Valuing Accounts Receivable

1. Valuing Accounts Receivable • Some receivables will become uncollectible • Not reported as assets if no future benefit • Net realizable value: the collectible amount • Receivables are written down to their collectible amount • By recording bad debt expense • In the same period as related revenues are recorded: matching of revenues and expenses

2. The Allowance Method Three features of allowance method: • Amount of uncollectible receivables is estimated and recorded at end of period • Specific amounts determined uncollectible are written off against the allowance • Specific amounts that are recovered are reversed out of allowance and the collection recorded

3. 1. Recording Estimated Uncollectibles Assume that $24 000 of receivables are assumed to be uncollectible. The journal entry is as follows: Allowance for Doubtful Accounts • Deducted from Accounts Receivable in the current assets section of balance sheet – contra asset account • Net Realizable value = Accounts Receivable less Allowance for Doubtful Accounts • Look at p.415 for presentation in financial statements

4. Two Methods for Estimating the Allowance: • Percentage of Sales • Calculates bad debt expense as a percentage of net credit sales • Based on past experience and company’s credit policy • Example: 2% of credit sales of $1,200,000 = $24,000 • The adjusting entry would be: Bad Debts Expense 24 000 Allowance for Doubtful Accounts 24 000 • Better matches revenues and expenses • When calculating the adjusting entry the existing balance in the Allowance for Doubtful Accounts is ignored • The amount should be compared to what is actually written off, if it is significantly different than a different percentage should be used. • Also called the income statement method

5. Percentage of Receivables • Calculates the percentage of receivables that are estimated to be uncollectible • Based on past experience and credit policy • Can be applied to total receivables balance or amounts grouped by age • Requires an aging schedule to be prepared – this is easy to do in a computerized system • Better estimate of net realizable value – therefore the one usually used • See page 416 for an example of an aging schedule • The balance in the allowance for doubtful accounts must be taken into account. • For example, if a company has a balance of $5 000 and needs an allowance of $20 000, an adjusting entry of $15 000 (20 000 – 5 000) would be made • Bad debts expense 15 000 • Allowance for Doubtful Accounts 15 000 • Also called the balance sheet method

6. Income Statement Approach Percentage of Sales Matching Bad Debts Expense Sales Percentage of Receivables Net Realizable Value Allowance for Doubtful Accounts Accounts Receivable Comparison of Approaches Balance Sheet Approach

7. 2. Recording Write-Off of an Uncollectible Account • When collection has been tried and it appears impossible, the receivable needs to be written off • To keep good internal control write-offs should be approved by management • Assume that the accounts receivable from Kids Online of $4500 has been deemed uncollectible, the journal entry for the write-off would be as follows: • Only Balance Sheet accounts are affected for a write-off – the Net Realizable Value is not affected.

8. 3. Recovery of an Uncollectible Account • If a company ends up collecting cash from a customer that had previously been written off, two entries need to be made. • The entry to write off the account needs to be reversed to restore the customer’s account • The collection is recorded in the normal way • Assume the Kids Online account was subsequently collected, the journal entries would be as follows.

9. Homework • BE8-5,6,7,8,9