BUS512M
Module 5
Cash and
Accounts
Receivable
BE6-1, E6-4,
E6-5, P6-2
Current Asset Classification
A current asset is defined as any asset that is intended to be converted into
cash within one year or the company’s operating cycle, whichever is longer.
i.e., Cash, Marketable Securities, Accounts Receivable, Inventory,
Supplies, Prepaids
Proper Cash Management
• Restrictions placed on a company’s
access to its cash are typically imposed by
creditors to help ensure future interest and
principal payments, i.e., loan or debt covenants.
• Compensating balances are sometimes
required
• Control Record over cash, i.e., bank
reconciliation
• Physical Control over cash, i.e., petty
cash, signatures on checks
Accounts Receivable
• Accounts receivable arise from selling goods or
services to customers on account.
• Recorded at face amount to be collected.
• However, we must also reflect the fact that a
portion of A/R may not be collected.
– Net Realizable Value
• Reasons for lack of collection:
1. sales discounts (cash discounts)
2. sales returns
3. sales allowances
4. uncollectible A/R (bad debts, doubtful accounts)
Cash/Sales Discounts
• Offered to encourage early payment
• Examples
• 2/10, net 30
• 2/10, EOM
• Accounting approaches
• Gross Method - records discounts when taken
by customers
• Net Method - records discounts not taken by
customers
E6-4 Accounting for cash discounts
On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on
account for a gross price of $30,000. On May 5, the company sold cod
on account for a gross price of $20,000. the terms of both sales were
3/10, n/30. Crab Cove received payment for the first sale on May 6,
2012, and the payment for the second sale on May 31,2012. Provide
all necessary journal entries.
a. Assume the Gross Method.
E6-4 Accounting for cash discounts
On May 1, 2012, Crab Cove Fishing Company sold Maine lobster on
account for a gross price of $30,000. On May 5, the company sold cod
on account for a gross price of $20,000. the terms of both sales were
3/10, n/30. Crab Cove received payment for the first sale on May 6,
2012, and the payment for the second sale on May 31,2012. Provide
all necessary journal entries.
b. Assume the Net Method.
P6-2 Cash Discounts
During March the following credit sales and collections occurred. Company prepares
quarterly financials. Required: Prepare the journal entries to record these
transactions.
March 3 Sold goods to AAA for a gross price of $1,400. Terms 2/10,n/30.
March 8 Sold goods to BBB for a gross price of $800. Terms 2/10, n/30.
March 11 Received full payment from AAA.
March 28 Received full payment from BBB.
March 29 Sold goods to CCC for a gross price of $1,800. Terms 2/10, n/30.
Sales Returns and Allowances
• Internal control
• Customer returns and allowances tracked
Net Sales in Financial Statements
• Eli Lilly:
• NIKE
Accounts Receivables in the Financial Statements
• Income Statement – Bad Debts Expense is typically included in Selling Expense, which is often combined with General and Administrative Expense (SG&A)
• Balance Sheet – Accounts Receivable may be shown in any one of the following ways:
WALMART:
NIKE Balance Sheet and footnote:
WALMART footnote:
Eli Lilly footnote:
Excerpt from Coca Cola’s 2011 10-K is a typical footnote disclosure of the activity in the Allowance for Doubtful Accounts:
Coca Cola Balance Sheet disclosures for 2011 and 2010:
• Cash Flow Statement (Indirect Method) – may be shown as an adjustment to net income for the change in Accounts Receivable, Net, such as with Eli Lilly below:
Or as a separate adjustment for the Provision for Bad Debts and the remaining change in Accounts Receivable:
Direct Write-off Method for AR
• Used primarily in Cash Basis Accounting
• No adjusting journal entry
• Write-off entry
• Recovery entry
Accounting for Bad Debts
Specific Write-off or
Allowance Method?
Specific Write-off Method:
Recognize Bad Debts Expense when individual accounts are determined to be uncollectible
Allowance Method:
Estimate Bad Debts Expense each year and reduce Accounts Receivable using a contra account. Move the reduction from the contra to the Accounts Receivable account when a specific account is known to be uncollectible
Entry:
Bad Debts Exp. xx Accounts Rec. xx
Which method is used to estimate bad debts expense?
% of Accounts Receivable Method Recognize Bad Debts Expense for the amount that will cause the contra account balance to equal the % of year- end accounts receivable not expected to be collected.
% of Sales Method
Recognize Bad Debts Expense for the amount of bad debts expected to result from the current year’s sales, using a percent of sales
Aging of Accounts Receivable Method
Same as the % of Accounts Receivable Method except it uses different percentages for accounts based on their age -- higher % for older accounts.
Journal Entries for Allowance Method on next slide
To record bad debts expense:
Bad Debts Expense xxx
Allowance for Uncollectible Accounts xxx
To write off bad accounts:
Allowance for Uncollectible Accounts xxx
Accounts Receivable xxx
Journal Entries for Allowance method of
Accounting for Bad Debts
Recovery of Bad Debts
If a receivable is collected after it has been written off, it should be restored by making the reverse of the entry that was made to write it off:
Allowance Method
Accounts Receivable xxx
Allowance for Bad Debts xxx Specific Write-Off Method
Accounts Receivable xxx
Bad Debts Expense xxx
The collection of the receivable is then recorded in the usual fashion:
Cash xxx
Accounts Receivable xxx
Allowance for Doubtful Accts.
(T-account)
Allowance for Doubtful Accts.
Beginning
Balance
AJE estimates bad debt
expense
Bad Debts Expense
AJE estimates
bad debt expense
Accounts Receivable
Write-off of
accounts
receivable
Ending
Balance
Customer pays
AR Write-off
The AJE to record the estimate of
uncollectibles. Aging calculates the
expense amount necessary to
achieve the “desired ending
balance” in the allowance account.
OR % of Sales is the Expense and
then compute EB in Allowance
account.
Recover write-off
Beginning Bal.
Credit sales Recover write off
Ending Bal.
BE6-1 Analysis of AR:
The following information was taken from the 2009 Annual report of Emerson
Electric Co. Balance Sheet (in millions):
Receivables were in 2009 $3,623 and in 2008 $4,618; less
allowance for uncollectibles of $93 and $90, respectively.
a. Compute total AR as of the end of 2009 and 2008, and compute the bad
debt allowance as a % of total AR. Did the % increase or decrease?
b. The bad debt expense reported on Emerson’s 2009 income statement did
not equal $93. Explain why.
Note on estimating bad debts using the allowance method:
Regardless of which method is used to estimate bad debts (% of sales, % of accounts receivable, or aging of
accounts), in the final analysis the balance in the allowance account on the balance sheet should represent a fair
expectation of the amount that will not be collected of the outstanding accounts receivable. Hence, the net accounts receivable balance on the balance sheet should represent the expected “net realizable value” of the receivables.
Estimating Bad Debt Expenses
• Percent of Sales Method
• Percent of Accounts Receivable Method
• Aging of Accounts Receivable Method
Bad Debts/Doubtful Accounts/Uncollectible Accounts
• Note that we do not know in this year which A/Rs
will not be collected in future. Therefore, we must
estimate uncollectibles.
• We will focus on the % of Sales or Aging of AR to
estimate uncollectibles for the AJE. The
percentage of sales method is simpler, but the
Aging of A/R method is more accurate.
• Under IFRS, the methods used to estimate and
account for uncollectible are very similar to those
under US GAAP.
Percentage of Sales Method
• Usually based on credit sales, but may use
total sales or net sales as basis.
• Calculation:
Sales x % = Bad Debt Expense
(focus on the debit side of the AJE)
• Called the Income Statement approach,
because: revenues x % = expense.
• After making entry find the resulting ending
balance in the Allowance account.
E6-5 Bad debts under the allowance method.
Arlington Cycle Company began operations on 1/1/11.
The company reported the following on its 2011
financials:
Gross sales in 2012 $1,400,000 and $1,500,000 in
2011.
AR in 2012 $600,000 and $650,000 in 2011.
Actual bad debt write-offs in 2012 $22,000 and
$10,000 in 2011.
Arlington estimates bad debts at 2% of gross sales.
Analyze the activity in the allowance for doubtful
accounts T-account, and comment on whether the bad
debt estimate has been sufficient to cover the
writeoffs.
Gross sales in 2012 $1,400,000 and $1,500,000 in 2011.
AR in 2012 $600,000 and $650,000 in 2011.
Actual bad debt write-offs in 2012 $22,000 and $10,000 in 2011.
Arlington estimates bad debts at 2% of gross sales.
Aging Method: Percentages of A/R
• Based on ending A/R and ending Allowance account.
• Calculation:
Ending A/R x % = Ending Allowance
(focus on the credit side of the AJE)
• Called Balance Sheet approach, because: ending
asset x % = ending contra asset.
• Requires the analysis of the Allowance account and
A/R before preparing the AJE.
• An aging schedule of A/R is the most accurate way to
estimate uncollectibles (see Figure 6-11).
Year-end Entries: Bad Debts
• During 2010, Omega Company had net sales of $11,400,000. Most
of the sales were on credit. At the end of 2010, the balance of
Accounts Receivable was $1,400,000, and Allowance for
Uncollectible Accounts had a debit balance of $48,000.
• Omega Company's management uses two methods of estimating
uncollectible accounts expense: the percentage of net sales
method and the accounts receivable aging method. The
percentage of uncollectible sales is 1.5 percent of net sales, and
based on an aging of accounts receivable, the end-of-year
uncollectible accounts total $140,000.
1. Prepare the end-of-year adjusting entry to record the
uncollectible accounts expense under each method.
2. What will the balance of Allowance for Uncollectible Accounts be
after each adjustment?
3. Why are the results different?
4. Which method is likely to be more reliable? Why?
During 2010, Omega Company had net sales of $11,400,000. Most of the sales were on credit. At the end of 2010, the balance of Accounts Receivable was $1,400,000, and Allowance for Uncollectible Accounts had a debit balance of $48,000.
Omega Company's management uses two methods of estimating uncollectible accounts expense: the percentage of net sales method and the accounts receivable aging method. The percentage of
uncollectible sales is 1.5 percent of net sales, and based on an aging of accounts receivable, the end-of- year uncollectible accounts total $140,000.
1. Prepare the end-of-year adjusting entry to record the uncollectible accounts expense under each method.
2. What will the balance of Allowance for Uncollectible Accounts be after each adjustment?
Aging of AR
Customer
Account Total Not Yet Due 1–30 Days Past
Due
31–60 Days Past Due
61–90 Days Past Due
Over 90 Days Past Due
Balance Forward $89,640 $49,030 $24,110 $9,210 $3,990 $3,300
Time Percentage Considered Uncollectible
Not yet due 2
1–30 days past due 5
31–60 days past due 15
61–90 days past due 25
Over 90 days past due 50
Emory Company uses the accounts receivable aging method to estimate uncollectible accounts. At the
beginning of the year, the balance of the Accounts Receivable account was a debit of $90,430, and the balance of Allowance for Uncollectible Accounts as a credit of $8,100. During the year, the company had sales on account of $475,000, sales returns and allowances of $6,200, worthless accounts written off of $8,800, and collections from customers of $452,730. At the end of year (December 31, 2012), a junior accountant for Emory Company was preparing an aging analysis of accounts receivable.
At the top of page 5 of the report, the following totals appeared:
To finish the analysis, the following accounts need to be classified:
From past experience, the company has found that the following rates are realistic for estimating uncollectible accounts:
Required
Complete the aging analysis of accounts receivable.
Compute the end-of-year balances (before adjustments) of Accounts Receivable and Allowance for Uncollectible Accounts.
Prepare an analysis computing the estimated uncollectible accounts.
Calculate Garcia Company's estimated uncollectible accounts expense for the year (round the amount to the nearest whole dollar).
What role do estimates play in applying the aging analysis? What factors might affect these estimates?
