AR SMBA05 Class5

8/7/2019 AR SMBA05 Class5

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Accounts Receivable

Chapter 6

Accounts Receivable

Chapter 6



Accounts receivable is aAccounts receivable is acurrent asset that arisescurrent asset that arisesfrom sales on credit.from sales on credit.

It is also the total amountIt is also the total amountcustomers owe the firm.customers owe the firm.

They are sometimes calledThey are sometimes called³trade accounts receivable.´³trade accounts receivable.´

Accounts ReceivableAccounts Receivable



Value Of ReceivablesValue Of Receivables

Receivables are reported at their Receivables are reported at their face value less an allowance for face value less an allowance for accounts which are likely to beaccounts which are likely to be

uncollectible.uncollectible.

The amount which is actuallyThe amount which is actuallyexpected to be collected is calledexpected to be collected is called

the net realizable value (NRV).the net realizable value (NRV).GAAP requires that A/R be reportedGAAP requires that A/R be reportedat NRV.at NRV.



Used only when badUsed only when bad

debts are a very smalldebts are a very smallitem or when credititem or when creditsales are insignificant.sales are insignificant.

GAAPGAAP Not GAAPNot GAAP

Allowance MethodAllowance Method Direct WriteDirect Write--Off Off MethodMethod

A/R A/R MethodMethod

SalesSalesMethodMethod



Direct Write-off Direct Write-off

Direct WriteDirect Write--Off Off

No estimate of bad debts is made.No estimate of bad debts is made.

Only when a specific account is known to beOnly when a specific account is known to be

uncollectible (customer files bankruptcy, for uncollectible (customer files bankruptcy, for example) is bad debts expense recorded.example) is bad debts expense recorded.

Method does not do a very good job of Method does not do a very good job of matching the revenue (sale) with the expensematching the revenue (sale) with the expense

(bad debt), because a company often(bad debt), because a company oftendiscovers an account is uncollectible in adiscovers an account is uncollectible in aperiod subsequent to the one in which theperiod subsequent to the one in which thesale was made.sale was made.



Allowance MethodAllowance Method

Estimates the bad debt expense for the accountingEstimates the bad debt expense for the accountingperiod as an adjustment when it is time to prepare theperiod as an adjustment when it is time to prepare thefinancial statements.financial statements.

Records the amount as a deduction in accountsRecords the amount as a deduction in accountsreceivable (A/R) , even though it is not known whosereceivable (A/R) , even though it is not known whoseaccounts will be ³bad.´accounts will be ³bad.´

Create an account called :allowance for uncollectibleCreate an account called :allowance for uncollectibleaccounts´ (a contraaccounts´ (a contra--asset account) to hold theasset account) to hold thedeductions in A/R until the firm can identify the specificdeductions in A/R until the firm can identify the specificaccounts that are bad and remove them form the books.accounts that are bad and remove them form the books.



Allowance MethodAllowance Method

The bad debts estimate is based upon:The bad debts estimate is based upon:

Sales, or Sales, or

Accounts ReceivableAccounts ReceivableThe allowance method attempts to matchThe allowance method attempts to matchthe expense (bad debts) with the revenuethe expense (bad debts) with the revenue(sale) by recording the expense in the same(sale) by recording the expense in the same

period as the sale even though theperiod as the sale even though thecompany has not specifically identifiedcompany has not specifically identifiedwhich accounts will go unpaid.which accounts will go unpaid.





Accounts Receivable MethodAccounts Receivable Method

Focuses on the balance sheet and uses an agingFocuses on the balance sheet and uses an agingschedule to estimate the amount of accountsschedule to estimate the amount of accountsreceivable (A/R) that will not be collectible.receivable (A/R) that will not be collectible.

Analyzes A/R to determine how long each accountAnalyzes A/R to determine how long each accounthas been outstanding. The longer the account hashas been outstanding. The longer the account hasbeen outstanding, the greater the likelihood it will notbeen outstanding, the greater the likelihood it will notbe collected.be collected.

The company estimates the percentage of A/R thatThe company estimates the percentage of A/R that

will be uncollectible. An adjustment is made to thewill be uncollectible. An adjustment is made to theallowance account to reflect that estimate, and the badallowance account to reflect that estimate, and the baddebts expense equals the amount of the adjustment.debts expense equals the amount of the adjustment.



1. Provided $5,000 services on

account.

1. Provided $5,000 services on

account.

Assets = Liab. + Cont. Cap. + Ret. Earnings

+5000 A/R +5000 Sales

Revenue

Income Statement

Statement of Changes in Equity

Statement of Cash Flows


+5000 A/R +5000 Sales

Revenue

Income Statement





2. Collected $4,000 cash onaccounts receivable.

2. Collected $4,000 cash onaccounts receivable.


+4000 cash(4000) A/R

Income Statement




+4000 cash(4000) A/R

Income Statement





3. Adjusting entry recorded to reflect theestimate of 5% of ending A/R to be

uncollectible.

3. Adjusting entry recorded to reflect theestimate of 5% of ending A/R to be

uncollectible.

Assets = Liab. + C C. + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

Income Statement

S

tatement of Changes in Equity Statement of Cash Flows

Assets = Liab. + C C. + Ret. Earnings

(50) Allowance (50) Bad Debts Expense

Income Statement

S

tatement of Changes in Equity Statement of Cash Flows



Financial statements at the end of

Year 1:

Financial statements at the end of

Year 1:

Income Statementfor Year 1

Sales $5,000Bad debt expense 50

Net Income $4,950

Statement of Cash Flowsfor the Year 1

Cash from operations $4,000Cash from investing -0-Cash from financing-0-

Total change in cash $4,000



Assets:

Cash $4000 AR 1,000 Allowance (50)

Net A/R 950

Total Assets $4,950 $4,950

Liab. + Equity:

RE $4,950

Balance Sheet at the end of Year 1



Year 2:1-Wrote off a $40 A/R that was

determined to be uncollectible

Year 2:1-Wrote off a $40 A/R that was

determined to be uncollectible

Assets = Liab. + CC + Ret. Earnings

(40) AR+40 Allowance

Income Statement



Assets = Liab. + CC + Ret. Earnings

(40) AR+40 Allowance

Income Statement





2-Provided $6,000 worth of services

on account.

2-Provided $6,000 worth of services

on account.

Assets = Liab. + CC. + Ret. Earnings

+6000 AR +6000 revenue

Income Statement:

Statement of Changes in Equity: Statement of Cash Flows:


+6000 AR +6000 revenue

Income Statement:

Statement of Changes in Equity: Statement of Cash Flows:



3- Collected $4,500 cash from

accounts receivable.

3- Collected $4,500 cash from

accounts receivable.


+4500 Cash(4500) AR

Income Statement

Statement of Changes in Equity Statement of Cash Flows


+4500 Cash(4500) AR

Income Statement

Statement of Changes in Equity Statement of Cash Flows



4-Adjust the accounting records to reflectthe expectation that 5% of the ending AR

balance would be uncollectible.

(Balance is $2460.)

4-Adjust the accounting records to reflectthe expectation that 5% of the ending AR

balance would be uncollectible.

(Balance is $2460.)


IncomeStatement

:

Statement of Changes in Equity:

Statement of Cash Flows:


IncomeStatement

:

Statement of Changes in Equity:

Statement of Cash Flows:



WhereD

o WeStand?Where

Do We

Stand?

We overestimated bad debts by $10--we estimated $50but we only wrote off $40 in the subsequent year.

This year our estimate is 5% of $2,460 (BB 1,000 + 6,000credit sales - $4,500 collections -$40 accounts written off)=$123. But since we overestimated last year, we only need

to record $113 this year.



4.b Adjust the accounting records toreflect the expectation that 5% of theending A/R balance would be

uncollectible.

4.b Adjust the accounting records toreflect the expectation that 5% of theending A/R balance would be

uncollectible.Assets = Liab. + Cont. Cap. + Ret. Earnings

(113) allowance (113) bad

for doubtful debts expenseaccounts

Income Statement




(113) allowance (113) bad

for doubtful debts expenseaccounts

Income Statement





Summary Of The Allowance MethodSummary Of The Allowance Method

One way to estimate bad debtOne way to estimate bad debtexpense is to use a percentage of expense is to use a percentage of ending A/R (or an aging schedule)ending A/R (or an aging schedule)

When an actual account is writtenWhen an actual account is writtenoff as uncollectible, it is removedoff as uncollectible, it is removedfrom A/R and the Allowancefrom A/R and the AllowanceAccount. THERE IS NO NETAccount. THERE IS NO NET

EFFECT ON ASSETS and NOEFFECT ON ASSETS and NOEXPENSE at the time of the writeEXPENSE at the time of the write--off.off.



Accounts Receivable for

Hershey Foods

Accounts Receivable for

Hershey Foods

Documents

AR SMBA05 Class5