xbad debt expense restructuring of debt inventory calculations LIFO FIFO weighted average lower cost of market inventory 611 643 661 665 16 20 22 PPE only 22 LT Debt only and 28 31 425 459 ch 8 9 10 11 Ch 8 Accounts Receivable Assessing net realizable value accounts receivable are generally reflected in the balance sheet at their net realizable value two things must be estimated to determine the net realizable value of receivables o 1 Uncollectibles the amount that will not be collected because customers are unable to pay o 2 Returns and allowances the amount that will not be collected because customers return the merchandise or are allowed a reduction in the amount owed o NRV of receivables Gross amount owned Estimated Uncollectibles Estimated returns allowances Why estimating uncollectibles is important o Most companies establish credit policies by weighing the expected cost customer collection and billing costs plus potential bad debts of credit sales against the benefit of increased sales o This tradeoff illustrates that bad debts are often unavoidable o The matching principle requires that some estimate of uncollectible accounts be offset against current period sales Writing off bad debts o Only when the seller knows which specific receivable is uncollectible can the individual account be written off o Estimated losses from customers who are ultimately unable to pay are treated as an expense of the period in which the sale is made Assessing the NRV of Acc Receivable o Two things must be estimated to determine the net realizable value of receivables The amount that will not be collected because customers are unable to pay called uncollectibles The amount that will not be collected because customers return the merchandise for credit or are allowed a reduction in the amount owed called returns and allowances Estimating Uncollectibles o Receivables arising from credit sales never collected o Companies could adopt stringent credit standards but lose a lot of potential customers if they choose to only take those with high credit rating o Companies est credit policies by weighing the expected cost of credit sales customer billing and collection costs plus potential bad debt losses against the benefit of increased sales o Bad debts are unavoidable o Accrual accounting requires that estimated losses from customers who are ultimately unable to pay are treated as an expense of the period in which the sale is made o Companies use 2 alternative approaches to estimate uncollectible accounts Sales revenue approach Analyze past customer records to determine the of sales that will be uncollectible o If you gain 100 000 in sales for the quarter and 5 of the revenue from past quarters is uncollectible your bad debt expense 5 000 o 100 000 x 0 05 o The journal entry would be DR Bad Debt expense 5 000 CR Allowance for Uncollectibles 5 000 Gross Accounts Receivable Approach Rather than taking the out of sales take it out of accounts receivable for the quarter o If the company determines that at any given time 5 of gross accounts receivable will be uncollectible and gross acct receivable at March 31 2011 2 000 000 and the allowance for uncollectible balance is 60 000 the required allowance for uncollectibles 100 000 2 million X 0 05 o However since our uncollectible balance allowance is only 60 000 and required allowance for uncollectibles came out to be 100 000 we must add 40 000 to the allowance account DR Bad Debt Expense 40 000 CR Allowance for Uncollectibles 40 000 o The 10 000 is then added to the original uncollectibles balance to determine the new allowance for uncollectibles These are done as estimates because we are unable to know which specific accounts will become uncollectible accounts Writing Off Bad Debts When a specific account receivable is known to be uncollectible the entire account must be removed from the books No bad debt is expense is recorded because the 2 above alternative approaches would have already taken out the bad debt expense writing off bad debts just results in removing the account from the books Example If a company determines than a 750 receivable cannot be collected from X company Journal Entry o DR Allowance for Uncollectibles 750 o CR Accounts Receivable X company 750 NOTE Only when the seller knows which specific receivable is uncollectible can the individual account x Company be written off Assessing the Adequacy of the Allowance for Uncollectible Account Balance To determine whether or not the allowance for uncollectibles balance is reasonable given the current economic conditions and customer circumstances management must perform an aging of accounts receivable Aging of accounts receivable o A determination of how long each receivable has been on the books o Receivables long past due likely exist because the customer has been unable to pay o Performed by subdividing total accounts receivable into different age categories A firm must base its allowance and bad debt expense on its existing receivables even if it uses a of sales approach to establish its allowance A modest change in the rate used to estimate bad debt expense is much different Estimating Sales Returns and Allowances When goods are returned or price allowance granted the customer s account receivable must be reduced and an income statement change made At the end of the reporting period companies estimate the expected amount of future returns and allowances arising from receivables currently on the books Estimated because we do not know which specific accounts will return their order Some companies engage in aggressive revenue recognition which is recognizing revenue when an order is being delivered rather than waiting for the customer to accept the order This overstates acct receivables and income because some customers will not be satisfied after receiving the order and will return it o Example Journal Entry o Assume that the corporation agrees to reduce by 5 000 the price of goods that arrived damaged at Bath Company The price adjustment is recorded as DR Sales returns and allowances 8 000 CR Accounts Receivable Bath Company 8000 Note the account debited above is an offset to sales revenues termed a Contra Asset account o At the end of the reporting period companies estimate the expected amount of future returns and allowances arising from receivables currently on the books If the estimated number is large in relation to the accounts receivable balance or to earnings the adjusting entry