Download accounts receivable

Chapter 8
Reporting
and Analyzing
Receivables
1
ACCOUNTS RECEIVABLE
o
The term receivables refers to
amounts due from individuals and
companies.
o
Accounts Receivable arise from
sales on credit to customers.
o
Receivables are claims that are
expected to be collected in cash.
o
Receivables represent one of a
company’s most liquid assets
2
How are Accounts Receivable
Recognized in the Accounts?
DR Accounts Receivable
CR Sales (or Service Revenue)
Accounts Receivable are reduced by
Sales Discounts and/or
Sales Returns & Allowances
3
RECOGNIZING ACCOUNTS
RECEIVABLE
General Journal
Date
July 5
Account Titles
Sales Returns and Allowances
Accounts Receivable – Polo Company
Debit
100
Credit
100
When a business receives returned merchandise previously
When a business sells merchandise to a customer on credit,
sold to a customer on credit, Sales Returns and Allowances
Accounts Receivable is debited and Sales is credited.
is debited and Accounts Receivable is credited (decreased).
4
Accounts Receivable Issues
Companies sell on credit to increase their volume
of sales.
Accounts where customers will not or cannot pay
are called Uncollectible Accounts or Bad Debts.
The loss of these amounts is considered an
expense of selling on credit
Key Issue: What portion of credit sales/accounts
receivable are uncollectible?
5
VALUING ACCOUNTS
RECEIVABLE
 Receivables are valued at their
CASH REALIZABLE VALUE -
The net amount expected to be received in cash,
excluding amounts that the company estimates it
will not be able to collect.
You have to SUBTRACT the uncollectible amounts
from the gross receivable amount
Losses for Bad Credit
Debited to Bad Debts Expense
6
Uncollectible Accounts
Two methods of accounting for uncollectible
accounts:
Direct Write-Off Method (not GAAP)
Allowance Method (GAAP)
 Percentage of credit sales
 Percentage of receivables
 Aging accounts receivable
7
DIRECT WRITE-OFF
METHOD
 Direct write-off method
• An entry is made for bad debts expense when an account is
determined to be uncollectible at which time the loss is charged
to Bad Debts Expense
 Accounts receivable are reported at their gross
amount on the balance sheet
 No matching of bad debts expense with the sales
revenue
 Not GAAP therefore Not Acceptable for financial
reporting purposes
8
Direct Write-Off Method
11/1/02
Bad Debt Expense. . . . . . . . . . . . . . 4,000
Accounts Receivable . . . . . . . . .
4,000
To write off an uncollectible account for
purchases made on 8/1/01.

Method is objective because bad debt expense is
written off at the time it proves to be uncollectible.

However, the Direct Write-Off method is NOT
GAAP because it violates the matching principle
where:
All costs and expenses in generating revenues
must be identified with those revenues period by
period
9
Implications of the
Direct Write-Off Method
Income Manipulation is Possible.
When is it acceptable?
 Income Tax Purposes
 Small Businesses
 Materiality
10
EFFECTS OF DIRECT WRITEOFF METHOD
11
THE ALLOWANCE METHOD
 Allowance method
• required when bad debts are deemed to be
material in amount
 Uncollectible accounts are estimated
• at the end of each period
• expense for the uncollectible accounts is matched
against sales in the SAME accounting period in
which the sales occurred
 Results in
• Receivables being stated at Cash Realizable Value
i.e. the amount of CASH expected to be collected
12
THE ALLOWANCE METHOD
General Journal
Date
Account Titles
Dec. 31
Bad Debts Expense
Allowance for Doubtful Accounts
Debit
Credit
12,000
12,000
Estimated uncollectibles are debited to Bad
Debts Expense and credited to Allowance for
Doubtful Accounts at the end of each period.
13
Balance Sheet (partial)
Current Assets:
Cash
$14,800
Accounts Receivable
Less: Allowance for D/A
Accounts Receivable, NET
Merchandise Inventory
Prepaid expense
Total Current Assets
$200,000
- 12,000
188,000
Amount you
expect to
collect
310,000
25,000
$537,800
The Allowance for Doubtful Accounts is a
CONTRA-ASSET account
14
THE ALLOWANCE METHOD
General Journal
Date
Account Titles
Mar. 1
Allowance for Doubtful Accounts
Accounts Receivable - R. A. Ware
Debit
Credit
500
500
Actual uncollectibles are debited to Allowance for Doubtful
Accounts and credited to Accounts Receivable at the time
the specific account is written off.
15
The Allowance Method
 Bad debt losses are MATCHED against the sales
they help produce.
 Cannot identify at the time of sale which
customers will not pay.
 Losses from uncollectible accounts must be
ESTIMATED as an operating expense in the fiscal
year in which the sales are made.
 Record bad debt expense in the period of sale
16
The Allowance Method
 Can be optimistic or pessimistic about
estimated bad debts.
• If optimistic, expense smaller and net
income higher.
• If pessimistic, expense larger and net
income smaller.
 In either case, the estimated loss should
be realistic, based on experience, the
economy, etc
17
Estimating Bad Debts
Two Methods of Estimating Bad Debts:

Balance Sheet Approach

Income Statement Approach
18
Balance Sheet Method
Uses a % of A/R to estimate the
uncollectible amount
Income Statement Method
Uses a % of Net Credit Sales to
estimate the uncollectible amount
19
Estimating Bad Debts
B/S APPROACH
% OF Accounts Receivable
I/S APPROACH
% OF Net Credit Sales
Amount of uncollectibles = a
straight %of the current year’s
net credit sales.
 Based on experience of prior
years, modified for changes
expected in current year.
 Any existing balance in
Allowance for D/A is NOT
considered in the adjusting
entry to record bad debt
expense.

Amount of uncollectibles = a
% of total receivables balance
at period’s end.
 Focus is on estimating total
bad debts existing at end of
period.
 The ending balance in
Allowance for D/A is the
amount of total receivables
estimated to be uncollectible.

20
Comparison of the Two Methods
21
Example - Income Statement
Approach
• Assume the following account balances
Credit Sales
Sales R & A
Accounts Receivable
Allowance for D/A
10,000,000
200,000
3,000,000
45,000 (credit)
• It is estimated that 2% of Net Sales will be
uncollectible.
22
Example - Income Statement
Approach
• Calculation of Bad Debt Expense:
(Sales - Sales R&A) x % Uncollectible
(10,000,000 - 200,000) x 2% = 196,000
• Adjusting Entry:
Bad Debt Expense
Allowance for D/A
196,000
196,000
23
I/S Approach
T-Account Illustration
Allowance for D/A
45,000
196,000
The I/S method
ignores the
ending balance
in the
Allowance A/C
241,000
Existing Credit
Balance
Bad Debt Expense
$196,000
Ending Balance
in the Allowance
24
I/S Approach…F/S Presentation
•
Balance Sheet
Accounts Receivable
$3,000,000
Less: Allowance for D/A
( 241,000)
Net Realizable Value of A/R 2,759,000
•
Income Statement
Net Sales
$9,800,000
Operating Expenses:
Bad Debt Expense
196,000
25
Example…B/S Approach
• Assume the same information as before
Sales
Sales R & A
Accounts Receivable
Allowance for D/A
•
10,000,000
200,000
3,000,000
45,000 (credit)
It is estimated that 10% of the Accounts
Receivable will be uncollectible.
26
Example…B/S Approach
•
Calculation of the Desired Balance of Allowance
for Doubtful Accounts:
Accounts Receivable x % Uncollectible
3,000,000 x 10% = 300,000
•
Adjustment for an existing Allowance Balance to
calculate Bad Debt Expense:
Desired Balance PLUS Debit Balances or
MINUS Credit Balances
300,000 - 45,000 = 255,000
27
B/S Approach
T-Account Illustration
Allowance for D/A
45,000
Existing Credit
Balance
??
The Objective
of the B/S
method is to
end up with
the correct
balance in the
Allowance A/C
300,000
Bad Debt Expense
255,000
Desired Balance
of the Allowance
Bad Debt Expense
Allowance for D/A
255,000
255000
28
B/S Approach…F/S Presentation
• Balance Sheet:
Accounts Receivable
Less: Allowance for D/A
Net Realizable Value of A/R
• Income Statement:
Net Sales
Operating Expenses:
Bad Debt Expense
$ 3,000,000
( 300,000)
2,700,000
$ 9,800,000
255,000
29
What if the Allowance Account had an existing
20,000 debit balance?
Calculation of the Desired Balance of Allowance
for Doubtful Accounts:
• Accounts Receivable x % Uncollectible
3,000,000 x 10% = 300,000
•
Adjustment for an existing Allowance Balance
to calculate Bad Debt Expense
Desired Balance PLUS debit balances or
MINUS credit balances
300,000 + 20,000 = 320,000
30
What if the Allowance Account had an existing
20,000 debit balance?
Allowance for D/A
20,000
Again, the objective
of the B/S method
Is to arrive at the
correct ending
balance in the
Allowance A/C
??
300,000
Existing Debit
Balance
Bad Debt Expense
320,000
Desired Balance
of the Allowance
31
B/S Approach:
AJE & F/S Presentation
•
•
Adjusting Entry:
Bad Debt Expense
Allowance for D/A
320,000
Balance Sheet (Same as before)
Accounts Receivable
Less: Allow for D/A/
Net Realizable Value
•
320,000
$ 3,000,000
( 300,000)
2,700,000
Income Statement:
Net Sales
Operating Expenses
Bad Debt Expense
$9,800,000
$ 320,000
32
Aging Accounts Receivable

A more refined and accurate method of estimating
the appropriate ending balance in the Allowance for
Bad Debts.

Requires a company to base its calculations on how
long its receivables have been outstanding.

Each receivable is categorized according to age,
such as




Current
1-30 days past due
31-60 days past due, etc.
The total amount in each classification is multiplied
by an appropriate uncollectible percentage
(determined by experience).
33
AGING SCHEDULE
Allowance for Doubtful Accounts
528 Beg Balance
1,700
?
2,228 Ending Balance
12/31/01
Bad Debt Expense. . . . . . . . . . . . . .
1,700
Allowance for Doubtful Accounts . . . . . .
1,700
To adjust the Allowance account to desired balance.
34
Write-Off as Uncollectible
•
Specific customer accounts that have been
determined to be uncollectible should be removed
from A/R.
•
Totally separate from the estimation of and
adjustment for Bad Debt Expense discussed
earlier.
Allowance for Doubtful Accounts
Accounts Receivable
$$
$$
35
Why Accounts Written Off Will Differ
from Estimates
The total of Accounts Receivable written off rarely
equals the estimated uncollectible amount
– When the total of accounts written off is less than
estimated uncollectible accounts:
The allowance account will have a credit balance at year end
– When the total of accounts written off is greater than
estimated uncollectible accounts:
The allowance account will have a debit balance at year end
36
Writing Off an Uncollectible Account
• When it becomes clear an account will not be
collected, the amount should be written off to
Allowance for Uncollectible Accounts
• The uncollectible amount was already accounted
for as an expense when the allowance was
established
37
Example of Writing Off an
Uncollectible Account
Jan. 15, 20x3: R. Deering, who owes the company $250, is
declared bankrupt by federal court
Jan. 15
Allowance for Uncollectible Accounts
250
Accounts Receivable
To write off receivable from R. Deering as
uncollectible; Deering declared bankrupt on
January 15
Allowance for Uncollectible Accounts
Dec 31, bal.
Jan. 15
2,459
250
Accounts Receivable
Dec 31, bal.
44,400
250
250
Jan. 15
Bal.
The write-off does NOT
affect the estimated net
realizable value of
accounts receivable
2,209
Bal.
44,150
Net realizable value of A/R
Before write-off
$44,400 – $2,459 = $41,941
After write-off
$44,150 – $2,209 = $41,941
38
Recovery of Accounts Receivable Written Off
• Occasionally a customer whose account has
been written off as uncollectible will pay all or part
of the amount owed
• Two journal entries are required:
– One to reverse the earlier write-off
– Another to show the collection of the account
39
Example of Recovering an Account Previously
Written Off
Sep. 1, 20x3: R. Deering notified the company that he could
pay $100 of his account and sent a check for $50
Sep. 1
Sep. 1
Accounts Receivable
100
Allowance for Uncollectible Accounts
To reinstate the portion of the account of R.
Deering now considered collectible;
originally written off January 15
Cash
Accounts Receivable
Collection from R. Deering
100
50
50
40
MANAGING RECEIVABLES
41
Setting Credit Policies
• Companies sell on credit to be competitive and
increase sales
• To increase the likelihood of selling to customers
who will pay on time, companies develop control
procedures and maintain a credit department
42
EVALUTING LIQUIDITY OF
RECEIVABLES

Ratios are computed to evaluate the liquidity (how
quickly the asset can be converted to cash) of a
company’s accounts receivable.

Accounts receivables turnover ratio used to assess
the liquidity of the receivables.

Average collection period is also used to assess
liquidity, a rule of thumb is that the average
collection period should not exceed the credit term
period.
43
Receivable Turnover
Reflects the relative size of a company's
accounts receivable and the success of its seasonal
conditions and interest rates
Net Sales
Receivable Turnover 
Average Net Accounts Receivable
Receivable turnover for Pioneer Corporation:
$5,052,700,000
Receivable Turnover 
($940,300,000  $805,564,000)  2
This means that, on
average, receivables
were turned into cash
5.8 times during the
accounting period
$5,052,700,000

$872,932,000
 5.8 times
44
Average Days’ Sales Uncollected
Shows, on average, how long it takes to collect
an accounts receivable
365 days
Average Days' Sales Uncollect ed 
Receivable Turnover
Compute Pioneer’s average days’ sales uncollected
365 days
Average Days' Sales Uncollect ed 
5.8
This means that the average length
of time it takes Pioneer Corp. to
receive payment for credit sales is
62.9 days
 62.9 days
45
EVALUTING LIQUIDITY OF
RECEIVABLES
46
Let’s Review
Brendan Corporation sells its goods on
terms of 2/10, n/30. It has a receivables
turnover ratio of 7. What is its average
collection period (days)?
a. 2,555.
b. 30.
c. 52.
d. 210.
47
Let’s Review
Brendan Corporation sells its goods on
terms of 2/10, n/30. It has a receivables
turnover ratio of 7. What is its average
collection period (days)?
a. 2,555.
b. 30.
c. 52.
d. 210.
48