Net Income
Ex: Assume Abrams Co. has an Accounts Receivable balance of $227,500 before any write-offs. An account totalling $2,500 is identified as uncollectible. The opening balance in Allowance for doubtful accounts is $11,000 credit. Journal Entry: Allowance for doubtful accounts Accounts Receivable To record write-off
Accounts Receivables Less: Allowance for Doubtful Accounts Accounts Receivable (net)
2500 2500
Balance Before Write-off $227,500
Balance after Write-off $225,000
11,000 $216,500
8,500 $216,500
Financial Statement Presentation -
Accounts Receivable is presented at the amount net of the Allowance for Doubtful Accounts Not required to show the actual Allowance for Doubtful Accounts amount
Example: ABC Company has credit sales of $100,000 in March. Opening A/R = $56,000, opening Allowance for doubtful accounts = 0. Bad debts are estimated to be ½ % of sales. During the month, $1,500 of accounts was specifically identified as being uncollectible. Required: Give the balance in A/R and Allowance for doubtful Accounts at the end of March, assuming ABC uses: a) Direct Write-off Method b) Allowance Method (based on sales)
a) Bad Debt Expense
1,500
A/R
1,500
Balance in Accounts Receivable: $56,000 + 10,000 – 1,500 = $154,500 Balance in AFDA = 0 Net A/R = $154,500 – 0 = $154,500
b) Bad Debt Expense = (100,000x0.005%) Allowance of Doubtful Accounts A/R To record write-off of bad debts
1,500
Bad Debt Expense Allowance for Doubtful Accounts To record provision for uncollectible accounts
500
1,500
500
Balance in A/R: $56,000 + $100,000 - $1,500 = $154,500 Balance in AFDA: $0 - $1500 + 500 = -$1000 is debit balance Net A/R: $154,500 + 1,000 = $155,500
Under the “aging of accounts receivable method”, the balance in the allowance for doubtful accounts is adjusted to the amount determined to be uncollectible at the reporting date, which is based on the analysis of the aging of the A/R listing. Example: Assume that ABC Company’s estimates that 75% of amounts over 60 days old are uncollectible and 95% of amounts over 90 days will never be collected either. At the end of March, the A/R listing shows $5,000 remains uncollected after 60 days and $2,500 is still receivable after 90 days.
Required: Determine the appropriate Journal Entries assuming the allowance method is used.
1500
1500
0 – 30 31 – 60 61 – 90 91 – 120 111,500 41,400 38,000 6,600
120+ 2500
2%
5%
10%
25%
50%
2,230 E = $16000
2070
3800
1650
1250
Allowance of Doubtful Accounts
1,500 1,500
1,500
To record write-off of bad debts Bad Debt Expense Allowance for Doubtful Accounts
7,625 7,625
Target Allowance for Doubtful Accounts:
= =
(75% of $5,000) + (95% of $2,500) $ 6,125.00
Bad Debt Expense = 6,125 + 1,500 = 7,625
B/S: A/R Less: Allowance A/R (net)
154,500 (6,125) $148,375
N.B: Under the “Receivable Method”, our focus is on having the correct balance in allowance for doubtful accounts – i.e. to have the right balance sheet balance. Hence, we adjust the allowance to get to the balance we want. Under the “sales method”, our focus is instead on the income statement – i.e. we want to show the right amount of bad debt expense each period, according to our estimation.
Credit Card Sales: Since collection from banks is assured, we record the debit to our account for the credit of the sale at full amount, less the credit card fee charged Ex. To record a $500 mastercard sales, assuming a 3% fee is charged by Mastercard: JE: Mastercard Account Credit Card Expense Sales
485 15 500
Ratio Analysis: Quick Ratio (Acid Test) = Current Liabilities
Cash +Short Term Investment + Net Accounts Receivables / Total
Accounts Receivable Turnover Ratio = Net Sales / Average Net Accounts Receivable Days’ Sales in Receivables = 365 days / Accounts Receivable Ratio -
We want the days’ sales in receivables to be as low as possible and AR Turnover Ratio to be as high as possible.
Must be presented on Balance Sheet at their recoverable amount / realizable value. Trade receivables should be separately disclosed from o Related party receivables o Notes receivables
Accounting for Uncollectible Receivables i)
Direct write-off method a. Only account for uncollectible Accounts Receivables with they are identified (as they occur) and record bad debt expense at that time b. Not GAAP c. Only appropriate when uncollectible accounts are very small
Journal Entry to write-off accounts: Bad Debt Expense Accounts Receivables
xx xx
If subsequent collection arises: Cash
xx Bad Debt Expense
ii)
xx
Allowance Method a. GAAP (PEGAAP, IFRS) b. Consistent with the MATCHING PRINCIPLE c. Record the expense of bad debt in same period as year of credit sale d. How: establishing an “Allowance for Doubtful Accounts“ account i. Contra asset account ii. Subtract from Accounts Receivable to arrive at net amount e. Under this method, we estimate bad debt expense and record it at period end as an adjusting entry f. When actual uncollectible account is identified; i. No effect on Income Statement ii. No effect on net Accounts Receivable g. 2 methods to calculate Allowance for Doubtful Accounts i. Sales method ii. Accounts receivables (aging) method h. Sales Method
i. income statement approach ii. aims to record best estimate of bad debt expense iii. Bad Debt Expense = Credit Sales x Estimated Uncollectible Journal Entry: Bad Debt Expense
xx
Allowance for Doubtful Accounts
i.
Example: Total 200,000 Est % no collect Estimated Allowance
xx
Accounts Receivable (Aging) Method i. Balance Sheet approach ii. Aims to calculate best estimate of the Allowance for Doubtful Accounts (so that Accounts Receivable presented is at realizable value) iii. Requires a review of A/R aged listing at report date and estimate which % in each aging category is expected to be uncollectible iv. We calculate the actual Allowance for Doubtful Accounts account, not the bad debt expense. Abrams Co. has an aged A/R schedule that show the following balances at December 31: 0 – 30 111,500 2%
31 – 60 41,400 5%
61 – 90 38,000 10%
91 – 120 6,600 25%
120+ 2500 50%
2,230
2070
3800
1650
1250
E = $16000
Note: If allowance has a debit balance prior to the Allowance for Doubtful Accounts adjustment entry, we must add this amount to the target Allowance for Doubtful Accounts balance calculated to get the required adjustment amount -
If the Allowance balance is too high prior to the Allowance for Doubtful Accounts adjusting entry, we would require a credit to Bad Debt Expense.
Write-offs under the Allowance Method: -
Regardless of the method used to calculate the allowance for doubtful accounts, the entry to write-off specific accounts is the same.
Journal Entry: Allowance for Doubtful Accounts
xx
Accounts Receivable – Specific Customer Account
-
xx
No effect to net realizable value of Accounts Receivables No effect to Net Income
Ex: Assume Abrams Co. has an Accounts Receivable balance of $227,500 before any write-offs. An account totalling $2,500 is identified as uncollectible. The opening balance in Allowance for doubtful accounts is $11,000 credit. Journal Entry: Allowance for doubtful accounts Accounts Receivable To record write-off
Accounts Receivables Less: Allowance for Doubtful Accounts Accounts Receivable (net)
2500 2500
Balance Before Write-off $227,500
Balance after Write-off $225,000
11,000 $216,500
8,500 $216,500
Financial Statement Presentation -
Accounts Receivable is presented at the amount net of the Allowance for Doubtful Accounts Not required to show the actual Allowance for Doubtful Accounts amount
Example: ABC Company has credit sales of $100,000 in March. Opening A/R = $56,000, opening Allowance for doubtful accounts = 0. Bad debts are estimated to be ½ % of sales. During the month, $1,500 of accounts was specifically identified as being uncollectible. Required: Give the balance in A/R and Allowance for doubtful Accounts at the end of March, assuming ABC uses: a) Direct Write-off Method b) Allowance Method (based on sales)
a) Bad Debt Expense
1,500
A/R
1,500
Balance in Accounts Receivable: $56,000 + 10,000 – 1,500 = $154,500 Balance in AFDA = 0 Net A/R = $154,500 – 0 = $154,500
b) Bad Debt Expense = (100,000x0.005%) Allowance of Doubtful Accounts A/R To record write-off of bad debts
1,500
Bad Debt Expense Allowance for Doubtful Accounts To record provision for uncollectible accounts
500
1,500
500
Balance in A/R: $56,000 + $100,000 - $1,500 = $154,500 Balance in AFDA: $0 - $1500 + 500 = -$1000 is debit balance Net A/R: $154,500 + 1,000 = $155,500
Under the “aging of accounts receivable method”, the balance in the allowance for doubtful accounts is adjusted to the amount determined to be uncollectible at the reporting date, which is based on the analysis of the aging of the A/R listing. Example: Assume that ABC Company’s estimates that 75% of amounts over 60 days old are uncollectible and 95% of amounts over 90 days will never be collected either. At the end of March, the A/R listing shows $5,000 remains uncollected after 60 days and $2,500 is still receivable after 90 days.
Required: Determine the appropriate Journal Entries assuming the allowance method is used.
1500
1500
0 – 30 31 – 60 61 – 90 91 – 120 111,500 41,400 38,000 6,600
120+ 2500
2%
5%
10%
25%
50%
2,230 E = $16000
2070
3800
1650
1250
Allowance of Doubtful Accounts
1,500 1,500
1,500
To record write-off of bad debts Bad Debt Expense Allowance for Doubtful Accounts
7,625 7,625
Target Allowance for Doubtful Accounts:
= =
(75% of $5,000) + (95% of $2,500) $ 6,125.00
Bad Debt Expense = 6,125 + 1,500 = 7,625
B/S: A/R Less: Allowance A/R (net)
154,500 (6,125) $148,375
N.B: Under the “Receivable Method”, our focus is on having the correct balance in allowance for doubtful accounts – i.e. to have the right balance sheet balance. Hence, we adjust the allowance to get to the balance we want. Under the “sales method”, our focus is instead on the income statement – i.e. we want to show the right amount of bad debt expense each period, according to our estimation.
Credit Card Sales: Since collection from banks is assured, we record the debit to our account for the credit of the sale at full amount, less the credit card fee charged Ex. To record a $500 mastercard sales, assuming a 3% fee is charged by Mastercard: JE: Mastercard Account Credit Card Expense Sales
485 15 500
Ratio Analysis: Quick Ratio (Acid Test) = Current Liabilities
Cash +Short Term Investment + Net Accounts Receivables / Total
Accounts Receivable Turnover Ratio = Net Sales / Average Net Accounts Receivable Days’ Sales in Receivables = 365 days / Accounts Receivable Ratio -
We want the days’ sales in receivables to be as low as possible and AR Turnover Ratio to be as high as possible.
