FAR-F3-M2-Trade Receivables Flashcards
Is the direct write off method allowed under GAAP?
No, the direct write off method is not in conformity with GAAP
Other than the direct write off method, what is the other method of accounting for bad debt?
The allowance method. It uses the allowance for doubtful assets account
How is the provision for bad debt allowance determined?
Either using the income statement approach, which calculates bad debt expense as a percentage of sales. Or the balance sheet approach which calculates bad debt allowance as a percentage of AR. This approach calculates the ending balance of the allowance account that must be recorded at year end.
Under the direct write off method, what is the JE to record bad debt?
Under the direct write off method, when the account becomes uncollectible, it is written off to bad debt expense and AR is reduced by the same amount
Dr. Bad Debt Expense XXX
Cr. Accounts Receivable (XXX)
JE for subsequent collection of AR Written off:
Dr. Cash XXX
Cr. Uncollectible accounts recovered (XXX)
**Remember that the direct write off method is not GAAP
Under the allowance method, what are the JE’s to record bad debt?
The allowance is a contra account to AR. So it has a credit balance. The idea is that an allowance amount is set for the year (it’s an estimate) and when bad debt is actually written off, the allowance is debited (lowered).
To record the provision every period:
Dr. Bad Debt Expense
Cr. Allowance for doubtful accounts
To write off uncollectible debt:
Dr. Allowance for doubtful accounts
Cr. Accounts Receivable
To record the subsequent collection of AR written off, first you need to restore the account previously written off, then record cash collected:
Dr. Accounts Receivable
Cr. Allowance for doubtful accounts
To record cash collected:
Dr. Cash
Cr. Accounts Receivable
What are the three criteria for determining whether a transfer of receivables is considered a loan or a sale?
If all three are met, then the transfer is considered a sale. If ANY are NOT met, then its considered a loan:
1. The transferred receivables are not accessible by the company - control is given up.
2. The transferee has the right to sell or pledge the receivables.
3. There’s no agreement that lets the company keep control of the receivables.
What is the difference between factoring receivables with recourse and without recourse?
If a company assigns their receivables to a factor (usually a bank) for a fee and receives cash in return, this can be done with recourse or without recourse. Without recourse is considered a sale of the receivables because once transferred the receivables are up to the factor to deal with and collect on.
*Recourse definition: The bank has the legal right to demand compensation or payment.
What are factoring receivables?
Many businesses will use their receivables as an immediate source of cash by selling or factoring the receivables. Basically, the company is selling their receivables on a discount in exchange for cash.
How is AR recorded on the balance sheet?
AR is recorded at NET REALIZABLE VALUE on the balance sheet, the amount of cash the company expects to actually collect.
Items that reduce AR are sales discounts, sales returns and uncollectible amounts. How are claims against suppliers treated?
Claims against suppliers are included as A/R, therefore they increase A/R.
The amount charged to earnings for bad debt expense includes the provision for bad debt made each period throughout the year and?
The amount charged to earnings for bad debt expense includes the provision for bad debt made each period through the year and an adjustment made at year end to increase or decrease the balance in the allowance account if needed.
If the receivables are transferred but the transferee doesn’t have the right to sell the receivables and the transferor keeps control, is this considered a sale or a loan?
If the receivables are transferred, but the transferee doesn’t have the right to sell the receivables and the transferor keeps control, then the transaction is considered SECURED BORROWING. They are just using their receivables as collateral and receiving a loan.
To record a secured borrowing transaction:
Dr. Cash
Cr. Note Payable
Requires a note disclosure.
What is the concept of discounting a notes receivable and what is the general formula for calculating the amount of interest income?
Discounting notes receivable arise when the holder endorses the note to a third party and receives a sum of cash.
Step 1. Calculate maturity value of note by adding interest to the face amount of the note:
Principle of note (aka face value of note)
+Interest on note if held to maturity
= Maturity value of note
Step 2: Calculate the bank discount on the payoff value at maturity:
Bank Discount amount = Maturity value of note * Discount Rate * Time left on the note to maturity from date of transfer.
Step 3: Compute the amount PAID by the bank for the note aka Bank Proceeds:
Maturity value of note
-Bank Discount
=Amount paid by bank for note (bank proceeds)
Step 4: Determine the interest income (or expense) by subtracting the face value of the note from the amount paid by the bank for the note:
Bank Proceeds
-Principle of Note
= Interest Income
