Chapter 8 Accounting for Receivables The term receivables refers to amounts due from individuals and companies Claims that are expected to be collected in cash Represent the company s most liquid assets Significance of a company s receivables as a percentage of its assets depends on various factors its industry the time of year whether it extends long term financing and its credit policies Receivables are classified as 1 Accounts Receivable Accounts receivable are various amounts customers owe on account Result from the sale of goods and services Expected to be collected within 30 60 days Most significant type of claim for a company There are 3 issues associated with accounts receivable 1 Recognizing accounts receivable Service organization records a receivable when it provides service on account Merchandiser records accounts receivable at the point of sale of merchandise on account Debits Accounts Receivable and credits Sales Revenue merchandiser Some retailers issue credit cards Retailer charges interest on the balance due if not paid within a specified period 25 30 days 2 Valuing accounts receivable How should companies report receivables in the financial statements Report on the balance sheet as an asset Determining the amount to report is sometimes difficult because some receivables will become uncollectable Each customer must satisfy the credit requirements before the credit sale is approved Some accounts receivable become uncollectable Ex a customer may not be able to pay because of a downturn in the economy etc Companies record credit losses as debits to the Bad Debt Expense Uncollectible Accounts Expense Normal and necessary risk of doing business on a credit basis 2 Methods are used in accounting for uncollectible accounts 1 Direct Write off Method for Uncollectible Accounts Under the direct write off method when a company determines a particular account to be uncollectable it charges the loss to Bad Debt Expense Shows only actual losses from uncollectibles Company will report accounts receivable at its gross amount Can reduce the usefulness of both the income statement of the balance sheet In one year companies will do a huge sales promotion sales increase dramatically and accounts receivable increases dramatically Next year customers default on loans bad debt expense increases dramatically and accounts Under this method companies often record bad debt expense in a period different from the period in which receivable plummets they record the revenue Does not attempt to match bad debt expense to sales revenues in the income statement Does not show accounts receivable in the balance sheet at the amount the company actually expects to get Unless bad debt losses are insignificant direct write off method is not acceptable for financial reporting 2 Allowance Method for Uncollectible Accounts Allowance method of accounting for bad debts involves estimating uncollectible accounts at the end of each period Provides better matching on the income statement and ensures that companies state receivables on the balance sheet at their cash net realizable value Cash net realizable value the net amount the company expects to receive in cash Excludes amounts that the company estimates it will not collect Reduces receivables in the balance sheet by the amount of estimated GAAP requires the allowance method for financial reporting purposes when bad debts are material in amount Has 3 essential features uncollectible accounts Chapter 8 Pg 1 Chapter 8 Accounting for Receivables 1 Companies estimate uncollectible accounts receivable Match this expense against revenues in the same accounting period in which they record the revenues 2 Companies debit estimated uncollectibles to Bad Debt Expense and credit them to Allowance for Doubtful Accounts through an adjusting entry at the end of the period Allowance for Doubtful Accounts is a contra asset account to Accounts Receivable 3 When companies write off a specific amount they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to AR Recording Estimated Uncollectibles Bad Debt Expense is reported in the income statement as an operating expense usually as a selling expense Thus estimated uncollectibles are matched with sales in 2014 Recorded in the same year it made sales Companies use a contra account instead of a direct credit to Accounts Receivable because they do not know which Companies do not close Allowance for Doubtful Accounts at the end of the fiscal year customers will not pay Recording the Write Off of an Uncollectible Account Companies use various methods of collecting past due accounts such as letters calls and legal action When these options are exhausted the company should write off the account To prevent premature or unauthorized write offs authorized management personnel should formally approve each write off The Bad Debt Expense does not increase when the write off occurs Under the allowance method companies debit every bad debt write off to the allowance account rather than to Bad Debt Expense A write off affects only balance sheet accounts not income statement accounts Recovery of an Uncollectible Account Happens when a company collects from a customer after it has written off the account as uncollectible 1 Reverses the entry made in writing off the account 2 Journalize the collection in a usual manner The recovery of bad debt like the write off of a bad debt affects only balance sheet accounts Estimating the Allowance Companies must estimate the amount that they use to determine the amount of expected uncollectibles given Two bases are used to determine this amount 1 Percentage of sales anticipated credit policy Management estimates what of credit sales will be uncollectible based on past experience and Results in a better matching of expenses with revenues an income statement viewpoint Applies this percentage to either total credit sales or net credit sales of the current year The basis of estimating uncollectibles emphasizes the matching of expenses with revenues When the company makes the adjusting entry it disregards the existing balance in the Allowance for Doubtful Accounts 2 Percentage of receivables accounts Management estimates what percentage of receivables will result in losses from uncollectible Results in a better estimate of cash realizable value a balance sheet viewpoint Company prepares an aging schedule Aging the accounts receivable it classifies customer balances by the