Wk 4 - Receivables, Approaches to Write-Offs, and Payables (Ch9 & Ch11) Flashcards
Bad debts
- Overdue accounts which may or may not be recovered later
- Uncollectible accounts
- An expense
What to do if we cannot collect part of accounts receivable?
Undo (or some part of) that transaction
1. Reduce sales
2. Reduce account receivables
Allowance method
Making provision for bad debts before the bad debt event happens by:
- % of sales
- Aging of accounts
What financial statement does bad debt expense and allowance for bad debts go into?
Bad debt expense - balance sheet under accounts receivable
Allowance for bad debts -income statement under expenses
Direct write-off method
Write-off (i.e. cancel) the accounts receivable when they are “proven” to be uncollectible.
Journal entry for direct write-off method
Dr Bad debt expense
Cr Accounts receivable
Journal entry for allowance method
Dr Bad debt expense
Cr Allowance for bad debts (contra-asset - as it decreases A/R)
Allowance method 1 - percentage of sales
- Income statement approach: focuses on the amount of bad debt expense to be reported on the income statement for this period.
- Based on prior experience, calculated as a % of credit sales.
- Recorded as an adjusting entry at the end of the period.
- Add to the balance of the allowance for bad debts account
Allowance method 2 - ageing of accounts
- Balance sheet approach: focuses on the age of the accounts receivable and on which determines the ending balance of Allowance for bad debts.
- Older an account, the more likely it is uncollectible (i.e. bad debt).
- Estimate the ending balance, compare with the opening balance, figure out the bad debts expense.
DIfference between percentage of sales and ageing methods
- % of sales: adjusts allowance for doubtful debts BY the amount of bad debts expense.
- Ageing of accounts: adjusts allowance of doubtful debts TO the amount of uncollectable accounts receivable.
Under allowance method, bad debts amount is estimated. In the future, some clients cannot repay us. What is the journal entry?
Dr Allowance for bad debts
Cr Accounts receivable
What is a pro and con of the direct write-off method?
- Simple - no need to predict the future.
- Overstates asset and underestimates expense
How to recover bad debt using the allowance method?
Re-establish A/R:
Dr Accounts receivable
Cr Allowance for bad debts
THEN
Cash collection:
Dr Cash at bank
Cr Accounts receviable
How to recover bad debt using the direct write-off method
Re-establish A/R:
Dr Accounts receivable
Cr Bad debts expense
THEN
Cash collection:
Dr Cash at bank
Cr Accounts receivable
Bills receivable
- Essentially a (short-term) loan
- Similar to A/R but: bills receivable are more formally a debt and attracts interest
- Might arise from a sale or may be given in settlement of an A/R.
- Credit is extended to customers by means of a bill of exchange or promissory note.
Bills of exchange (form of bills receivable)
- Essentially a (short-term) loan but it can be transferrable.
Formula for interest on a bill
Interest = Principal x Rate x Duration
Recording bills receivable: if a bill is drawn on a sale, what is the journal entry?
Dr Bill receivable
Cr Sales revenue
Recording bills receivable: if a bill is drawn for settlement of an account receivable, what is the journal entry?
Dr Bill receivable
Cr Accounts receivable
Recording bills receivable: if collecting a bill at maturity, what is the journal entry?
Dr Cash at bank
Cr Bill receivable
Cr Interest revenue
Discounting a bill receivable
- Drawer (who will receive the money) may sell a bill (at discount) to a financial institution so as to receive money now, rather than at maturity
Contingent liability
It is a potential liability that does not appear on the balance sheet.
