accounting (receivables)
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Notes on how to account for receivablesTRANSCRIPT
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Chapter 10
Receivables
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Learning Objectives
1. Use the allowance method to account for bad debts
2. Use the direct write-off method to account for bad debts
3. Report receivables on the balance sheet
4. Use the acid-test ratio and days’ sales in receivables to evaluate a business
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Accounts receivable (Trade receivables)
Receivables
Bills receivable (Notes receivable)
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
The Allowance Method
Firms with significant credit sales will
use the allowance method to measure
bad debts
This makes an estimate of what debts
will go bad based on experience
This is recorded in a contra account
related to accounts receivable
Allowance for doubtful debts
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Use the allowance method
to account for bad debts
Objective 1
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Methods for Estimating Bad Debts
Percentage of Sales
Ageing of Accounts Receivable
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Percentage of Sales
This is also called the income statement approach.
It is based on prior experience of the business.
It is calculated as a percentage of credit sales.
It ignores the current balance of the allowance account.
The percentage used is adjusted as needed to reflect collection experience.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Percentage of Sales Example
The credit department of Anna’s
Boutique estimates (based on prior
experience) that 1% of net credit
sales are uncollectible.
Net credit sales for the year just
ended (Dec 31) were $500,000.
What is the adjusting entry?
$500,000 × 1.5% = $7,500.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Percentage of Sales Example
Dec 31,
Bad Debts Expense 7,500
Allowance for Bad Debts 7,500
Recorded bad debts expense for the year
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Decrease in Net Profits
Decrease in net Accounts Receivable
What is the effect of this adjusting entry?
Percentage of Sales Example
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Ageing of Accounts Receivable
This approach is also called the
balance sheet approach because it
focuses on accounts receivable.
Individual accounts receivable from
specific customers are analysed
according to the length of time they
remain outstanding.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Ageing of Receivables Example
Assume that International Hospital’s
past collection experience indicates the
following:
Length of time % uncollectible
1-30 days 2.0
31-60 days 3.0
61-90 days 5.0
90 + days 8.0
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Accounts Receivable
Allowance for
Bad Debts
Length Amount %
1-30 $1,900,000 2 $ 38,000
31-60 1,000,000 3 30,000
61-90 700,000 5 35,000
90 + 500,000 8 40,000
Total $4,100,000 $143,000
Ageing of Receivables Example
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Ageing of Receivables Example
The allowance account is adjusted to
this $143,000 balance:
Assume that the account currently has
a credit balance of $100,000.
What is the adjustment?
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
June 30
Bad Debts Expense 43,000 Allowance for Bad debts 43,000
To record the allowance for bad debts
What if the account had a debit balance of $1,000?
Ageing of Receivables
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Allowance for Bad Debts
Adjustment 1,000 144,000
Adjusted balance 143,000
Ageing of Receivables
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Comparing the Percentage of Sales and Ageing Methods
p.406
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Writing Off Bad Debts
What happens when it becomes
apparent that an account will not be
able to be collected?
It must be written off.
How?
Debit Allowance for Bad Debts.
Credit Accounts Receivable.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Recoveries
How is the collection of a previously
written off account recorded?
Debit Accounts Receivable (to reinstate
the account) and Credit Allowance for
Bad Debts.
Then
Debit Cash and Credit Accounts
Receivable (to record the collection).
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Use the direct write-off
method to account for
bad debts.
Objective 2
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Direct Write-Off Method
Using this method, an account is written
off only when it becomes uncollectible.
No allowance account is created.
This method is simple to use – but:
The balance sheet is overstated.
(No contra account).
The income statement is
understated.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Report receivables on the
balance sheet.
Objective 3
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Reporting Receivables
Some companies report a single amount
for their current receivables in the body of
the balance sheet.
They use a note to the financial statements
to give more details.
See BHP Billiton's example page 416
textbook.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Use the acid-test ratio and
days’ sales in receivables
to evaluate a business.
Objective 4
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Acid-test ratio = (Cash + Short-term investments
+ Net current receivables) ÷ Total current liabilities
Acid-test Ratio
This is a more stringent test of liquidity
than the current ratio.
It measures the entity’s ability to pay its
current liabilities immediately.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
Days’ Sales in Receivables
It is a measure of the time it takes to
collect receivables.
A smaller number indicates a quick
conversion to cash.
Horngren, Best, Fraser, Willett: Accounting 6e © 2010 Pearson Australia
One day’s sales = Net sales ÷ 365 days
Days’ sales in average accounts receivable =
Average net accounts receivable ÷ One day’s sales
Days’ Sales in Receivables
PowerPoint to accompany
End of Chapter 10