7.3 Valuation of AR

Which of the following methods of determining annual bad debt expense violates the expense recognition concept? Percentage of sales Percentage of ending accounts receivable Percentage of average accounts receivable Direct write-off

The direct write-off method usually fails to record expenses in the same period as the associated revenue and therefore violates the expense recognition concept. Percentage of sales and percentage of receivables both estimate bad debt expense and report in the same period as the related sales.

Illustration: Assume that Brown Furniture in 2020, its first year of operations, has credit sales of $1,800,000. Of this amount, $150,000 remains uncollected at December 31. The credit manager estimates that $10,000 of these sales will be uncollectible. The adjusting entry to record the estimated uncollectibles (assuming a zero balance in the allowance account) is:

allowance method for uncollectibles

Allowance for Doubtful Accounts

contra-asset account containing the estimated uncollectible accounts receivable

A trial balance before adjustment included the following: Debit Credit Accounts receivable $80,000 Allowance for doubtful accounts $730 Sales. $340,000 Sales returns and allowances. $8,000 Give journal entries assuming that the estimate of uncollectables is determined by taking (1) 5% of gross accounts receivable and (2) 1% of net sales.

(1) Bad Debt Expense ..........................................3,270 Allowance for Doubtful Accounts ............................. 3,270 Gross receivables $80,000 Rate 5% Total allowance needed 4,000 Present allowance (730) Adjustment needed $ 3,270 (2) Bad Debt Expense ............................................3,320 Allowance for Doubtful Accounts ............................. 3,320 Sales $340,000 Sales returns and allowances 8,000 Net sales 332,000 Rate 1% Bad debt expense $ 3,320

a)Larkspur, Inc. had net sales in 2020 of $1,476,200. At December 31, 2020, before adjusting entries, the balances in selected accounts were Accounts Receivable $257,500 debit, and Allowance for Doubtful Accounts $1,877 debit. Assume that 11% of accounts receivable will prove to be uncollectible. Prepare the entry to record bad debt expense b)Larkspur, Inc. had net sales in 2020 of $1,476,200. At December 31, 2020, before adjusting entries, the balances in selected accounts were Accounts Receivable $257,500 debit, and Allowance for Doubtful Accounts $2,690 credit. Assume Larkspur prepares an aging schedule that estimates total uncollectible accounts at $24,700. Prepare the entry to record bad debt expense.

257,500*11%=28,325 now add this to the 1,877 already in the allowance for doubtful accounts at the end of the year. Bad Debt Expense 30,202 Allowance for doubtful accounts. 30,202 on the next part subtract the allowance for doubtful accounts from the aging schedule. 24,700-2,690=22,010 Bad debt Expense 22,010 Allowance for doubtful accounts. 22,010

The required balance in Wheeler's Allowance for Doubtful Accounts is $36,750, based on an aging of its accounts receivable. The Allowance for Doubtful Accounts currently has a debit balance of $4,200. Wheeler's bad debt expense for the period is

36,750+4,200 40,950 The existing balance in Allowance for Doubtful Accounts is considered under the percentage-of-receivables method. Therefore, bad debt expense is $40,950 (Required Allowance for Doubtful Accounts Balance, $36,750 + Allowance for Doubtful Accounts current debit balance, $4,200).

Teal Mountain Distributors, Inc. had net sales in 2017 of $2,450,000. At December 31, 2017, before adjusting entries, the balances in selected accounts were Accounts Receivable $420,000 debit, and Allowance for Doubtful Accounts $2,700 debit. If Teal Mountain estimates that 5% of its receivables will prove to be uncollectible, prepare the December 31, 2017, journal entry to record bad debt expense.

420,000*.05 21,000+2,700

Aging accounts receivable is a variation of the percentage-of-sales approach to recognizing bad debt expense.

Aging is an estimation method used with the percentage-of-accounts receivable approach.

During the year, Trout Enterprises made an entry to write off an $8,000 uncollectible account. Before this entry was made, the balance in accounts receivable was $100,000 and the balance in the allowance account was $9,000. The net realizable value of accounts receivable before and after the write-off entry was

Before: Accounts Receivable, $100,000 - Allowance Account, $9,000 = $91,000. After: (Accounts Receivable, $100,000 - $8,000) - (Allowance Account, $9,000 - $8,000) = $91,000.

Valuation of AR

Companies value and report short‐term receivables at the net amount expected to be collected, which is not necessarily the amount legally receivable. Determining the net amount expected to be collected requires estimating uncollectible receivables. •Record credit losses as debits to Bad Debt Expense (or Uncollectible Accounts Expense)

Under the direct write-off method, bad debts are only recognized when an account is determined to be uncollectible.

True Bad debt expense is only recognized when an account is written off under the direct write-off method.

Illustration: The financial vice president of Brown Furniture authorizes a write-off of the $1,000 balance owed by Randall Co. on March 1. The entry to record the write-off is:

recording the write-off of uncollectible accounts

The percentage-of-sales approach of estimating bad debts does a better job of matching revenues (sales) and expenses (bad debt expense) on the income statement.

true The percentage-of-sales approach of estimating bad debts does a better job of matching revenues (sales) and expenses (bad debt expense) on the income statement. The percentage-of-receivables approach does the best job of presenting accounts receivable at their net realizable value.

allowance method detailed

•Involves estimating uncollectible accounts at end of each period •Ensures that companies state receivables on balance sheet at net realizable value •Companies estimate uncollectible accounts and net realizable value using information about past and current events as well as forecasts of future collectibility

Allowance method summarized

•Losses are estimated •Percentage-of-sales •Percentage-of-receivables •G A A P requires when material in amount

Percentage-of-Receivables Approach (estimating the allowance)

•Reports estimate of receivables at realizable value •Companies may apply this method using one composite rate, or an aging schedule using different rates

direct write-off method

•Theoretically deficient •No matching •Receivable not stated at cash realizable value •Not G A A P when material in amount

Recording the write-off of an uncollectible account

•When companies have exhausted all means of collecting a past-due account and collection appears impossible, the company should write off the account •In the credit card industry, for example, it is standard practice to write off accounts that are 210 days past due.