receivables Flashcards
when should possible default loss on credit sales be recognized?
Businesses take on the risk of the customer’s defaulting at the time a credit sale is made.
By the matching principle, the seller should therefore recognize the associated cost at the time of sale.
where is bad debt expense accumulated? what type of account is that?
This cost of customers’ potential failure to pay is called bad debt expense and is recognized in allowance for doubtful accounts. The allowance for doubtful accounts is a contra-asset account attached to the receivables account. (it is usually netted out when presenting receivables in the BS)
where is bad debt expense recognized in the IS?
net revenues
what is the adjustment to receivables when a customer actually defaults?
We have already taken an expense and created a ‘reserve’ (the allowance for doubtful accounts), so an actual default can simply be handled by reducing both accounts receivable and allowance for doubtful accounts. this entry has no effect on IS and BS totals. (it is called a write-off)
what are the entries that modify allowance for doubtful accounts?
bad debt expense recognition and write offs.
what are the 2 methods to calculate bad debt expense? how do they work?
income statement approach and balance sheet approach. Under the income statement approach, we calculate the expected amount of loss from customer defaults for all the credit sales made during the year (usually a percentage of sales).
This amount gets recorded as bad debt expense.
Under the balance sheet approach, we calculate how big the allowance needs to be, given the amount of receivables currently outstanding.
The bad debt expense is a plug number to adjust the current allowance balance to this target value.
what are the two ways of implementing the balance sheet approach?
The balance sheet approach to computing the allowance for doubtful accounts can be implemented by
a customer-by-customer analysis. Doubtful accounts are identified individually based on known facts and circumstances about the customer and on the reviewing manager’s judgment.
an aging of receivables. The allowance is a percentage of each account receivable. The percentage varies depending on the age of the receivable (i.e., the number of days it has been outstanding past its due date).
is BDE subjected to error? if so what is the effect?
yes as it is estimated, underestimating BDE reduces expenses this period, however if done consistently will deplete the allowance account as write offs consistently surpass BDE for the period.
