A6 Receivables
Under the allowance method, what entry is recorded
DR Bad Debt Expense CR Allowance for Credit Losses / Allowance for Uncollectible Accounts
What happens if a company fails to record estimated bad debt expense?
If bad debt expense is not recorded, total expenses are understated.
cons of factoring a receivable
It is a short-term cash solution. Investors and creditors could perceive factoring as a sign of financial difficulty. Fees and expenses can be very high.
factoring a receivable
When receivables are factored, they are sold for cash immediately, rather than waiting for the cash to be collected from customers. This usually involves a discount from the recorded value of the receivables to cover the risk of non-payment by customers.
AR BS presentation
direct writeoff - gross AR allowance - NRV (gross AR - allowance)
an account receivable is created when
organizations sell to customers without collecting cash at the time of sale
what separate the two methods allowance and direct write-off?
timing of expense
factoring with recourse
- rights of ownership remain with the original owner of the receivable and are not transferred to the factor. - The receivable then remains on the original owner's balance sheet. - The organization selling accounts receivable bears the risk of loss relative to collecting the customers' balances. - One advantage is that the fees are typically lower - The selling organization is required to compensate the factor for any loss so they estimate the amount of the resulting recourse obligation and record it at the time of the factoring. DR Cash 93,000 DR Due from Factor 5,000 DR Loss on Factoring 5,500 CR Accounts Receivable 100,000 CR Recourse Obligation 3,500
Under the allowance method, what happens when a specific account is written off?
Total assets will be unchanged. Under the allowance method an estimate is made of the dollar value of accounts receivable that will not be collected. This amount is the basis of bad debt expense. When an account is written off, the allowance for doubtful accounts is reduced (debited) and gross accounts receivable is reduced (credited) by the same amount. This means the cash realizable value is the same after the account is written off as it is before it is written off. This means total assets will be unchanged when a specific account is written off.
Under the allowance method, when is expense recorded
estimates the amount of bad debt it will incur and records the expense in the same period as the related sales. Recording an allowance helps an organization match expenses associated with uncollectible accounts to related revenues(matching principal); that's why it is accepted by GAAP
two ways to account for credit losses, or bad debts
- Allowance method - Direct write-off method
pros of factoring a receivable
- It is a quick source of cash. - Fees are usually based on the credit quality of the organization's customers, not the organization itself. - The organization can raise cash without incurring any additional debt. - The organization does not have to secure financing with existing assets.
two approaches for estimating uncollectible receivables under the allowance method
- Percentage of receivables or balance sheet approach - Percentage of net revenues/sales or income statement approach
receivable aging
- is used to estimate the total amount of uncollectible accounts at the end of the period. The estimated amount is compared to the amount remaining in the allowance account and the necessary adjustment is recorded. • If the allowance for uncollectible accounts is too small, bad debt expense is increased and income goes down. • If the allowance for uncollectible accounts is too large, bad debt expense is decreased and income goes up.
factoring without recourse
- transfers the ownership of the receivable to the factor and removes it from the balance sheet - This means that the factor (the organization purchasing the accounts receivable from the selling organization) bears the risk of loss relative to collecting the customers' balances. - The selling organization typically receives less cash on the sale because the buyer has increased risk. - If the customer does not ultimately pay the factor, the selling organization is not impacted. DR 91,000 DR Due from Factor 4,000 DR Loss on Factoring 5,000 CR Accounts Receivable 100,000
When should a merchandiser recognize an account receivable?
At the point of sale Revenue is recognized when earned and realized (or realizable). Earned means that the seller has done substantially all it is required to do and realized or realizable means it has received cash or a claim to cash. For a merchandiser both of these typically happen at the point of sale as the seller provides the goods (earned) and receives cash or a claim to cash (selling on credit).
How is factoring of receivables different from securitization of receivables?
In factoring, factors buy receivables and take on the billing and collection functions, whereas securitization is the process of converting illiquid assets into liquid assets by bundling similar receivables into an investment fund.
what happens if the amount of uncollectible account expense is overstated at year end?
Net Accounts Receivable will be understated If uncollectible accounts expense is overstated, then allowance for doubtful accounts will also be overstated. This is because the allowance account is the offsetting account in the journal entry to record uncollectible account expense. Since net accounts receivable is calculated as gross accounts receivable less allowance for doubtful accounts, if the allowance account is overstated then net accounts receivable will be understated.
What will happen if the amount of bad debt expense is understated at year-end?
Net accounts receivable will be overstated. When bad debt expense is recorded the off-setting credit is to allowance for doubtful accounts. The allowance is needed to reduce the net realizable value of accounts receivable to the amount expected to be collected. If bad debt expense is understated, the allowance for doubtful is understated. This results in the net accounts receivable being overstated.
When a company collects on an account after writing it off as uncollectible, it makes one journal entry:
Reversing the entry made when writing off the account, and another entry recording the collection in the usual manner Writing off an accounts receivable requires a journal entry to remove the receivable (credit) and decrease the allowance for doubtful accounts (debit). DR allowance for doubtful accounts CR AR When an account that was previously written off is collected, a journal entry reinstating the account must be made. This is a reverse of the entry to write off the account. DR AR CR allowance for doubtful accounts A second entry recording the collection in the usual manner is also made. DR Cash CR AR/Uncollectible Accounts Recovered (revenue account)
When the allowance method of recognizing bad debt expense is used, the allowance for doubtful accounts would decrease when a(n):
Specific uncollectible account is written off. This answer is correct. When the allowance method of recognizing bad debts is used, the entry to establish the allowance account is: Bad Debt Expense xx Allowance for bad debts xx The entry to write off a specific uncollectible account is Allowance for bad debts xx Accounts Receivable xx
A customer of Irving Gemstones owed $20,000 on account. Due to nonreceipt of payments after 5 months of the due date, the amount was written off as doubtful using the direct write-off method. After 2 years, the customer paid the full amount due. How should this transaction be journalized?
The amount received should be debited to Cash and credited to a revenue account, such as Uncollectible Accounts Recovered. If an account written off using the direct write-off method is subsequently collected, the amount is debited to Cash and credited to a revenue account, such as Uncollectible Accounts Recovered.
Percentage of revenues (income statement approach)
The organization assumes a certain percentage of sales are uncollectible and records bad debt expense based on that at the time of sale DR Bad Debt Expense CR Allowance for Bad Debt Expense
Percentage of receivables (balance sheet approach)
The organization assumes a percentage of existing accounts receivable will not be collectible and adjusts the allowance account to reflect that at the time the financial statements are prepared
Allowance method
The organization estimates the amount of bad debt it will incur and records the expense in the same period as the related sales using an allowance account. This method is based on accrual accounting and is used for GAAP purposes.
Direct write-off method
The organization waits until a specific account is identified as not collectible and removes the accounts receivable with an offsetting entry to bad debt expense. This method is more like a cash basis and is used for tax purposes - A disadvantage is that the expense for bad debt is not matched to the revenue associated with the sale. - Generally, it is not acceptable for U.S. GAAP reporting purposes unless the uncollectible amounts are clearly immaterial or there is no reasonable basis for estimating bad debts.
writeoff under allowance method
When a specific customer account is identified as uncollectible, the organization can write off the amount by reducing both the allowance for uncollectible accounts and accounts receivable. This adjustment does not change the amount of Net Accounts Receivable reflected on the balance sheet. The entry to write off the sale noted above would be: DR Allowance for Uncollectible Accts 100 CR Accounts Receivable 100
The cash realizable value of accounts receivable in the balance sheet is the same
before and after an account is written off. DR allowance for doubtful accounts CR gross accounts receivable
If accounts receivable decreases,
it means cash collections exceeded credit sales.
credit risk (default risk)
measures the risk that a customer will not ultimately pay the organization what they promised at the time of sale.
the organization can write off the amount identified as uncollectible by
reducing both the allowance for uncollectible accounts and accounts receivable: DR Allowance for Uncollectible Accts CR AR No change to NRV; just reswizzle between the accts
Net Realizable Value (NRV)
required by GAAP that accounts receivable be carried on the balance sheet - gross accounts receivable less - the allowance for credit losses (sometimes called uncollectible accounts or bad debts), - returns and allowances, and - discounts. Estimation of the allowance for credit losses can be done by using a percentage of outstanding accounting receivable or an aging of accounts receivable approach, or by using a percentage of sales or of net credit sales approach.
Under the allowance method, the organization is reducing accounts receivable without knowing
which specific customers will not pay their debts in the future. The use of a separate account for the estimate of uncollectible receivables will allow the sum of the subsidiary (individual customer) ledgers to reconcile to the account receivable balance.
