Download The Allowance Method

c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
o The receivables that result from sales on
account are normally accounts receivable or
notes receivables.
o Receivables includes all money claims against
other entities, including people, companies,
and other organization.
Classification of Receivables
o Accounts receivable are normally expected to
be collected within a relatively short period,
such as 30 or 60 days.
o Notes receivable are amounts that customers
owe for which a formal, written instrument of
credit has been issued. often used for credit
periods of more than 60 days.
Trade Receivable: A.R, and N.R. that result from sales transactions.
Classification of Receivables
o Other receivables expected to be collected
within one year are classified as current assets.
If collection is expected beyond one year,
these receivables are classified as noncurrent
assets and reported under the caption
Investments. Examples of other receivables
include:
 Interest receivable
 Taxes receivable
 Receivables from officers or employees
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Uncollectible Receivables
o Companies often sell their receivables to other
companies. This is called factoring the
receivables, and the buyer of the receivables is
called a factor.
Uncollectible Receivables
o Regardless of how careful a company is in
granting credit, some credit sales will be
uncollectible. The operating expense recorded
from uncollectible receivables is called bad
debt expense, uncollectible accounts expense,
or doubtful accounts expense.
Uncollectible Receivables
o Some indications that an account may be
uncollectible include the following:
 The receivable is past due.
 The customer does not respond to the company’s
attempts to collect.
 The customer files for bankruptcy.
 The customer closes its business.
 The company cannot locate the customer.
Uncollectible Receivables
o The direct write-off method of accounting for
uncollectible receivables records bad debt
expense only when an account is determined
to be worthless.
Used by small businesses and ones with few receivables.
o The allowance method records bad debt
expense by estimating uncollectible accounts
at the end of the accounting period.
Used by businesses that have large amount of
receivables.
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Direct write-off method of accounting for
uncollectible receivables
Under this method, Bad Debt Expense is not
recorded until the customer’s account is
determined to be worthless. At that time, the
customer’s account receivable is written off.
Direct Write-Off Method
o On May 10, a $4,200 account receivable from D.
L. Ross has been determined to be
uncollectible.
Direct Write-Off Method
o The account written off on May 10 is later
collected on November 21.
Reinstatement
entry
Receipt of
cash entry
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The Allowance Method
o The allowance method estimates the uncollectable
accounts receivable at the end of the accounting period.
o On December 31, ExTone Company estimates that a total
of $30,000 of the $200,000 balance of their accounts
receivable will eventually be uncollectible.
The specific customer accounts cannot be decreased,
so a contra account, for Doubtful Accounts Allowance ,
is credited.
The Allowance Method
o The net amount that is expected to be
collected, $170,000 ($200,000 – $30,000), is
called the net realizable value (NRV) of the
receivables.
o The adjusting entry affects the balance sheet
by reducing receivables to the NRV and affects
the income statement by matching
uncollectible expenses $30,000 with revenues
o Account Receivable still has a debit balance of
$200,000 at that time.
The Allowance Method
o On January 21, John Parker’s account of $6,000
is written off because it is uncollectible.
Note that the allowance
account credited earlier is
debited at the write-off,
not Bad Debt Expense.
THE
ALLOWANCE
METHOD
The allowance
account will have a
credit balance at the
end of period if the
write-offs during the
period are less than
the beginning
balance.
It will have a debit
balance if the writeoffs exceed the
beginning balance.
The Allowance Method
o During 2012, ExTone Company writes off
$26,750 of uncollectible accounts, including
the $6,000 account of John Parker. After posting
all entries to write off uncollectible amounts,
Allowance for Doubtful Accounts will have a
credit balance of $3,250 ($30,000 – $26,750).
The Allowance Method
o If ExTone Company had written off $32,100 in
accounts receivable during 2012, Allowance
for Doubtful Accounts would have a debit
balance of $2,100.
The Allowance Method
o Nancy Smith’s account of $5,000, which was
written off on April 2, is later collected on June
10. Two entries are needed: one to reinstate
Nancy Smith’s account and a second to record
receipt of the cash.
Reinstatement
entry
Receipt of
cash entry
Estimating Uncollectibles
o The allowance method requires an estimate of
uncollectible accounts at the end of the period.
Two methods are used to estimate the amount
debited to Bad Debt Expense.
 Percent of sales method (Since accounts
receivable are created by credit sales, uncollectable
accounts can be estimated as a percent of credit
sales).
 Analysis of receivables method
Percent of Sales Method
o If ExTone Company’s credit sales for the
period are $3,000,000 and it is estimated that
3/4% will be uncollectible, Bad Debt Expense
is debited for $22,500 ($3,000,000 x .0075).
o This approach disregards the credit or debit
balance in the allowance account before the
adjustment.
Percent of Sales Method
After the adjusting entry on December 31 is
posted
o Allowance for Doubtful Accounts will have a
balance of $25,750 ($3,250 CR + $22,500).
o Allowance for Doubtful Accounts will have a
balance of $20,400 ($22,500 - $2,100 DR).
PERCENT OF
SALES METHOD
PE 9-3A
At the end of the current year, Accounts Receivable
has a balance of $325,000; Allowance for Doubtful
Accounts has a credit balance of $3,900; and net
sales for the year total $4,500,000. Bad debt expense
is estimated at ½ of 1% of net sales.
Determine (a) the amount of the adjusting entry for
uncollectable accounts;
(b) the adjusted balances of Accounts Receivable,
Allowance for Doubtful account, and Bad Debt
Expense;
(c) The net realizable value of accounts receivable.
PE 9-3B
At the end of the current year, Accounts Receivable
has a balance of $2,500,000; Allowance for Doubtful
Accounts has a debit balance of $9,000; and net
sales for the year total $32,000,000. Bad debt
expense is estimated at ¼ of 1% of net sales.
Determine (a) the amount of the adjusting entry for
uncollectable accounts;
(b) the adjusted balances of Accounts Receivable,
Allowance for Doubtful account, and Bad Debt
Expense;
(c) The net realizable value of accounts receivable.
Analysis of Receivables Method
o The longer an account receivable is
outstanding, the less likely it is that it will be
collected. Basing the estimate of
uncollectible accounts on how long specific
amounts have been outstanding is called
aging the receivables.
Analysis of Receivables Method
o The analysis of receivables method is applied
as follows:
 Step 1: The due date of each account receivable is
determined.
 Step 2: The number of days each account is past
due is determined.
 Step 3: Each account is placed in an aged class
according to its days past due.
 Step 4: The totals for each aged class are
determined.
Analysis of Receivables Method
 Step 5: The total for each aged class is multiplied by
an estimated percentage of uncollectible accounts
for that class.
 Step 6: The estimated total of uncollectible
accounts is determined as the sum of the
uncollectible accounts for each aged class.
Analysis of Receivables Method
o The preceding steps are summarized in an
aging schedule, and this overall process is
called aging the receivables.
ANALYSIS OF
RECEIVABLES
METHOD
Analysis of Receivables Method
o The estimate based on the age of receivables
is compared to the balance in the allowance
account to determine the amount of the
adjusting entry.
Analysis of Receivables Method
o ExTone Company has an unadjusted credit
balance of $3,250 in Allowance for Doubtful
Accounts. In Exhibit 1, the estimated
uncollectible accounts totaled $26,490. The
amount to be added to the allowance account
is $23,240 ($26,490 – $3,250 CR). The adjusting
entry is as follows:
Analysis of Receivables Method
o After the preceding adjusting entry is posted
to the ledger, ExTone Company’s Allowance
for Doubtful Accounts will have an adjusted
balance of $26,490. This is the amount that was
determined by aging the accounts.
Same amount as the estimated amount
determined by the aging process.
Analysis of Receivables Method
o If ExTone Company’s unadjusted balance of
the allowance account had been a debit
balance of $2,100, the amount of the
adjustment would have been $29,590 ($26,490
+ $2,100 DR).
COMPARING
ESTIMATION
METHODS
ONLY
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Comparing Methods
o The primary differences between the direct
write-off and allowance methods are
summarized below.
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Characteristics of Notes Receivable
o A note receivable, or promissory note, is a
written document containing a promise to pay.
o
Characteristics of a promissory note are as
follows:
 The maker is the party making the promise to
pay.
 The payee is the party to whom the note is
payable.
(continued)
Characteristics of Notes Receivable
 The face amount is the amount the note is written
for on its face.
 The issuance date is the date a note is issued.
 The due date or maturity date is the date the note
is to be paid.
 The term of a note is the amount of time between
the issuance and due dates.
 The interest rate is the rate of interest that must be
paid on the face amount for the term of the note.
Notes Receivable
LO 6
The maturity value is the amount that must be
paid at the due date of the note, which is the
sum of the face amount and the interest.
NOTES
RECEIVABLE
Due Date of a 90-day Note
o What is the due date of a 90-day note dated
March 16?
 Days in March
31
 Minus issuance date of note
16
 Days remaining in March
15
 Add days in April
30
 Add days in May
31
 Add days in June
(due date of June 14)
 Term of note
90
days
14
90 days
Alternate Approach
o Total days in note
 Number of days in March
 Issue date of note, March 16
90 days
31
(16)
 Remaining days in March
15 days
 Number of days in April
30
 Number of days in May
31 days
 Residual days in June
Answer: June 14
(14) days
DUE DATE OF A
90-DAY NOTE
Accounting for Notes Receivable
o Received a $6,000, 12%, 30-day note dated
November 21, 2014, in settlement of the
account of W. A. Bunn Company.
Accounting for Notes Receivable
o On December 21, when the note matures, the
firm receives $6,060 from W. A. Bunn Company
($6,000 face amount plus $60 interest).
Interest= Face Amount x Interest Rate x (term/ 360
days)
The maturity value is the amount that must be paid
at the due date of the note, which is the sum of the
face amount and the interest.
Accounting for Notes Receivable
o If W. A. Bunn Company fails to pay the note on the
due date, it is considered a dishonored note
receivable. The note and interest are transferred
back to the customer’s account receivable.
The dishonored note receivable is the note and interest
when the company fails to pay.
Accounting for Notes Receivable
o A 90-day, 12% note dated December 1, 2014, is
received from Crawford Company to settle its
account, which has a balance of $4,000.
Accounting for Notes Receivable
o Assuming that the accounting period ends on
December 31, an adjusting entry is required to
record the accrued interest of $40 ($4,000 x
0.12 x 30/360).
Accounting for Notes Receivable
o On March 1, 2015, $4,120 is received for the
note ($4,000) and interest ($120).
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REPORTING
RECEIVABLES ON
THE BALANCE
SHEET
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
H.W:
PE 9-1 A , PE 9-1 B
PE 9-2 A , PE 9-2 B
PE 9-3 A , PE 9-3 B
PE 9-4 A , PE 9-4 B
PE 9-5 A , PE 9-5 B
EX9-3
EX9-4
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.