ACCT101 Receivables III

ACCTG101

Receivables III

Arthur Rosada, CPA

DOUBTFUL ACCOUNTS EXPENSE

In a business which sells inventory in the normal course of the business, doubtful accounts expense is an expense related to sales.

Hence, it is considered as a selling expense.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

In the previous modules, it was mentioned that the allowance for doubtful accounts is a contra-asset account.

Hence, it has a credit balance. It is an estimate of the amount whose collection is doubtful.

The journal entry the recording of doubtful accounts expense and for the establishment of the allowance for doubtful accounts is

Doubtful accounts expense                           xx

  Allowance for doubtful accounts                               xx

Why do we need to estimate? We need to estimate because we do not know for sure if they will be collected or not.

WITHOUT ALLOWANCE FOR DOUBTFUL ACCOUNTS

If there no allowance for doubtful accounts recognized, the business has to wait for the actual determination that the related accounts cannot be collected. 

ILLUSTRATION

If goods were sold in the month of December, the company needs to send collection notice to the customers concerned in the month of January. Some of them still won’t pay in January. 

The company will again need to send collection notice in the month of February.  Some of them will still not be able to pay in February. 

The company will perhaps once again send collection notice in the month of March. Still, some will not be able to pay in March. Perhaps, they have no plan of paying at all. 

Hence, the company, in an effort to save time, collection effort and collection spending, will just decide that the related accounts are uncollectible.

If no allowance for doubtful accounts has been set up and no doubtful accounts expense, has been recognized, the doubtful accounts expense will be recognized in march, at which time the uncollectibility was established. 

The journal entry shall be

Doubtful accounts expense          xx

  Accounts receivable                                         xx

This is called direct write-off.

DIRECT WRITE-OFF METHOD

Under the direct write off method, when a business determines an invoice is uncollectible, it can debit doubtful accounts expense or bad debts expense and credit accounts receivable immediately.

This eliminates the effect of the revenue recognized by recognizing an expense. This eliminates from the record as well the balance of the accounts receivable related to the said invoice.

The down side of this approach, however, is that it is possible that the revenue recognition for the sale may be in one period and the recognition of the related expense is in another period.

Hence, this will be a violation of the matching principle.

MATCHING PRINCIPLE

Please see next slide for the video

ALLOWANCE METHOD

Under the allowance method, as we have already discussed in the previous modules, in the period of sale, the related doubtful accounts expense and allowance for doubtful accounts are recognized.

This is in congruence with the matching principle.

Hence, it could also be said to be consistent with accrual basis of accounting.

Multiple Choice

Which method of recording bad debt loss in consistent with matching principle?

• Allowance method

• Direct Write-off method

Multiple Choice

Which method of recording bad debt loss in consistent with accrual accounting?

• Allowance method

• Direct write-off method

ALLOWANCE METHOD

Illustration

In the period of sale, the doubtful accounts are determined based on sales revenue or on the remaining accounts receivable at the end of the period. There is a need to estimate because collection efforts must still be made before the accounts can be determined to be actually uncollectible. Such efforts may extend beyond the current year end.

The related receivable and allowance accounts will be in the record of the company until the related amounts are determined to be actually uncollectible.

When a business determines after year-end that an invoice is actually uncollectible, it will not any more debit doubtful accounts expense or bad debts expense because such has already been recorded in the prior period. The entry to record the write off is a debit to allowance for doubtful accounts or allowance for bad debts and credit accounts receivable immediately. This eliminates the related accounts receivable and allowance accounts.

Multiple Choice

When the allowance method of recognizing uncollectible accounts is used, the entry to record the write off of a special account would

• Decrease both accounts receivable and the allowance for uncollectible accounts.

• Decrease accounts receivable and increase allowance for uncollectible accounts.

• Increase the allowance for uncollectible accounts and decrease net income.

• Decrease both accounts receivable and net income

Multiple Choice

When the allowance method of recognizing bad debt expense is used, the allowance for doubtful accounts would decrease when

• Specific account receivable is collected

• Account previously written off is collected

• Account previously written off becomes collectible

• Specific uncollectible account is written off

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. How much is the bad debts expense for the period?

• 20,000

• 25,000

• 5,000

• 0

EXPLANATION:

500,000 x .05 = 25,000

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. How much is the allowance for bad debts at the end of the period?

• 20,000

• 25,000

• 45,000

• 0

EXPLANATION FOR BAD DEBTS EXPENSE TO BE RECORDED:

500,000 x .05 = 25,000

This amount will be added to the existing 20,000 balance of allowance. Hence, the ending balance is 45,000.

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. P15,000 of the accounts receivable were written off during the period. How much is the bad debts expense for the period?

• 20,000

• 25,000

• 5,000

• 0

EXPLANATION:

The additional amount to be recorded as bad debts expense and allowance for bad debts is 25,000. 

The write off will be recorded by a debit to allowance and a credit to accounts receivable. It will not have any effect on the expense account.

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. P15,000 of the accounts receivable were written off during the period. How much is the allowance for bad debts at the end of the period?

• 20,000

• 25,000

• 5,000

• 30,000

EXPLANATION:

The additional amount to be recorded as bad debts expense and allowance for bad debts is 25,000. 

The write off will be recorded by a debit to allowance and a credit to accounts receivable. It will decrease the allowance.

20,000 + 25,000 – 15,000 = 30,000

ESTIMATING OF BAD DEBTS UNDER ALLOWANCE METHOD

We have already discussed in the previous modules that estimates for bad debts could be made based on sales revenue or based on the remaining balance of the accounts receivable.

If the estimate is made based on sales or specifically based on credit sales, it focuses on the relation of the expense to the revenue. Hence, we could say that it focuses on the impact on the income statement rather that the statement of financial position.

If the estimate is made based on the remaining balance of the accounts receivable, it focuses on the relationship of the asset and contra-asset.

Hence, we could say that it focuses on the impact on the statement of financial position rather than the income statement.

Multiple Choice

A method of estimating bad debts that focuses on the income statement whether rather than the statement of financial position is the allowance method based on

• Credit sales

• The balance in the trade accounts receivable

COLLECTION OF AN ACCOUNT ALREADY WRITTEN OFF

The preferred method of accounting for write offs is the allowance method. Let us recall the entry for writing of an account under allowance method:

Allowance for doubtful accounts       xx

  Accounts receivable                                    xx

They were written off because they were judged to be uncollectible. Since these accounts turn out to be collectible, such entry will be reversed.

Accounts receivable                           xx

  Allowance for doubtful accounts                xx

Then, journal entry shall be made for the collection.

Cash                                      xx

  Accounts receivable                        xx

This means that if there is a collection of an account that has already been written off, the accounts receivable was debited and then, credited.

Hence, it shall not be affected.

On the other hand, the allowance account was credited and hence, increased.

Let us recall the entry for writing of an account under direct write off method:

Bad debts expense                              xx

  Accounts receivable                                    xx

They were written off because they were judged to be uncollectible. Since these accounts turn out to be collectible, such entry will be reversed if collection is made in the same period as the write off.

Accounts receivable                           xx

  Bad debt expense                                       xx

Then, journal entry shall be made for the collection.

Cash                                       xx

  Accounts receivable                        xx

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. P15,000 of the accounts receivable were written off during the period. Of the amount of receivable already written off, P5,000 have been collected. How much is the bad debts expense for the period?

• 20,000

• 25,000

• 5,000

• 30,000

EXPLANATION:

The additional amount to be recorded as bad debts expense and allowance for bad debts is 25,000. 

The write off will be recorded by a debit to allowance and a credit to accounts receivable. It will not have any effect on the expense account.

The collection of an earlier written off account will mean debiting to accounts receivable and crediting to allowance; then, debiting to cash and crediting to accounts receivable. Likewise, it has no effect on expense.

Multiple Choice

The Donald Inc. has a beginning balance of allowance for bad debts amounting to P20,000. During the period, credit sales amounted to P500,000 and bad debts expense is P5% of credit sales. P15,000 of the accounts receivable were written off during the period. Of the amount of receivable already written off, P5,000 have been collected. How much is the allowance for bad debts at the end of the period?

• 20,000

• 25,000

• 35,000

• 30,000

EXPLANATION:

The additional amount to be recorded as bad debts expense and allowance for bad debts is 25,000. 

The write off will be recorded by a debit to allowance and a credit to accounts receivable. It will decrease the allowance.

The collection of an earlier written off account will mean debiting to accounts receivable and crediting to allowance; then, debiting to cash and crediting to accounts receivable. It will increase the allowance.

20,000 + 25,000 – 15,000 +5,000 = 35,000

NORMAL BALANCE OF ALLOWANCE FOR BAD DEBTS

It is a contra-asset account.

Hence, its normal balance is credit.

A DEBIT BALANCE OF THE ALLOWANCE FOR BAD DEBTS CAN EXIST

A debit valance in the allowance for doubtful accounts can exist but only before the necessary adjustments were made at the end of the period.

After necessary adjustments will be made, the balance will either be zero or a credit balance.

D O N E

Please access the activity for this slide through the link provided.