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Chapter 4 Fall 2011

This document discusses accounts receivable as a current asset arising from credit sales, detailing how they are valued and reported under GAAP. It contrasts the allowance method, which estimates bad debts and matches expenses with revenues, with the direct write-off method, which records bad debts only when specific accounts are deemed uncollectible. Additionally, it provides examples of journal entries for recognizing sales, collecting cash, and adjusting for estimated uncollectibles.

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2 views41 pages

Chapter 4 Fall 2011

This document discusses accounts receivable as a current asset arising from credit sales, detailing how they are valued and reported under GAAP. It contrasts the allowance method, which estimates bad debts and matches expenses with revenues, with the direct write-off method, which records bad debts only when specific accounts are deemed uncollectible. Additionally, it provides examples of journal entries for recognizing sales, collecting cash, and adjusting for estimated uncollectibles.

Uploaded by

jnbgpm4cpt
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

CASH AND

ACCOUNTS RECEIVABLE

Chapter 4
ACCOUNTS RECEIVABLE
Accounts receivable is a current
asset that arises from sales on
credit.

It is also the total amount customers


owe the firm.

They are sometimes called “trade


accounts receivable.”
VALUE OF RECEIVABLES
Receivables are reported at their
face value less an allowance for
accounts which are likely to be
uncollectible.
The amount which is actually
expected to be collected is called the
net realizable value (NRV).
GAAP requires that A/R be reported at
NRV.
GAAP Not GAAP

Allowance Method Direct Write-Off


Method

Used only when


bad debts are a
very small item or
when credit sales
A/R Sales are insignificant.
Method Method
DIRECT WRITE-OFF

uNo estimate of bad debts is made.


uOnly when a specific account is known
to be uncollectible (customer files
bankruptcy, for example) is bad debts
expense recorded.
uMethod does not do a very good job of
matching the revenue (sale) with the
expense (bad debt), because a company
often discovers an account is uncollectible
in a period subsequent to the one in which
the sale was made.
ALLOWANCE METHOD
uEstimates the bad debt
expense for the accounting
period as an adjustment.
uRecords the amount as a
deduction in accounts receivable
(A/R), even though it is not
known whose accounts will be
“bad.”
uCreate an account called:
allowance for uncollectible
accounts” (a contra-asset
account) to hold the deductions
in A/R
ALLOWANCE METHOD

The bad debts estimate is based on:


uSales, or
uAccounts Receivable
The allowance method attempts to match
the expense (bad debts) with the revenue
(sale) by recording the expense in the same
period as the sale even though the
company has not specifically identified
which accounts will go unpaid.
ACCOUNTS RECEIVABLE METHOD

uUses an aging schedule to estimate


the amount of accounts receivable (A/R)
that will not be collectible.
uAnalyzes A/R to determine how long
each account has been outstanding. The
longer the account has been outstanding,
the greater the likelihood it will not be
collected.
uThe company estimates the percentage
of A/R that will be uncollectible. An
adjustment is made to the allowance
account to reflect that estimate, and the
bad debts expense equals the amount of
the adjustment.
1. PROVIDED $5,000 SERVICES ON
ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+5,000 A/R +5,000 Sales


Revenue

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
1. PROVIDED $5,000 SERVICES ON
ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+5,000 A/R +5,000 Sales


Revenue

¢ Income Statement YES, revenue is recognized.


¢ Statement of Changes in Equity
¢ Statement of Cash Flows
1. PROVIDED $5,000 SERVICES ON
ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+5,000 A/R +5,000 Sales


Revenue

¢ Income Statement YES, revenue is recognized.


¢ Statement of Changes in Equity YES, via NI.
¢ Statement of Cash Flows
1. PROVIDED $5,000 SERVICES ON
ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+5,000 A/R +5,000 Sales


Revenue

¢ Income Statement YES, revenue is recognized.


¢ Statement of Changes in Equity YES, via NI.
¢ Statement of Cash Flows NO, no cash here.
2. COLLECTED $4,000 CASH ON
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,000 cash
(4,000) A/R

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
2. COLLECTED $4,000 CASH ON
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,000 cash
(4,000) A/R

¢ Income Statement NO
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
2. COLLECTED $4,000 CASH ON
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,000 cash
(4,000) A/R

¢ Income Statement NO
¢ Statement of Changes in Equity NO
¢ Statement of Cash Flows
2. COLLECTED $4,000 CASH ON
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,000 cash
(4,000) A/R

¢ Income Statement NO
¢ Statement of Changes in Equity NO
¢ Statement of Cash Flows YES, operating cash inflow.
3. ADJUSTING ENTRY RECORDED TO REFLECT THE
ESTIMATE OF 5% OF ENDING A/R TO BE

UNCOLLECTIBLE.

Assets = Liab. + C C + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
3. ADJUSTING ENTRY RECORDED TO REFLECT THE
ESTIMATE OF 5% OF ENDING A/R TO BE

UNCOLLECTIBLE.

Assets = Liab. + C C + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

¢ Income Statement YES, expense is recognized.


¢ Statement of Changes in Equity
¢ Statement of Cash Flows
3. ADJUSTING ENTRY RECORDED TO REFLECT THE
ESTIMATE OF 5% OF ENDING A/R TO BE

UNCOLLECTIBLE.

Assets = Liab. + C C + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

¢ Income Statement YES, expense is recognized.


¢ Statement of Changes in Equity
¢ Statement of Cash Flows
3. ADJUSTING ENTRY RECORDED TO REFLECT THE
ESTIMATE OF 5% OF ENDING A/R TO BE

UNCOLLECTIBLE.

Assets = Liab. + C C + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

¢ Income Statement YES, expense is recognized.


¢ Statement of Changes in Equity YES, via NI.
¢ Statement of Cash Flows
3. ADJUSTING ENTRY RECORDED TO REFLECT THE
ESTIMATE OF 5% OF ENDING A/R TO BE

UNCOLLECTIBLE.

Assets = Liab. + C C + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

¢ Income Statement YES, expense is recognized.


¢ Statement of Changes in Equity YES, via NI.
¢ Statement of Cash Flows NO, no cash here.
FINANCIAL STATEMENTS AT THE END OF YEAR 1:

Statement of Cash Flows


Income Statement For Year 1
for Year 1
Cash from operations $4,000
Cash from investing -0-
Sales $5,000 Cash from financing -0-
Bad debts expense 50
Total change in cash $4,000
Net Income $4,950
Balance Sheet at the end of Year 1:

Assets: Liabilities + SH Equity:


Cash $4,000
AR 1,000
Allowance (50)
Net A/R 950 RE $4,950

Total Assets $4,950 Total L & SHE $4,950


YEAR 2:
1-WROTE OFF A $40 A/R THAT WAS
DETERMINED TO BE UNCOLLECTIBLE

Assets = Liab. + Cont. Cap. + Ret. Earnings

(40) AR-Jones
+40 Allowance

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
YEAR 2:
1-WROTE OFF A $40 A/R THAT WAS
DETERMINED TO BE UNCOLLECTIBLE

Assets = Liab. + Cont. Cap. + Ret. Earnings

(40) AR-Jones
+40 Allowance

¢ Income Statement NO
¢ Statement of Changes in Equity NO
¢ Statement of Cash Flows NO
2-PROVIDED $6,000 WORTH OF SERVICES
ON ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+6,000 AR +6,000 revenue

¢ Income Statement:
¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
2-PROVIDED $6,000 WORTH OF SERVICES
ON ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+6,000 AR +6,000 revenue

¢ Income Statement: YES, revenue is recognized.


¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
2-PROVIDED $6,000 WORTH OF SERVICES
ON ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+6,000 AR +6,000 revenue

¢ Income Statement: YES, revenue is recognized.


¢ Statement of Changes in Equity: YES, via NI.
¢ Statement of Cash Flows:
2-PROVIDED $6,000 WORTH OF SERVICES
ON ACCOUNT.
Assets = Liab. + Cont. Cap. + Ret. Earnings

+6,000 AR +6,000 revenue

¢ Income Statement: YES, revenue is recognized.


¢ Statement of Changes in Equity: YES, via NI.
¢ Statement of Cash Flows: NO, no cash here.
3- COLLECTED $4,500 CASH FROM
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,500 Cash
(4,500) AR

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
3- COLLECTED $4,500 CASH FROM
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,500 Cash
(4,500) AR

¢ Income Statement: NO
¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
3- COLLECTED $4,500 CASH FROM
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,500 Cash
(4,500) AR

¢ Income Statement: NO
¢ Statement of Changes in Equity: NO
¢ Statement of Cash Flows:
3- COLLECTED $4,500 CASH FROM
ACCOUNTS RECEIVABLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+4,500 Cash
(4,000) AR

¢ Income Statement: NO
¢ Statement of Changes in Equity: NO
¢ Statement of Cash Flows: YES
4-ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING AR BALANCE
WOULD BE UNCOLLECTIBLE.
(BALANCE IS $2,460.)
Assets = Liab. + Cont. Cap. + Ret. Earnings

¢ Income Statement:
¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
4-ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING AR BALANCE
WOULD BE UNCOLLECTIBLE.
(BALANCE IS $2,460.)
Assets = Liab. + Cont. Cap. + Ret. Earnings

¢ Income Statement:
¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
WHERE DO WE STAND?

We overestimated bad debts by $10--we


estimated $50 but we only wrote off $40 in the
subsequent year.

This year our estimate is 5% of $2,460 (BB


1,000 + 6,000 credit sales - $4,500 collections -
$40 accounts written off) = $123. But since we
overestimated last year, we only need to record
$113 this year.
4.B ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING A/R BALANCE
WOULD BE UNCOLLECTIBLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad


for doubtful debts
accounts expense

¢ Income Statement
¢ Statement of Changes in Equity
¢ Statement of Cash Flows
4.B ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING A/R BALANCE
WOULD BE UNCOLLECTIBLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad


for doubtful debts
accounts expense

¢ Income Statement: YES, expense is recognized.


¢ Statement of Changes in Equity:
¢ Statement of Cash Flows:
4.B ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING A/R BALANCE
WOULD BE UNCOLLECTIBLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad


for doubtful debts
accounts expense

¢ Income Statement: YES, expense is recognized.


¢ Statement of Changes in Equity: YES, via NI.
¢ Statement of Cash Flows:
4.B ADJUST THE ACCOUNTING RECORDS TO REFLECT THE
EXPECTATION THAT 5% OF THE ENDING A/R BALANCE
WOULD BE UNCOLLECTIBLE.

Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad


for doubtful debts
accounts expense

¢ Income Statement: YES, expense is recognized.


¢ Statement of Changes in Equity: YES, via NI.
¢ Statement of Cash Flows: NO, no cash here.
SUMMARY OF THE ALLOWANCE METHOD

One way to estimate bad debt


expense is to use a percentage of
ending A/R (or an aging schedule)
When an actual account is written off
as uncollectible, it is removed from
A/R and the Allowance Account.
THERE IS NO NET EFFECT ON
ASSETS and NO EXPENSE at the
time of the write-off.

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