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Topic 6: Accounts Receivable/ Debtors

Topic 6: Accounts Receivable/ Debtors. Contents. Overview of revenue recognition Recording the credit sales Calculating the Profit Accounts Receivable / Debtors Estimating the uncollectible debts Methods to write-off the bad debts. Revenue Recognition. When:

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Topic 6: Accounts Receivable/ Debtors

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  1. Topic 6: Accounts Receivable/ Debtors

  2. Contents • Overview of revenue recognition • Recording the credit sales • Calculating the Profit • Accounts Receivable / Debtors • Estimating the uncollectible debts • Methods to write-off the bad debts

  3. Revenue Recognition • When: • the work has been substantially completed (the company has done something) When should revenue be recognized? And: cash, or a valid promise of future payment, has been received (the company has received something in return)

  4. Discuss Recognition Concerns • As a practical matter, how do most companies handle recognition? • record sales when goods are shipped to customers. • recognize credit sales as revenues before cash is collected. • recognize revenues from services when the service is performed, not necessarily when cash is received.

  5. Jan 1 Cash. . . . . . . . . . . . . . . . . . . . 4,000 Accounts Receivable. . . . . . 5,000 Sales Revenue . . . . . . . . . 9,000 Sold 20 top hats for cash and 25 top hats for credit. Revenue Recognition On January 1, Formal Apparel sold 20 top hats for cash and another 25 for credit. Each hat sold for $200. How should the $9,000 of revenue be recorded?

  6. When the inventory is sold on account: Jan. 10 Accounts Receivable. . . . . . . . . . 2,000 Sales Revenue. . . . . . . . . . . . . 2,000 Sold equipment to Edison on account. When the collection takes place: Feb. 1 Cash . . . . . . . . . . . . . . . . . . . . . . . 2,000 Accounts Receivable . . . . . . . 2,000 Payment from Edison for equip. sold. Credit Sale and Collection On January 10, Mountain Mining sold Edison Excavation $2,000 of equipment on account. Mountain Mining received payment on February 1.What entries are made?

  7. Discuss the Complications withRevenue Recognition • Sales Discounts Offered as incentives for buyers to make prompt payments. • Sales Returnsand Allowances Merchandise is returned because the customer did not want it or because it was defective. • Uncollectible Accounts Occur when a company is unable to collect on receivables.

  8. What Do These Sales Discount Terms Mean? Two percent discount if paid within 10 days, net amount due in 30 days. • 2/10, n/30 • 1/10, n/30 • 2/10, EOM • 1/15, EOM One percent discount if paid within 10 days, net amount due in 30 days. Two percent discount if paid within 10 days, balance due by end of the month. One percent discount if paid within 15 days, balance due by end of the month.

  9. If paid within the discount period: Jan. 10 Cash. . . . . . . . . . . . . . . . . . . . . . . . 980 Sales Discounts . . . . . . . . . . . . . . 20 Accounts Receivable. . . . . . . . 1,000 Collected cash within discount period for $1,000 credit sale. If not paid within the discount period: Feb. 15 Cash. . . . . . . . . . . . . . . . . . . . . . . . 1,000 Accounts Receivable. . . . . . . . 1,000 Collected cash on account receivable. Credit Sale and Collection Tidy Paint Supplies sold $1,000 of equipment on account on January 3. The terms of the sales agreement are 2/10, n/30.What are the collection entries if paid on January 10 or on February 15?

  10. What Are Contra-Revenue Accounts? • A contra account is offset or deducted from another account. • Sales Discounts is a contra-revenue account. • Sales Discounts is deducted from sales revenue on the income statement. • Sales Discounts is included with other revenue accounts in the general ledger, but it has a debit balance (where revenue accounts normally have a credit balance).

  11. Gross Sales • Less: Sales Discounts • Returns and Allowances • Net Sales How Are Sales Returns and Allowances Reported? • A contra account deducted from sales revenue on the income statement.

  12. Sales entry: Jan. 10 Accounts Receivable (or Cash). . . 2,500 Sales Revenue . . . . . . . . . . . . . . 2,500 Sold equipment on account (for cash). Sales return entry: Jan. 17 Sales Returns and Allowances . . . 250 Accounts Receivable (or Cash). 250 Previously sold equipment was returned. Example: Sales Return On January 10, Handy Man Hardware sold $2,500 of equipment during its annual sale. One week later, $250 of equipment was returned.What are the entries?

  13. Learning Objective • Record the losses resulting from credit customers who do not pay their bills.

  14. What Are Receivables? • A company’s claims for money, goods, or services. • An account receivable is a current asset representing money due for services performed or merchandise sold on credit. • When an account receivable becomes uncollectible, a bad debt expense is incurred.

  15. Debtors Definition A debtor is a person who has an obligation to pay debt to a business resulting from the activities of buying stocks or inventories 2 types of debtors: i. Trade Debtors- debtors from sales of stock/ inventory ii. Debtors – from sales of assets.

  16. Credit sale: Jan. 10 Accounts Receivable . . . . . . . . . . 1,000 Sales Revenue . . . . . . . . . . . . . 1,000 Sold equipment on account. Collection--2/10, n/30: Jan. 30 Cash. . . . . . . . . . . . . . . . . . . . . . . . 1,000 Accounts Receivable. . . . . . . . 1,000 Payment received n/30. Example: Accounts Receivable On January 10, Carson Cameras sold $1,000 of equipment on account. The terms of the agreement are 2/10, n/30. Payment was received on January 30. What are the entries?

  17. Discuss Uncollectible Accounts. • Occur when customers do not pay for items or services purchased on credit. • When an account receivable becomes uncollectible, a firm incurs a bad debt loss. • Recognized as a cost of doing business, so classified as a selling expense. • Two ways to account for these losses: • the direct write-off method. • the allowance method.

  18. 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. Review The Direct Write-Off Method • Method is objective because bad debt expense is written off at the time it proves to be uncollectible. • However, the method violates the matching principle that says: • All costs and expenses in generating revenues must be identified with those revenues period by period.

  19. 8/1/02 Bad Debt Expense. . . . . . . . . . . . . . 4,000 Allowance for Bad Debts . . . . . . 4,000 To adjust the Allowance account to the desired balance. Discuss The Allowance Method • A firm uses its experience or industry averages to estimate the amount of receivables that will be uncollectible. • Allowance for Bad Debts is a contra-asset account that is offset against Accounts Receivable on the balance sheet. • As actual losses are recognized, Allowance for Bad Debts is reduced.

  20. Reverse Write-off: Aug. 1 Accounts Receivable . . . . . . . . . . 4,000 Allowance for Bad Debts . . . . . 4,000 To reinstate a written-off receivable. Eliminate Receivable: Aug. 1 Cash. . . . . . . . . . . . . . . . . . . . . . . . 4,000 Accounts Receivable. . . . . . . . 4,000 Payment for written-off receivable. Reversing Written-off Receivables What are the entries if the credit customer eventually pays? Companies must have good control over both cash collection procedures and accounting for accounts receivable; otherwise such payments could be pocketed by an employee who receives cash without the company’s knowledge.

  21. Estimating Uncollectible Accounts Receivable • What are the three methods? • As a percentage of credit sales • As a percentage of total receivables • Aging accounts receivable

  22. Amount of uncollectible = a straight percentage of the current year’s credit sales. Based on experience of prior years, modified for changes expected in current year. Any existing balance in Allowance for Bad Debts is not considered in the adjusting entry to record bad debt expense. Explain the Percentage of Credit Sales Method

  23. Amount of uncollectible = a percentage of total receivables balance at period’s end. Focus is on estimating total bad debts existing at the end of the period. The ending balance in Allowance for Bad Debts is the amount of total receivables estimated to be uncollectible. Explain the Percentage of Total Receivables Method

  24. AS A PERCENTAGE OF CREDIT SALES Amount of uncollectibles = a straight percentage of the current year’s credit sales. Based on experience of prior years, modified for changes expected in current year. Any existing balance in Allowance for Bad Debts is not considered in the adjusting entry to record bad debt expense. AS A PERCENTAGE OF TOTAL RECEIVABLES Amount of uncollectibles = a percentage of total receivables balance at period’s end. Focus is on estimating total bad debts existing at period’s end. The ending balance in Allowance for Bad Debts is the amount of total receivables estimated to be uncollectible. Estimating Uncollectible Accounts Receivable

  25. AS A PERCENTAGE OF CREDIT SALES AS A PERCENTAGE OF TOTAL RECEIVABLES Estimating Uncollectible Accounts Receivable In practice, a company should consider both techniques to ensure that each yields roughly consistent results.

  26. 12/31/01 Bad Debt Expense. . . . . . . . . . . . . . 2,701 Allowance for Bad Debts . . . . . . 2,701 To adjust the Allowance account to desired balance. Uncollectible Accounts Allowance Norm’s Tools had credit sales of $100,000. The current accounts receivable balance is $30,510. The allowance for bad debts balance is $350. Historically, 10 percent of the accounts receivable ending balance is not collected.What is the adjusting entry? Bad Debt Expense Allowance for Bad Debts 350 Bal. Exp. 2,701 2,701 Exp. End. Bal. 2,701 3,051 End. Bal.

  27. 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). Review Aging Accounts Receivable

  28. Uncollectible Accounts Expense Copy That had credit sales during the year of $200,000. Using the aging method and the data on the aging receivables worksheet, determine the journal entry needed. The beginning balance for Allowance for Bad Debts is $150. Aging Receivables Worksheet Percentage Estimated to be AgeBalanceUncollectible Amount Current. . . . . . . . . . $10,000 1.5% $ 150 1-30 days. . . . . . . . 4,000 4.0 160 31-90 days. . . . . . . 2,100 20.0 420 Over 90 days. . . . . 1,000 40.0 400 $17,100 $1,130

  29. 12/31/01 Bad Debt Expense. . . . . . . . . . . . . . 980 Allowance for Bad Debts . . . . . . 980 To adjust the Allowance account to desired balance. Uncollectible Accounts Expense Copy That had credit sales during the year of $200,000. Using the aging method and the data on the aging receivables worksheet, determine the journal entry needed. The beginning balance for Allowance for Bad Debts is $150. Bad Debt Expense Allowance for Bad Debts 150 Bal. Exp. 980 980 Exp. End. Bal. 980 1,130 End. Bal.

  30. Dr Bad Debt Expenses Cr Allowance for Doubtful Debts • Allowance for Doubtful Debt: • What is the difference between the bad debt and allowance for doubtful debt? • - Bad debt is a debt that cannot be collected within the accounting period. • - Allowance for doubtful debt is an expected debt that cannot be collected within the accounting period.

  31. Dr Bad Debt Expense Cr Allowance for Doubtful Debts An allowance for doubtful debt is made to comply with: i. Matching principle ii. Prudence The journal entry to record bad debt expense:

  32. Using the Allowance for BD & Doubtful Debt to write-off Bad Debt Expense: • Example 1: (No Allowance on doubtful debts account:) • The information below is about Ainun Enterprise for the year ended 31/12/09. Debtor (before bad debt written off) RM 80,000 Bad Debt written off RM 2,200

  33. Dr Cr Bad Debt Expense 2,200 Debtors 2,200 (being a bad debt written off) Income Statement 2200 Bad Debt Expense 2200 (posting to Income Statement) Bal b/d 80,000 Bad debts exp. 2,200 Debtors 2,200 Inc. Statement . 2,200 Bal. c/d 77,800 80,000 80,000 2,200 2,200 • Journal Entry: • Debtors’ a/cBad debt expense

  34. Operation Expenses : Bad debt 2,200 Current Asset Debtors 77,800 (-) Allow for d/d ( 0) 77,800 • Presentationin Income Statement: • Income Statement for the year ended … • Presentation in Balance Sheet: • Balance Sheet as at ….

  35. Using the Allowance for BD & DD to write-off Bad Debt Expense: • Example 2: (No bad debts written off and Allowance for BD & doubtful debt is created): • The information below is about Ainun Enterprise for the year ended 31/12/09. Debtor (before bad debt written off) RM 80,000 Ainun expected that uncollectible debt is 3% from the debtors balance. Workings: Allowance for Bad Debt & Doubtful debt on 31/12/2009 80,000 x 3% = RM 2,400

  36. Dr Cr Bad Debt Expense 2,400 Allowance for BD & DD 2,400 (being an allowance for d/d for the year) Bal c/d 2,400 Bad debt exp. 2,400 All d/d 2,400 IS 2,400 2,400 2,400 • Journal Entry: • Allowance for BD & DD a/c • Bad debt expense a/c

  37. Operation Expense : Bad debt 2,400 Current Asset Debtors 80,000 (-) Allow. for d/d ( 2,400) 77,600 • Presentation in Income Statement: • Income Statement • Presentation in Balance Sheet: • Balance Sheet as at….

  38. Using the Allowance for BD & DD to write-off Bad Debts Expenses: • Example 3: (Decrease in Allowance for BD & DD): • The information below is about Ainun Enterprise for the year ended 31/12/09. Debtor (before bad debt written off) RM 80,000 Bad debt written off RM 2,200 Allowance for doubtful debt (1/1/09) RM 2,500 Ainun expected that un-collectible debt is 2% from the debtors balance Workings: Provision for doubtful debt on 31/12/2009 (80,000 – 2,200) x 2% = RM 1,556

  39. Dr Cr Allowance for BD & DD 2,200 Debtors 2,200 (being a bad debt written off) Bad debt expense 1,256 Allowance for BD & DD 1,256 (being a decrease in allowance for doubtful debt) • Journal Entry:

  40. Debtors 2,200 Balance b/d 2,500 Balance c/d 1,556 Bad debts expenses 1,256 3,756 3,756 All. For BD DD 1,256 Income Stat. 1,256 Bal b/d 80,000 All for BD &DD 2,200 Bal. c/d 77,800 80,000 80,000 • Allowance for BD & DD a/c • Bad debt expense a/c • Debtor a/c

  41. Operation Expenses : Bad debt 1,256 Current Asset Debtors 77,800 (-) All for BD & DD ( 1,556) 76,244 • Presentation in Income Statement: • Income Statement • Presentation in Balance Sheet: • Balance sheet as at

  42. Using the Allowance for Doubtful Debt to write-off Bad Debts Expenses: • Example 4: (Increase in Allowance for BD & DD): • The information below is about Ainun Enterprise for the year ended 31/12/09. Debtor (before bad debt written off) RM 80,000 Bad debt written off RM 2,200 Allowance for BD & DD (1/1/09) RM 2,000 Ainun expected that uncollectible debt is 5% from the debtors balance Workings: Allowance for BD & DD on 31/12/2009 (80,000 – 2,200) x 5% = RM 3,890

  43. Dr Cr Allowance for doubtful debt 2,000 Bad Debt Expense 200 Debtors 2,200 (being a bad debt written off) Bad debts expenses 3,890 Allowance for doubtful debt 3,890 (Being an increased in the Allowance for BD & DD a/c) • Journal Entry:

  44. Debtors 2,000 Balance b/d 2,000 Balance c/d 3,890 Bad debt expense 3,890 5,890 5,890 Debtors 200 Income Stat. 4,090 All for BD & DD 3,890 4,090 4,090 Bal b/d 80,000 All for BD & DD 2,000 Bad debts exp. 200 Bal. c/d 77,800 80,000 80,000 • Allowance for BD & DD a/c • Bad debt expense a/c • Debtors’ a/c

  45. Operation Expenses : Bad debt 4,090 Current Asset Debtors 77,800 (-) All for BD & DD ( 3,890) 73,910 • Presentation in Income Statement: • Income Statement • Presentation in Balance Sheet: • Balance sheet as at

  46. Using the Allowance for BD & Doubtful Debt to write-off Bad Debts Expenses: • Example 5: (Bad debt over Provision): • The information below is about Ainun Enterprise for the year ended 31/12/09. Debtor (before bad debt written off) RM 80,000 Bad debt written off RM 800 Allowance For BD & DD (1/1/09) RM 1,650 Ainun expected that un-collectible debt is 1% from the debtors balance Workings: Allowance for BD & DD on 31/12/2009 (80,000 – 800) x 1% = RM 792

  47. Dr Cr Allowance for BD & DD 800 Debtors 800 (being a bad debt written off) Allowance for BD & DD 58 Bad debt over provision 58 (Being a bad debt over provision) • Journal Entry:

  48. Debtors 800 Balance b/d 1,650 Bad debt over prov. 58 Balance c/d 792 1,650 1,650 Income Stat. 58 All for BD & DD 58 Bal b/d 80,000 All for BD & DD 800 Bal. c/d 79,200 80,000 80,000 • Allowance for BD & DD a/c • Bad debt over provision a/c • Debtors’ a/c

  49. Other Income: Bad debt over provision 58 Current Asset Debtors 79,200 (-) Allowance for BD & DD ( 792) 78,408 • Presentation in Income Statement: • Income Statement • Presentation in Balance Sheet: • Balance sheet as at….

  50. Bad Debt Recovered • debt that is considered bad is then paid back by the debtor • (for the full amount or half of the amount) • Example : • On 15/6/2009, one of the customers name • Azam has paid back his debt for an amount of RM2,000

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