ACIS-2115 - Reading Notes - 8-2 - Valuation of Accounts Receivable PDF

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This is a common taught course. All sections of ACIS 2115 follow the same schedule and cover the same content.
Prof: L Almond
Reading for section 8.2...

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Daniel T. Eisert

ACIS-2115

8.2 – Valuation of Accounts Receivable ACIS-2115: Principles of Accounting October 20, 2019 (Week 9)

Valuing Accounts Receivable

Accounting for Uncollectible Accounts

Recall ~ companies report accounts receivable on the balance sheet as an asset, but determining the amount to report is sometimes difficult because some receivables will become uncontrollable.  Example: A customer may not be able to pay because of a decline in its sales revenue due to a downturn in the economy or unexpected bills.  Companies record credit losses as bad debt expense or uncollectable accounts expense. 1. Direct Write-Off Method: chanrges the loss to bad debt expense.  Example: Warden Co. writes off as uncollectible M. E. Doran’s $200 balance on December 12. Writes off uncollectible amount Bad Debt Expense 200 Dec. Accounts Receivable 200 12 (To record write-off of M. E. Doran account) - Using this method, bad debt expebse will show only actual losses from uncollectibles. - The company will report accounts receivable at its gross amount. - Reduces the relevence of the income statement and balance sheet.  Example: In 2022, Quick Buck Company wanted to increase revenues by offering computers to college students without requiring money down and with no credit-approval process. It sold millions of computers. In 2023, nearly 35% of students defaulted on their lowns. This made 2022’s statements look great, but the balance sheet and income statement in 2023 looked awful (i.e., bad debt expense increases deamatically and accounts receiable plummets). Unless bad debt losses are insignificant, the direct-write off method is not acceptable for financial reporting purposes. 2. Allowance Method: estimates uncollectible amounts at the end of each period. This better matches expenses with revenues on the income statement and ensures that companies state receivables on the balance sheet at their cash (net) realizable value. - Cash (net) relizable value is the net amount the company expects to receive in cash. It exclused amounts that the company estimates it will not collect. This reduces receivables in the balance sheet by the amount of estimated uncollectible receivables. Companies must use this method for financial reporting purposes when bad debts are material1 in amount.

1 Material refers to anything significant or important to financial statement users.

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ACIS-2115 Companies estimate uncollectible amounts receivable. Companies debit estimated uncollectibles to bad debt expense and credit them to allowance for doubtful accounts through an adjusting entry at the end of each period. When companies write off a specific amount, they debit actual uncollectibles to allowance for doubtful accounts and credit that amount to accounts receivable. Example: Writes off uncollectible amount Bad Debt Expense 12,000 Dec. Allowance for Doubtful Accounts 12,000 31 (To record estimate of uncollectible accounts) Recording the write-off of an uncollectible account Allowance for Doubtful Accounts 500 Mar. Accounts Receivable 1 (Write-off of R. A. Ware account) Accounts Receivable Jan. 1 Bal. 200,000 Mar. 1 500 Mar 1. Bal. 199,500

Accounts Receivable Allowance for Doubtful Accounts Cash Relizable Value

500

Allowance for Doubtful Accounts Mar 1. 500 Jan 1. Bal. 12,000 Mar 1. Bal. 11,500 Before Write-Off $200,000 $12,000 $188,000

After Write-Off $199,500 $11,500 $188,000

Recovery of an Uncollectible Account Accounts Receivable 500 Allowance for Dountful Accounts (To reverse write-off of R. A. Ware account) July Cash 500 1 Accounts Receivable (To record collection from R. A. Ware)

500

500

Note that the recovery of a bad-debt, like the write-off of a bad debt, only affects balance sheet accounts. Companies often sell their receivables to another company for cash, thereby shortening the cash-to-cash operating cycle. Why? - They may be a major, reasonable source of cash when money is tight. - Billing and collection are often timeconsuming and costly. -

Disposing of Accounts Receivable

Selling receivables Cash 588,000 Apr. Service Charge Expense (2% at 600K) 12,000 2 Accounts Receivable (To record the sale of accounts receivable)

600,000

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ACIS-2115 Accounting for Credit Card Sales Cash 970 Mar. Service Charge Expense 30 22 Sales Revenue 1,000 (To record Visa credit card sales)

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