Week 8 Flashcards
Accounts receivable
A receivable represents a business’ claim on the assets of another entity.
The most common type of receivable is an account receivable.
An account receivable is an amount owed by a customer who has purchased the company’s product or service.
Sometimes these receivables are referred to as trade receivables
(Trade Debtors) because they arise from the trade of the company.
Sales returns and allowances
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Reporting accounts receivable
Because accounts receivable are expected to be collected quickly, they are classified and reported as current assets.
Companies must follow the principle of conservatism and report their accounts receivable at fair value (net realisable value).
NRV
Net realisable value is the amount of cash that a business expects to collect from its total or gross accounts receivable balance. It is calculated by subtracting from gross receivables the amount that a company does not expect to collect.
Uncollectible accounts
Bad debts expense is included in the calculation of profits (or losses) but is usually combined with other operating expenses on the statement of comprehensive income.
An uncollectible account is written-off (the asset is removed) and an expense is recognised.
When the expense is recognised depends on the method of accounting for uncollectible accounts.
There are two methods to account for bad debt expense:
direct write-off method
allowance method
Direct write-off method
Under the direct write-off method, bad debt expense is recorded when the business determines that a receivable is uncollectible and removes it from its records.
While this method is required for most tax purposes and is simple, it violates GAAP (the matching principle).
Recording the direct write-off method
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Shortcomings of the direct write-off method
Shortcomings of the direct write-off method are:
it fails to match bad debt expense with revenue, since it delays the expense until the account is determined to be uncollectible
it provides an opportunity to manipulate earnings each period by strategically writing-off accounts
it does not provide the best estimate of how accounts receivable affect expected cash inflow.
Estimating the amount of uncollectible accounts
When estimating bad debt expense using the allowance method, either or both of the following may be used:
percentage-of-sales approach:
percentage-of-receivables or ageing of accounts receivable approach
percentage-of-sales approach:
multiply sales for the period by a percentage set by the company. Typically, this percentage is between 1–2 per cent of credit sales, but may vary with volume of business, ease with which credit is granted and general economic conditions.
percentage-of-receivables or ageing of accounts receivable approach
percentage-of-receivables or ageing of accounts receivable approach: this is a function of a company’s receivables balance, where the allowance account is adjusted to reflect the estimate of the uncollectibles from existing accounts.
The allowance method
As such, the allowance method splits the accounting into two entries:
to record an estimate of bad debt expense
to write off receivables when they become uncollectible
Percentage of sales approach
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Ageing of accounts receivable approach
A more refined version of the percentage-of-receivables approach.
Recognising that receivables become less collectible as they get older, companies often prepare ageing schedules for their receivables.
An ageing schedule is a listing and summation of accounts receivable by their ages.
Ageing of accounts receivable approach example
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Writing off specific accounts using the allowance method
Min Ly determines in 2010 that a $2 500 ( excluding GST) receivable from William is uncollectible and decides to write it off.
When a firm decides that a particular customer account is uncollectible, it removes that account by debiting the allowance for bad debts and crediting accounts receivable for that specific customer.
This process is called writing off the account.
Writing off specific accounts using the allowance method (2)
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Recovery of a write-off
Occasionally, a company will collect a receivable previously written off. When this payment occurs, two entries are made:
The first entry reverses the original writing off.
The second entry records the collection of cash and the reduction of the receivable.
Liabilities Defined
Three essential characteristics
Present obligation to an external party
Obligation must have resulted from past events
Must have future outflow of resources embodying economic benefits
Recognition of liabilities
Criteria for recognition
it is Probable that future economic benefit will flow from the entity- On demand/On a specified date/On the occurrence of a specified event
the amount at which the settlement will take place can be measured reliably.
Recognition of liabilities
Recognition avoids
Understatement of liabilities
Overstatement of equity
Bills Payable - Example
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Provisions
Nature of provisions
Liabilities of uncertain timing or amount
Accumulated depreciation and Allowance for Doubtful Debts not provisions
Examples include
Provision for long-service leave
Provision for warranties
