Download Write-off of Accounts Receivable

BUS210
Cash and
Accounts
Receivable
Current Asset Classification
A current asset is defined as any asset that is intended to be converted into
cash within one year or the company’s operating cycle, whichever is longer.
i.e., Cash, Marketable Securities, Accounts Receivable, Inventory,
Supplies, Prepaids
Proper Cash Management
• Restrictions placed on a company’s
access to its cash are typically imposed by
creditors to help ensure future interest and
principal payments, i.e., loan or debt covenants.
• Compensating balances are sometimes
required
• Control Record over cash, i.e., bank
reconciliation
• Physical Control over cash, i.e., petty
cash, signatures on checks
Accounts Receivable
• Accounts receivable arise from selling goods or
services to customers on account.
• Recorded at face amount to be collected.
• However, we must also reflect the fact that a
portion of A/R may not be collected.
– Net Realizable Value
• Reasons for lack of collection:
1. sales discounts (cash discounts)
2. sales returns
3. sales allowances
4. uncollectible A/R (bad debts, doubtful accounts)
Cash/Sales Discounts
• Offered to encourage early payment
• Examples
2/10, net 30
• 2/10, EOM
•
• Accounting approaches
Gross Method - records discounts when taken
by customers
• Net Method - records discounts not taken by
customers
•
E6-4 Accounting for cash discounts
On May 1, 2015, Crab Cove Fishing Company sold Maine lobster on
account for a gross price of $30,000. On May 5, the company sold cod
on account for a gross price of $20,000. the terms of both sales were
3/10, n/30. Crab Cove received payment for the first sale on May 6,
2015, and the payment for the second sale on May 31,2015. Provide
all necessary journal entries.
a. Assume the Gross Method.
E6-4 Accounting for cash discounts
On May 1, 2015, Crab Cove Fishing Company sold Maine lobster on
account for a gross price of $30,000. On May 5, the company sold cod
on account for a gross price of $20,000. the terms of both sales were
3/10, n/30. Crab Cove received payment for the first sale on May 6,
2015, and the payment for the second sale on May 31,2015. Provide
all necessary journal entries.
b. Assume the Net Method.
P6-2 Cash Discounts/Sales Discounts
During March the following credit sales and collections occurred. Company prepares
quarterly financials. Required: Prepare the journal entries to record these
transactions.
March 3
Sold goods to AAA for a gross price of $1,400. Terms 2/10,n/30.
March 8
Sold goods to BBB for a gross price of $800. Terms 2/10, n/30.
March 11
Received full payment from AAA.
March 28
Received full payment from BBB.
March 29
Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.
Sales Returns and Allowances
• Internal control
• Customer returns and allowances tracked
Direct Write-off Method for AR
•
•
•
•
Used primarily in Cash Basis Accounting
No adjusting journal entry
Write-off entry
Recovery entry
Accounting for Bad Debts
Specific
Write-off or
Allowance
Method?
Allowance Method:
Estimate Bad Debts Expense each year
and reduce Accounts Receivable using
a contra account. Move the reduction from
the contra to the Accounts Receivable
account when a specific account
is known to be uncollectible
% of Sales Method
Recognize Bad Debts Expense for the
amount of bad debts expected to result
from the current year’s sales, using a
percent of sales
Which
method is used
to estimate bad
debts expense?
Aging of Accounts Receivable Method
Same as the % of Accounts Receivable Method
except it uses different percentages for accounts
based on their age -- higher % for older accounts.
Journal Entries for Allowance Method on next slide
Specific Write-off Method:
Recognize Bad Debts Expense
when individual accounts are
determined to be uncollectible
Entry:
Bad Debts Exp.
Accounts Rec.
xx
xx
% of Accounts Receivable Method
Recognize Bad Debts Expense for the
amount that will cause the contra
account balance to equal the % of yearend accounts receivable not expected to
be collected.
Journal Entries for Allowance method of
Accounting for Bad Debts
To record bad debts expense:
Bad Debts Expense
Allowance for Uncollectible Accounts
xxx
xxx
To write off bad accounts:
Allowance for Uncollectible Accounts
Accounts Receivable
xxx
xxx
Recovery of Bad Debts
If a receivable is collected after it has been written off, it should be restored
by making the reverse of the entry that was made to write it off:
Allowance Method
Accounts Receivable
Allowance for Bad Debts
xxx
Specific Write-Off Method
Accounts Receivable
Bad Debts Expense
xxx
xxx
xxx
The collection of the receivable is then recorded in the usual fashion:
Cash
Accounts Receivable
xxx
xxx
Allowance for Doubtful Accts.
(T-account)
Allowance for Doubtful Accts.
Beginning
Balance
Recover write-off
Write-off of
accounts
receivable
Accounts Receivable
Recover write
off
Ending Bal.
AJE estimates
bad debt expense
AJE estimates bad debt
expense
Ending
Balance
Beginning Bal.
Credit sales
Bad Debts Expense
Customer pays
AR Write-off
The AJE to record the estimate of
uncollectibles. Aging calculates the
expense amount necessary to
achieve the “desired ending
balance” in the allowance account.
OR % of Sales is the Expense and
then compute EB in Allowance
account.
BE6-1 Analysis of AR:
The following information was taken from the 2012 Annual report of Emerson
Electric Co. Balance Sheet (in millions):
Receivables were in 2012 $4,983 and in 2011 $4,502; less
allowance for uncollectibles of $109 and $104, respectively.
a.
Compute total AR as of the end of 2012 and 2011, and compute the bad
debt allowance as a % of total AR. Did the % increase or decrease?
b.
The bad debt expense reported on Emerson’s 2012 income statement did
not equal $109. Explain why.
Estimating Bad Debt Expenses
• Percent of Sales Method
• Percent of Accounts Receivable Method
• Aging of Accounts Receivable Method
Note on estimating bad debts using the allowance method:
Regardless of which method is used to estimate bad debts
(% of sales, % of accounts receivable, or aging of
accounts), in the final analysis the balance in the allowance
account on the balance sheet should represent a fair
expectation of the amount that will not be collected of the
outstanding accounts receivable. Hence, the net accounts
receivable balance on the balance sheet should represent
the expected “net realizable value” of the receivables.
Bad Debts/Doubtful Accounts/Uncollectible Accounts
• Note that we do not know in this year which A/Rs
will not be collected in future. Therefore, we must
estimate uncollectibles.
• We will focus on the % of Sales or Aging of AR to
estimate uncollectibles for the AJE. The
percentage of sales method is simpler, but the
Aging of A/R method is more accurate.
• Under IFRS, the methods used to estimate and
account for uncollectible are very similar to those
under US GAAP.
Percentage of Sales Method
• Usually based on credit sales, but may use
total sales or net sales as basis.
• Calculation:
Sales x % = Bad Debt Expense
(focus on the debit side of the AJE)
• Called the Income Statement approach,
because: revenues x % = expense.
• After making entry find the resulting ending
balance in the Allowance account.
E6-5 Bad debts under the allowance method.
Arlington Cycle Company began operations on 1/1/14.
The company reported the following on its 2015
financials:
Gross sales in 2015 $1,400,000 and $1,500,000 in
2014.
AR in 2015 $600,000 and $650,000 in 2014.
Actual bad debt write-offs in 2015 $22,000 and
$10,000 in 2014.
Arlington estimates bad debts at 2% of gross sales.
Analyze the activity in the allowance for doubtful
accounts T-account, and comment on whether the bad
debt estimate has been sufficient to cover the
writeoffs.
Gross sales in 2015 $1,400,000 and $1,500,000 in 2014.
AR in 2015 $600,000 and $650,000 in 2014.
Actual bad debt write-offs in 2015 $22,000 and $10,000 in 2014.
Arlington estimates bad debts at 2% of gross sales.
P6-3 Bad debts over time
The company estimates bad debts at 3% of credit sales. The beginning balance in the
Allowance for doubtful accounts as of the beginning of 2013 was $10,000.
Credit sales
Actual bad debt write-offs
2015
2014
2013
$205,000
$200,000
$180,000
11,000
10,000
6,000
a. Provide the journal entries related to the Allowance account for all three years.
P6-3 Bad debts over time
The company estimates bad debts at 3% of credit sales. The beginning balance in the
Allowance for doubtful accounts as of the beginning of 2013 was $10,000.
Credit sales
Actual bad debt write-offs
2015
2014
2013
$205,000
$200,000
$180,000
11,000
10,000
6,000
b. Compute the balance in the allowance account at 12/31/15.
c. Comment on the sufficiency of the bad debts expense and the allowance over the 3
years.
P6-4 Uncollectibles over two periods
Company uses the percentage-of-net-sales method to account for bad debts.
Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015:
Gross sales
Sales discounts
Sales returns
2015
2014
$1,500,000
$1,800,000
100,000
130,000
50,000
20,000
a. Prepare the necessary adjusting entries on 12/31/14 to record the estimated bad
debt expense.
b. Assume the 1/1/2014 Allowance account balance was $65,000(credit) and that
$70,000 in bad debts were written off during year. What is the 12/31/14 balance
after adjustments.
P6-4 Uncollectibles over two periods
Company uses the percentage-of-net-sales method to account for bad debts.
Historically, 3% of net sales have proven to be uncollectible. During 2014 and 2015:
Gross sales
Sales discounts
Sales returns
2015
2014
$1,500,000
$1,800,000
100,000
130,000
50,000
20,000
c. Prepare the necessary adjusting entries on 12/31/15 to record the estimated bad
debt expense.
d. What is the 12/31/2015 Allowance balance? Assume that $85,000 in bad debts was
written off during the year.
Aging Method: Percentages of A/R
• Based on ending A/R and ending Allowance account.
• Calculation:
Ending A/R x % = Ending Allowance
(focus on the credit side of the AJE)
• Called Balance Sheet approach, because: ending
asset x % = ending contra asset.
• Requires the analysis of the Allowance account and
A/R before preparing the AJE.
• An aging schedule of A/R is the most accurate way to
estimate uncollectibles (see Figure 6-11).
E6-10 Aging schedule preparation
Compute the total receivables and expected bad debts as of the end of the
year based on the following:
Account age
Balance
Noncollection
Probability
$290,000
2%
1-45 days past due
110,000
5%
46-90 days past due
68,000
8%
Over 90 days past due
40,000
15%
Current
Aging of AR
Emory Company uses the accounts receivable aging method to estimate uncollectible accounts. At the
beginning of the year, the balance of the Accounts Receivable account was a debit of $90,430, and the balance
of Allowance for Uncollectible Accounts as a credit of $8,100. During the year, the company had sales on account
of $475,000, sales returns and allowances of $6,200, worthless accounts written off of $8,800, and collections
from customers of $452,730. At the end of year (December 31, 2015), a junior accountant for Emory Company
was preparing an aging analysis of accounts receivable.
At the top of page 5 of the report, the following totals appeared:
Customer
Account
Total
Balance Forward $89,640
Not Yet Due
1–30 Days Past
Due
31–60 Days Past
Due
61–90 Days Past
Due
Over 90 Days Past
Due
$49,030
$24,110
$9,210
$3,990
$3,300
To finish the analysis, the following accounts need to be classified:
From past experience, the company has found that the following rates are realistic for estimating uncollectible accounts:
Time
Percentage Considered Uncollectible
Not yet due
2
1–30 days past due
5
31–60 days past due
15
61–90 days past due
25
Over 90 days past due
50
Required
Complete the aging analysis of accounts receivable.
Compute the end-of-year balances (before adjustments) of Accounts Receivable and
Allowance for Uncollectible Accounts.
Prepare an analysis computing the estimated uncollectible accounts.
Calculate Emory Company's estimated uncollectible accounts expense for the year (round
the amount to the nearest whole dollar).
What role do estimates play in applying the aging analysis? What factors might affect these
estimates?
Year-end Entries: Bad Debts
•
During 2015, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the
end of 2015, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible
Accounts had a debit balance of $48,000.
• Omega Company's management uses two methods of estimating uncollectible accounts expense:
the percentage of net sales method and the accounts receivable aging method. The percentage of
uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the endof-year uncollectible accounts total $140,000.
1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each
method.
2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?
During 2015, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end
of 2015, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts
had a debit balance of $48,000.
Omega Company's management uses two methods of estimating uncollectible accounts expense: the
percentage of net sales method and the accounts receivable aging method. The percentage of
uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end-ofyear uncollectible accounts total $140,000.
1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each
method.
2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?
3.
4.
Why are the results different?
Which method is likely to be more reliable? Why?
Write-off of Accounts Receivable
Colby Company, which uses the allowance method, has Accounts Receivable
of $65,000 and an allowance for uncollectible accounts of $6,400 (credit). The
company sold merchandise to Irma Hegerman for $7,200 and later received
$2,400 from Hegerman. The rest of the amount due from Hegerman had to
be written off as uncollectible. Using T accounts, show the beginning balances
and the effects of the Hegerman transactions on Accounts Receivable and
Allowance for Uncollectible Accounts.
What is the amount of net accounts receivable before and after the write-off?
E6-8 Write-offs and Entries
The company estimates bad debts each year at 2% of credit sales. End of the year
amounts from the annual report are:
2015
2014
Credit sales
$75,300
$61,500
Accounts receivable
9,400
9,200
Allowance for bad debts
1,300
1,000
55
70
Bad debt recoveries
a. Compute the actual amount of write-offs during year.
b. Infer the journal entries that explain the accounts receivable and the related
allowance accounts activity during the year.
Liquidity Ratios
• Working Capital =CA-CL
• Current Ratio = CA/CL
• Quick Ratio or Acid Test Ratio =
(CA-Inv & Prepaids)/CL
How are these ratios affected by the journal entries you will
learn this chapter?
Sale on Account:
Cash Collection:
AR Writeoff:
AR Recovery:
Bad Debt AJE:
P6-7 Ignoring Potential Bad Debts
Income Statement
Sales
Cost of goods sold
Balance Sheet
$200,000 Cash
102,000 Accounts receivable
Gross profit
98,000 Other assets
Expenses
65,000 Total assets
Net income
$33,000 Current liabilities
$5,000
85,000
40,000
$130,000
13,000
Long-term NP
80,000
SHE
37,000
Total L + SHE
$130,000
The above financial information is for the Hadley Company’s first year of operation.
The income statement was not adjusted for bad debt expense. A large percentage
of sales were to 3 customers, one of which, Litzenberger Supply is in questionable
financial health, although still in business. Litzenberger owes Hadley $50,000 as
of the end of first year.
P6-7 continued
Required:
a. Adjust the financial statements of Hadley Company to reflect a more conservative
reporting with respect to bad debts, i.e. set up a provision. Recompute net
income. How does this adjustment affect your assessment of Hadley’s first year
of operations?
b.
Why would auditors probably require that Hadley choose the more conservative
reporting?
c.
Hadley’s CFO claims that no bad debt expense should be recorded because
Litzenberger is still conducting operations as of the end of year. How would you
respond to this claim?