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ACCOUNTS RECEIVABLE

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Problems with Direct Write-Off ... No net income or total asset effect at the time of write-off. If the account is later collected: ... – PowerPoint PPT presentation

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Title: ACCOUNTS RECEIVABLE


1
ACCOUNTS RECEIVABLE REVENUE RECOGNITION
  • Accounting ASW
  • Summer 2004

2
Issue What to do about bad debts?
  • So far
  • Accounts Receivable 420
  • Sales Revenue
    420

3
Two potential approaches
  • Direct write-off method
  • Allowance method
  • Problem 6.13

4
Direct Write-Off Method
  • Only allowed for financial reporting if bad
    debts are immaterial, but required for tax
  • At the time of sale
  • No entry
  • When the account is deemed uncollectible
  • Bad Debt Expense 1.2
  • Accounts Receivable
    1.2

5
  • If the account is later collected
  • Accounts Receivable 1.2
  • Bad Debt Expense
    1.2
  • Cash 1.2
  • Accounts Receivable
    1.2
  • (The entry is made through accounts receivable
    rather than directly to cash for a record of the
    accounts receivable having been collected.)

6
Problems with Direct Write-Off
  • Accounts Receivable are overstated (in terms of
    expected receipts)
  • Net income is overstated
  • Revenue and expenses are not matched
  • Discretion affecting net income in when to call
    uncollectible

7
Allowance Method
  • Generally required for financial reporting
  • Record bad debts estimate at time of sale to
    expense and account receivable contra
  • Bad Debt Expense 8.4
  • Allow. for Doubtful
  • Accts. (AR contra)
    8.4
  • Net income effect at time of sale

8
  • When the account is deemed uncollectible
  • All. for Doubtful Accts. 1.2
  • Accounts Receivable
    1.2
  • No net income or total asset effect at the time
    of write-off

9
  • If the account is later collected
  • Accounts Receivable 1.2
  • All. for Doubtful Accts.
    1.2
  • Cash 1.2
  • Accounts Receivable
    1.2

10
  • Advantages of allowance method
  • - Matches revenue and expenses in period
    of sale
  • - Records net accounts receivable at
    expected cash collection
  • Problem with allowance method
  • - Discretion in estimating bad debt expense
  • - Only works well if your estimates are
    good
  • Problem 6-13

11
How to estimate bad debts under the
allowance method
  • Percentage of sales
  • Aging of accounts receivable
  • Observation of large accounts
  • Often use all three together

12
Other Applications
  • Sales returns
  • Cash discounts
  • Sales allowance

13
ACCOUNTS RECEIVABLE AND BAD DEBTS T-ACCOUNTS
  • (Gross) Accounts Receivable
  • Beg. Bal.
  • Credit Sales Collections
  • Write-offs
  • Ending Bal.
  • Allowance for Doubtful Accounts
  • Beg. Bal.
  • Write-offs Bad Debt Exp.
  • Ending Bal.

14
Income Recognition Issues
  • Review of revenue recognition criteria
  • provided all (or substantial portion) of goods or
    services
  • have received an asset which can be measured
  • Issue What if completion spans several periods?

15
Long-Term Contracts
  • Construction spans several periods
  • Customers and terms decided in advance
  • May satisfy revenue recognition criteria before
    completion
  • Problem 6-22 (slightly different s)
  • 4M contract,
  • Costs of 0.8M, 2.0M and 0.4M in years 1-3

16
Completed Contract Method
  • Delay revenue recognition until completed
  • For our example,
  • recognize no income or expense in years 12
  • accumulate costs in construction in progress
    account (just like work in progress)
  • recognize 4.0M in revenue and 3.2M in expense
    in year 3

17
  • Often used if
  • construction in period is too short to justify
    spreading
  • buyer or terms are not set
  • total cost (and hence income) is too uncertain

18
Percentage Completion Method
  • Generally preferred by companies
  • Only used if
  • construction spans multiple periods
  • contract terms are set and collection is likely
  • total cost (and profit) are reasonably estimable

19
  • Recognize revenue each period in proportion to
    costs during the period
  • In our example,
  • 25 of costs occur in year 1, so 25 of revenue,
    costs and net income would be recognized in year
    1
  • 62.5 of revenue, costs and NI in year 2
  • 12.5 of revenue, costs and NI in year 3
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