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Accounts Receivable Provision for bad and doubtful debts

Accounts Receivable Provision for bad and doubtful debts. Revision. What is an accounts receivable? How does an accounts receivable happen?. Accounts Receivable. Accounts receivable same as trade debtor A/C receivable is a current asset on Balance Sheet.

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Accounts Receivable Provision for bad and doubtful debts

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  1. Accounts Receivable Provision for bad and doubtful debts

  2. Revision • What is an accounts receivable? • How does an accounts receivable happen?

  3. Accounts Receivable • Accounts receivable same as trade debtor • A/C receivable is a current asset on Balance Sheet. • A/C receivable happens when a business sells goods or services on credit to its clients.

  4. Accounts Receivable • Why giving credit? • Offering credit could increase the amount of overall sales and hence lead to increased profitability. • Competing businesses may offer credit to their customers • More convenient to have credit facilities

  5. Accounts Receivable • Cost of providing credit • Staff cost of running a credit facility • The opportunity cost involved in not receiving the cash immediately. • The cost of allowing discounts for prompt payments • The cost of bad debts when an accounts receivable does not pay

  6. Accounts Receivable • Credit policy • the minimum requirements to grant a credit • The procedure to grant a credit • The number of days given for accounts receivable to pay • The amount of discount for prompt payments • The amount of interest on overdue accounts • The follow-up procedure on overdue accounts

  7. Bad and doubtful debts • Bad and doubtful debts • The accounts receivable that fail to be paid. • An expense to businesses • A cost of providing credits

  8. Bad and doubtful debts Income Statement (extracted) for the year ended 30 June 2008 Revenue 15,000 less: Expenses xxx 2,000 Bad and doubtful debts 1,000 xxx 5,000 8,000 Net Profit 7,000

  9. Case study • 2009 • Jun 1 Credit sale of GST-free goods worth $500 are made to M James • June 30 Statement of account is sent to M James • June 30 the accounting period ends • Aug 1 M James should have settled his account with the business but failed to do so • Aug 31 A reminder letter is sent asking for payment • Sept 30 A letter threatening court action is sent to M James • Oct 20 The account is declared bad Question • Which financial year does the bad debt belong to? 08-09 financial year or 09-10 financial year? WHY?

  10. Case study • According to matching principle, the bad debt belongs to 08-09 financial year. • Bad debt can be dealt with in two ways • Write off directly when they happen; or • According to matching and prudence principle, provide allowance for bad and doubtful debts on balance day.

  11. Provision for doubtful debts • Provision for doubtful debts (allowance for doubtful debts) • enable a proper matching of revenue and expenses • estimate the accounts receivable on balance day how much are unlikely to be paid in the next accounting period.

  12. Provision for doubtful debts • Provision for doubtful debts (allowance for doubtful debts) • Listed on balance sheet • a contra asset account with a normal balance on credit side • as the negative of accounts receivable

  13. Provision for doubtful debts • Balance Sheet (extract) • as at 30 June 2008 Current Assets Cash 10,000 Accounts receivable 5,000 less: Provision for doubtful debts (1,000) 4,000 etc Historical Cost Book value / Net realisable value

  14. Determine the amount of the provision • Factors influence the determination • History of payments • General economic conditions • Economic cycle: boom – recession • Inflation • Interest rate • specific issues related to the industry

  15. Determine the amount of the provision • Methods used to determine the amount of provision for doubtful debts • Specific identification • Percentage of sales • Percentage of accounts receivable • Ageing analysis

  16. Specific identification • Investigate the accounts receivable of each client • Check previous credit rating • Examine the normal payment period of previous accounts receivable • Decide which accounts are doubtful and how much • Total the doubtful amount as provision for doubtful debts • E.g.?

  17. Percentage of credit sales • This is also called the profit and loss statement approach. • It is based on the prior experience of the business. • It is calculated as a percentage of netcreditsales.

  18. Percentage of sales • Example • The credit department of Clara’s Hardware estimates (based on prior experience) that 1% of net credit sales are uncollectible. • Net credit sales for the year just ended were $400,000. • Accounts receivable on balance day $410 000

  19. Percentage of net credit sales • Solution Bad debt expense= 400000x1%=4000 Income statement (extract) Income XX Less expenses Bad debt (4 000) XX

  20. Percentage of accounts receivable • estimate a certain percentage of accounts receivable to be doubtful • Based on past experience and • adjusted for current situation • Use the balance of accounts receivables multiplying the percentage as provision for doubtful debts

  21. Percentage of accounts receivable • Example • A review of previous years' actual accounts shows that bad debts were in line with the historical average of 1.5% of accounts receivables. • Considering the current economic condition, a provision of 2% of accounts receivable is to be raised in the accounts this year. • At 30 June, accounts receivable stand at $209,000.

  22. Percentage of accounts receivable • Solution Provision for doubtful debts = 209000x2%=4180 Balance Sheet (extract) Accounts receivable 209 000 Less Provision for doubtful debts (4 180) 204 820

  23. Ageing analysis • Accounts are analysed to determine how long they have been outstanding. • The longer a debt goes unpaid the less likely it is to be collected.

  24. Ageing analysis • Accounts may be classified as: • Current • 1-30 Days • 31-60 Days • 61-90 Days • Over 90 Days • The total of each age bracket is multiplied by an appropriate loss percentage. • The sum of these amounts represents the balance for the provision for bad debts.

  25. Ageing analysis Example Assume that Laurel Hospital’s past collection experience indicates the following: Length A/C Receivables%uncollectible Current $1,900,000 0.5 1-30 700,000 2 31-60 300,000 3 61-90 700,000 5 90 + 500,000 8 Total $4,100,000

  26. Ageing analysis • Solutions Length A/C Receivables%uncollectibleProvision Current $1,900,000 0.5 9 500 1-30 700,000 2 14 000 31-60 300,000 3 9 000 61-90 700,000 5 35 000 90 + 500,000 8 40 000 Total $4,100,000 107 500

  27. Ageing analysis • Solution Balance Sheet (extract) Accounts receivable 4 100 000 Less Provision for doubtful debts (107 500) 3 992 500

  28. Exercise • P272 7.19

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