A/R AND DOUBTFULL ACCOUNTS Chapter 9 pages 421-441

1. A/R AND DOUBTFULL ACCOUNTSChapter 9 pages 421-441 What occurs when companies sell on credit?  Gain Accounts receivable (A/R) Chapter 9 A/R

2. 1,000 July 1 1,000 To record sales on account. RECOGNIZING ACCOUNTS RECEIVABLE GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Accounts Receivable - Adorable Junior Sales When a business sells merchandise to a customer on credit, Accounts Receivable is debited and Sales is credited. Chapter 9 A/R

3. ADVANTAGES Increase revenue and sales thus Net Income Encourage purchases / consumption Turn inventory into a “productive” asset Generally this is how business is done! DISADVANTAGES Must finance the sale (it is like lending $) Lost A/R = bad debt expense Why do companies sell on credit? Chapter 9 A/R

4. Alternatives to Credit…p.431-434 • Credit Card sales(be careful…) • Like a cash sale, cc company receives 1 to 5% of revenue  why do companies love CC? AR 100 Sales 100 Cash 98 CC expense 2 AR 100 • Factoring (not the math kind!) • Small businesses will sell their A/R at a discount • Securitization(not G.W. Bush kind of security) • Use A/R as collateral for a loan Chapter 9 A/R

5. Direct Write-off method (p.424) • When a debt is determined to be uncollectible, the loss is charged to a bad debt expense • Example: after 8 months, it is determined that your customer Dogbreath is not going to pay you write it off Bad Debt expense $5000 A/R Dogbreath $5000 Write off Dogbreath act. • These companies value all outstanding A/R at its full value and only recognize an uncollectible account expense when the A/R proves uncollectible. • Not GAAP acceptable… Conservatism Matching Time Period Chapter 9 A/R

6. Allowance for doubtful Accounts • Every time a business sells goods or services on credit, a portion of those sales will likely be uncollectible. That is the bill for the goods or services will not be paid. The loss of the A/R asset is an expense. The account is a contra-asset (anti-asset) termed allowance for doubtful accounts Chapter 9 A/R

7. VALUING ACCOUNTS RECEIVABLE • To ensure that receivables are not overstated on the balance sheet, they are stated at their net realizable value. • Net realizable value is the net amount expected to be received in cash and excludes amounts that the company estimates it will not be able to collect. Chapter 9 A/R

8. Allowance Method p. 425 • example: stores like the Brick and Future Shop sell merchandise on credit. From past experience, the store knows that a small percentage of their A/R will be uncollectible. This uncollectible value is historically 2% of sales and is considered part of the cost of doing business. Journal entry for the uncollectible A/R on monthly sales of $150,000: A/R 150000 Sales 150000 Bad Debt expense 3000 (.02*150,000) Allowance for doubtful accounts 3000 Uncollectible AR expense for Q1 credit sales  What does this entry do to the Income Stmt? CONSERVATISM MATCHING PRINCIPLE estimate contra asset Chapter 9 A/R

9. THE BRICK Balance Sheet (partial) Net Realizable Value Current assets Cash $ 14,800 Accounts receivable $150,000 Less: Allowance for doubtful accounts 3,000 147,000 estimate contra asset CONSERVATISM MATCHING PRINCIPLE Chapter 9 A/R

10. Write-off of uncollectibles: p. 425 • When A/R from a specific customer is determined to be uncollectible, it is no longer an asset and should be “written off” or removed from the BS. • Example: When Eaton’s declared bankruptcy, an A/R from Eaton’s valued at $20,000 becomes uncollectible. Allowance for doubtful Accounts $20,000 A/R $20,000 Write off A/R Eaton’s; bankruptcy filing Chapter 9 A/R

11. Recovery of a write-off / bad debtp. 427(we can always hope) • Occasionally a receivable written off as worthless will later be collected or partially collected. • Example: Following liquidation of all assets, the trustee of Eaton’s pays 50 cents on the dollar to the unsecured creditors. (you get 50% of your A/R) A/R $10,000 Allowance for doubtful Accounts $10,000 Cash $10,000 A/R $10,000 Collection of 50% of previously written Eaton’s AR from bankruptcy Chapter 9 A/R

12. 1. Percentage of sales Expected bad debt losses are determined by applying a percentage of sales of the current period. This basis better matches expenses with revenues 2. Percentage of receivables Expected bad debt losses are determined by applying a percentage of AR The larger age of AR the larger the percent! BASES USED FOR THE ALLOWANCE METHOD p. 427 GAAP & Management Decision Chapter 9 A/R

13. ILLUSTRATION 9-4COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES Emphasis on Income Statement Relationships Percentage of Sales Percentageof Receivables Net Realizable Value Allowance Accounts for Receivable Doubtful Accounts Emphasis on Balance Sheet Relationships Chapter 9 A/R

14. Adjusting the Allowance for doubtful accounts at period end(p. 429) • If the balance in the allowance for doubtful accounts proves to be less than the actual uncollectible A/R then the balance in the allowance account must be increased: • Example: Brick booked $3000 bad debt expense for non-collectable AR for Q1; however, more A/R is aging due to the poor economy, and bad debt expense must be adjusted Bad Debt Expense $1000 allowance for doubtful accounts $1000 Adjustment for Q bad debt expenses based on aging AR Chapter 9 A/R