Accounting for Receivables

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Unit
8
Estimating Bad Debts
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BASES USED FOR THE ALLOWANCE METHOD

• Companies use either of two methods in the
  estimation of uncollectible accounts
• 1. Percentage of sales
• 2. Percentage of receivables
• Both bases are GAAP the choice is a management
  decision.

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ILLUSTRATION 9-4
COMPARISON OF BASES OF ESTIMATING UNCOLLECTIBLES
Percentage of Sales
Percentage of Receivables
Net Realizable Value
Allowance
Accounts
for
Receivable
Doubtful
Accounts

• Emphasis on Income Statement Relationships

Emphasis on Balance Sheet Relationships
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PERCENTAGE OF SALES BASIS

• In the percentage of sales basis, management
  establishes a percentage relationship between the
  amount of credit sales and expected losses from
  uncollectible accounts.
• Expected bad debt losses are
  determined by applying the
  percentage to the sales base
  of the current period.
• This basis better matches expenses
  with revenues.

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PERCENTAGE OF SALES BASIS Example 1
Situation A Pereira Company determines that 1
of net credit sales will become uncollectible. If
net credit sales are 170,000 the estimated bad
debt expense is 1700 (170,0001). The general
journal entry is
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PERCENTAGE OF SALES BASIS Example 2 Balance In
Doubtful Accounts
Situation B Pereira Company determines that 1
of net credit sales will become uncollectible. If
net credit sales are 170,000 the estimated bad
debt expense is 1700 (170,0001). However the
allowance for doubtful accounts still has a
credit balance of 1500. How much is journalized?
Answer the same as in situation A. Balances in
doubtful accounts are ignored.
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PERCENTAGE OF RECEIVABLES BASIS

• Under the percentage of receivables basis,
  management establishes a percentage relationship
  between the amount of accounts receivable and the
  required balance in the allowance account.
• This percentage can be applied to
  the total accounts receivable balance,
  or to individual accounts receivable balances
  stratified by age.

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PERCENTAGE OF RECEIVABLES BASIS

• The required balance in the allowance account is
  determined by applying the percentage to the
  accounts receivable balance at the end of the
  current period.
• The amount of the adjusting entry to record
  expected bad debt losses for the current period
  is the difference between the required balance
  and the existing balance in the allowance
  account.
• This basis produces the better estimate of net
  realizable value of receivables.

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PERCENTAGE OF RECEIVABLES BASIS EXAMPLE 1 Net
Receivables
Pereira Company decides to use the percentage of
receivables method to estimate bad debts. It
determines that 3 of total accounts receivables
will become uncollectibe. If the accounts
receivables total is 40,000 the estimated bad
debt expense is 1,200. (40,0003)
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PERCENTAGE OF RECEIVABLES BASIS EXAMPLE 2 Credit
Balance in Allowance for Doubtful Accounts
Pereira Company decides to use the percentage of
receivables method to estimate bad debts. It
determines that 3 of total accounts receivables
will become uncollectibe. If the accounts
receivables total is 40,000 the estimated bad
debt expense is 1,200. (40,0003). However
there is still a credit balance of 500 in the
allowance for doubtful accounts remaining from
last years adjusting entry. Therefore bad debt
expense is only 700. (1,200-500)
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PERCENTAGE OF RECEIVABLES BASIS EXAMPLE 3 Debit
Balance in Allowance for Doubtful Accounts
Pereira Company decides to use the percentage of
receivables method to estimate bad debts. It
determines that 3 of total accounts receivables
will become uncollectibe. If the accounts
receivables total is 40,000 the estimated bad
debt expense is 1,200. (40,0003). However
there is debit balance of 300 in the allowance
for doubtful accounts. In other words Pereira had
more bad debts than estimated. Therefore bad debt
expense is 1,500. (1,200300)
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PERCENTAGE OF RECEIVABLES BASIS EXAMPLE 4 Aging
of Accounts
Pereira Company decides to use the percentage of
receivables method to estimate bad debts.
However it wants to use the aging of accounts
receivables as a basis. Days 0-30 days 31-60
days 61-90 days 91-120 over 120 Amount 27,000 5,
700 3,000 2,400 1,900 Percent 2 4 10 50 7
5 Bad Debt 540 228 300 1200 1425 Total Bad
Debt Expense 3,693
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PERCENTAGE OF RECEIVABLES BASIS EXAMPLE 5
Pereira Company decides to use the percentage of
receivables method to estimate bad debts. In
using the aging of accounts receivables as a
basis the company determines that 3,693 of
receivables will become uncollectible. However
there is still a credit balance of 500 in the
allowance for doubtful accounts remaining from
last years adjusting entry. Therefore bad debt
expense is only 3,193 (3,693-500)
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SUMMARY OF UNCOLLECTIBLE ACCOUNTS
Methods of Write-Off
DIRECT
ALLOWANCE
PERCENTAGE OF ACCOUNTS RECEIVABLES
PERCENTAGE OF SALES
TOTAL RECEIVABLES
AGING OF RECEIVABLES
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DISPOSING OF ACCOUNTS RECEIVABLE

• To accelerate the receipt of cash from
  receivables, owners frequently
• 1. sell to a factor, such as a finance company
  or a bank, and
• 2. make credit card sales.

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DISPOSING OF ACCOUNTS RECEIVABLE

• A factor buys receivables from businesses for a
  fee and collects the payments
  directly from customers.
• Credit cards are frequently used by retailers who
  wish to avoid the paperwork of issuing credit.
• Retailers can receive cash more quickly from the
  credit card issuer.