7-1

Accounting for Accounts Receivable

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7-2

Lets turn our attention to accounts receivable.

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7-3

Uncollectible Accounts

If a company makes credit sales to customers, some accounts certainly will turn out to be uncollectible.

PAST DUE

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Reflecting Uncollectible Accounts in the Financial Statements

7-4

At the end of each period, record an estimate of the uncollectible accounts.

GENERAL JOURNAL
Date Account Titles and Explanation Uncollectible Accounts Expense Allowance for Doubtful Accounts Debit $$$$ $$$$ Credit

Selling expense
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Contra-asset account
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7-5

The Allowance for Doubtful Accounts

Accounts receivable Less: Allowance for doubtful accounts Net realizable value of accounts receivable
The net realizable value is the amount of accounts receivable that the business expects to collect.

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Writing Off an Uncollectible Account Receivable

When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.

7-6

GENERAL JOURNAL
Date Account Titles and Explanation Allowance for Doubtful Accounts Accounts Receivable (X Customer) Debit $$$$ $$$$ Credit

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Writing Off an Uncollectible Account Receivable

7-7

Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes. K-Max would make the following entry.

GENERAL JOURNAL
Date Jan. Account Titles and Explanation Accounts Receivable (J. Clark)
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Debit 500

Credit 500

5 Allowance for Doubtful Accounts

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Writing Off an Uncollectible Account Receivable

Assume that before this entry, the Accounts Receivable balance was $10,000 and the Allowance for Doubtful Accounts balance was $2,500.

7-8

Lets see what effect the write-off had on these accounts.

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Writing Off an Uncollectible Account Receivable

Before Write-Off Accounts receivable $ 10,000 Less: Allow. for doubtful accts. 2,500 Net realizable value $ 7,500

7-9

After Write-Off $ 9,500 2,000 $ 7,500

Notice that the $500 write-off did not change the net realizable value nor did it affect any income statement accounts.
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7-10

Monthly Estimates of Credit Losses

At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate.

Two Approaches to Estimating Credit Losses:

1. Balance Sheet Approach

2. Income Statement Approach

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Estimating Credit Losses The Balance Sheet Approach

Year-end Accounts Receivable is
broken down into age classifications.

7-11

Each age grouping has a

different likelihood of being uncollectible.

Compute a separate allowance

for each age grouping.
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Estimating Credit Losses The Balance Sheet Approach

At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows:
EastCo, Inc. Schedule of Accounts Receivable by Age

7-12

Days Past Due

December 31, 2005 Accounts Estimated Estimated Receivable Bad Debts Uncollectible Balance Percent Amount

Current 1 - 30 31 - 60 Over 60

45,000 15,000 5,000 2,000 67,000

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Estimating Credit Losses The Balance Sheet Approach

At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows:
EastCo, Inc. Schedule of Accounts Receivable by Age

7-13

Days Past Due

December 31, 2005 Accounts Estimated Estimated Receivable Bad Debts Uncollectible Balance Percent Amount

Current 1 - 30 31 - 60 Over 60

45,000 15,000 5,000 2,000 67,000

1% 3% 5% 10%

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Estimating Credit Losses The Balance Sheet Approach

At December 31, 2005, the receivables for EastCo, Inc. were categorized as follows:
EastCo, Inc. Schedule of Accounts Receivable by Age

7-14

Days Past Due

December 31, 2005 Accounts Estimated Estimated Receivable Bad Debts Uncollectible Balance Percent Amount

Current 1 - 30 31 - 60 Over 60

45,000 15,000 5,000 2,000 67,000

1% $ 3% 5% 10% $

450 450 250 200 1,350

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Estimating Credit Losses The Balance Sheet Approach

EastCos unadjusted balance in the allowance account is $500. Per the previous computation, the desired balance is $1,350.
Allowance for Doubtful Accounts 500 850 1,350

7-15

GENERAL JOURNAL
Date Account Titles and Explanation Allowance for Doubtful Accounts
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Debit 850

Credit 850

Dec. 31 Uncollectible Accounts Expense

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7-16

Lets look at another way to estimate credit losses!

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Estimating Credit Losses The Income Statement Approach

Uncollectible accounts percentage is based on actual uncollectible accounts from prior years credit sales. Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.

7-17

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Estimating Credit Losses The Income Statement Approach

7-18

Net Credit Sales % Estimated Uncollectible Amount of Journal Entry

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Estimating Credit Losses The Income Statement Approach

In 2005, EastCo had credit sales of $60,000.

7-19

Historically, 1% of EastCos credit sales has been uncollectible. For 2005, the estimate of uncollectible accounts expense is $600.
($60,000 .01 = $600) Now, prepare the adjusting entry for December 31, 2005.
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Estimating Credit Losses The Income Statement Approach

GENERAL JOURNAL
Date Account Titles and Explanation Allowance for Doubtful Accounts Debit 600

7-20

Credit 600

Dec. 31 Uncollectible Accounts Expense

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Recovery of an Account Receivable Previously Written Off

7-21

Sometimes, after an account receivable has been written off, a customer will send in a payment. If this happens, should the customers payment be returned since the account has been written off

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7-22

GENERAL JOURNAL
Date Account Titles and Explanation Allowance for Doubtful Accounts Accounts Receivable (X Customer) Entry to Write Off JOURNAL GENERAL Debit $$$$ $$$$ Credit

Date

Account Titles and Explanation Accounts Receivable (X Customer) Allowance for Doubtful Accounts Cash Accounts Receivable (X Customer)

Debit $$$$

Credit $$$$

$$$$ $$$$

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7-23

Direct Write-Off Method

This method makes no attempt to match revenues with the expense of uncollectible accounts.

GENERAL JOURNAL
Date Account Titles and Explanation Accounts Receivable (X Customer)
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Debit $$$$

Credit $$$$

June 15 Uncollectible Accounts Expense

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7-24

Concentrations of Credit Risk

Concentrations of credit risk occur if a significant portion of a companys receivables are due from a few major customers or from customers operating in the same industry or geographic region. The Law requires disclosure of all significant concentrations of credit risk in the notes to the financial statements.
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Exercise 7.9
companys accounts receivable and credit losses during the current year:
Net credit sales for the year Accounts receivable at year-end Uncollectible accounts receivable: Actually written off during the year .. 96,000 Estimated portion of year-end receivables expected to prove uncollectable(per aging Schdule) 84000

7-25

The credit manager of Monitor Fuel has gathered the following information about the
8,000,000 1,750,000

180,000

Prepare one journal entry summarizing the recognition of uncollectable accounts expense for the entire year under each of the following independent assumptions: a) Uncollectible accounts expense is estimated at an amount equal to 2.5% of net credit sales. b) Uncollectible accounts expense is recognized by adjusting the balance in the Allowance for Doubtful Accounts to the amount indicated in the year-end aging schedule. The balance in the allowance account at the beginning of the current year was $25,000 c) The company uses the direct write-off method of accounting for uncollectible accounts.
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7-26

a.

Uncollectible Accounts Expense 200,000 Allowance for Doubtful Accounts.. 200,000 To record estimated uncollectible accounts expense at 2.5% of net credit sales ($8,000,000 x 2.5% = $200,000). Uncollectible Accounts Expense 155,000 Allowance for Doubtful Accounts..155,000 To increase balance in allowance account to required $84,000: opening Allownce $ 25,000 Write-offs during year.. (96,000) Excess Allownce required $ 71,000 Additional Allownce 13,000 total Allownce $ 84,000

b.

c.

Uncollectible Accounts Expense.96,000 .. Accounts Receivable.. 96,000

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Assignment Questions:
Problem 7.3(Aging Accounts

Receivable Write offs), 7.4(Accounting for Uncollectible Accounts)