Accounts Receivable Generally, two major issues: • How to Record Sales Discounts • How to Record Doubtful Receipts
Accounts Receivable Generally, two major issues: How to Record Sales Discounts How to Record Doubtful Receipts.
Apr 02, 2015
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Accounts Receivable
Generally, two major issues:
• How to Record Sales Discounts
• How to Record Doubtful Receipts
Accounts ReceivableDiscounts
The most prevalent is the cash discount for early payment on the account.
Example: 2/10, n/30
Accounts ReceivableDiscounts
The most prevalent is the cash discount for early payment on the account.
Example: 2/10, n/30
2% discount if paid within 10 days
Accounts ReceivableDiscounts
The most prevalent is the cash discount for early payment on the account.
Example: 2/10, n/30
Net amount due in 30 days.
Usually for firms whose clients generally take advantage of the discounts
Accounts ReceivableDiscounts
Two methods to record the discount:
• Gross Method: record primary sale at gross amount
Usually for firms whose clients generally don’t take advantage of the discounts
• Net Method: record primary sale at net-of-discount amount
Gross Method
Jan 1 Accts Rec 10,000Sales 10,000
Accounts ReceivableDiscounts
Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms.
Accounts ReceivableDiscounts
Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms.
Recorded as if discount won’t be taken
Gross Method
Jan 1 Accts Rec 10,000Sales 10,000
Accounts ReceivableDiscounts
Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000Sales 10,000
Net Method
Jan 1 Accts Rec 9,800Sales 9,800
Accounts ReceivableDiscounts
Example: Jan 1st, sell $10,000 of product under 2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000Sales 10,000
Net Method
Jan 1 Accts Rec 9,800Sales 9,800
Recorded as if discount will be taken
Gross Method
Jan 9 Cash 9,800Sales Discs 200
Accts Rec 10,000
Accounts ReceivableDiscounts
Example: Jan 9th, receive payment within discount period
Accounts ReceivableDiscounts
Example: Jan 9th, receive payment within discount period
Gross Method
Jan 9 Cash 9,800Sales Discs 200
Accts Rec 10,000
If the discount is actually realized, it is recorded upon receipt of the cash payment. Sales Discounts is a contra-revenue account.
Accounts ReceivableDiscounts
Example: Jan 9th, receive payment within discount period
Gross Method
Jan 9 Cash 9,800Sales Discs 200
Accts Rec 10,000
Net Method
Jan 9 Cash 9,800Accts Rec 9,800
Accounts ReceivableDiscounts
Example: Jan 9th, receive payment within discount period
Gross Method
Jan 9 Cash 9,800Sales Discs 200
Accts Rec 10,000
Net Method
Jan 9 Cash 9,800Accts Rec 9,800
Discount has already been recorded on sales date.
Accounts ReceivableDiscounts
Example: Jan 29th, receive payment outside discount period
Now assume instead that the payment was sent after the discount period expired.
Accounts ReceivableDiscounts
Example: Jan 29th, receive payment outside discount period
Gross Method
Jan 29 Cash 10,000Accts Rec 10,000
No correction needed, since we already assumed the discount would not be taken.
Accounts ReceivableDiscounts
Example: Jan 29th, receive payment outside discount period
Gross Method
Jan 29 Cash 10,000Accts Rec 10,000
Net Method
Jan 29 Cash 10,000Accts Rec 9,800Forfeited Discount 200
Accounts ReceivableDiscounts
Example: Jan 29th, receive payment outside discount period
Gross Method
Jan 29 Cash 10,000Accts Rec 10,000
Net Method
Jan 29 Cash 10,000Accts Rec 9,800Forfeited Discount 200
Record the forfeited discount (a revenue account).
Accounts ReceivableDoubtful Receipts
One method of recording default is to record a loss when actual default occurs. This is called the direct write-off method.
All receivables have some probability of default. The default on payment needs to be recorded appropriately.
Not considered an acceptable method because it does not match revenues with costs effectively.
Accounts ReceivableDoubtful Receipts
The accepted method is called the Allowance Method.
An Allowance for Doubtful Accounts is set up as a contra-receivable account (contra-asset). It holds management’s best estimate for the amount of receivables that will default.
Accounts ReceivableDoubtful Receipts
To determine management’s best estimate for default, use one of two methods:
• Percentage of Sales Method: a fixed percentage of sales will be considered doubtful
This is also called the balance sheet approach, since the estimate is based on a percentage of a balance sheet receivable account.
This is also called the income statement approach, since the estimate is based on a percentage of sales revenue.
• Percentage of Receivables Method: a fixed percentage of the receivables balance will be considered doubtful
Accounts Receivable
Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected.
2000 Credit Sales:
0.70 x $200,000 = $140,000
Estimate of doubtful collections:
0.04 x $140,000 = $5,600
Doubtful Receipts: Percentage of Sales Method
Accounts Receivable
Example: Assume Paterno Corp. has $200,000 in sales during 2000. Of these sales, 30% are in cash and 70% are on credit. They estimate that 4% of their credit sales will not be collected.
Journal entry:
Bad Debt Expense $5,600Allowance for Doubtful Accts $5,600
Doubtful Receipts: Percentage of Sales Method
Accounts Receivable
Doubtful Receipts-Percentage of Receivables Method
Most firms know that the probability of default is based on the staleness of accounts.
For example, credit card companies recognize that the probability of default increases in the length of the time a credit card account remains past due.
Firms facing this scenario usually set up aging schedules that outline their estimates for default, based on the age of balances in receivable accounts.
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
Based on historical data, MBNA estimates the following default rates on its outstanding credit card receivables:
Age Estimated Default Rate
< 60 days old 5%
60-90 days old 10%
> 90 days old 20%
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
Assume MBNA has the following outstanding receivables balances:
Age A/R Balance
< 60 days old $2,500,000
60-90 days old $1,200,000
> 90 days old $1,000,000
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
MBNA would compute its ending balance for Allowance for Doubtful Accounts as follows:
Age A/R Balance Estimated Default Rate
AFDA
< 60 days old $2,500,000 5%
60-90 days old $1,200,000 10%
> 90 days old $1,000,000 20%
Totals
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
MBNA would compute its ending balance for Allowance for Doubtful Accounts as follows:
Age A/R Balance Estimated Default Rate
AFDA
< 60 days old $2,500,000 5% $125,000
60-90 days old $1,200,000 10% $120,000
> 90 days old $1,000,000 20% $200,000
Totals $445,000
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
Note that the aging schedule computes the Allowance for Doubtful Accounts ending balance.
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
Note that the aging schedule computes the Allowance for Doubtful Accounts ending balance.
The journal entry to record bad debt expense is for the difference between the AFDA beginning balance and this new ending balance.
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
AFDA
Beg Bal $375,000
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
AFDA
Beg Bal $375,000
End Bal $445,000
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
AFDA
Beg Bal $375,000
End Bal $445,000
$70,000
Bad-DebtExpense
Accounts Receivable
Doubtful Receipts-Percentage of Receivables MethodAging Schedule
AFDA
Beg Bal $375,000
End Bal $445,000
$70,000
Bad Debt Expense $70,000Allowance for Doubtful Accts $70,000
Accounts ReceivableSales Returns and Allowances
Returns and allowances are handled in the same manner as doubtful collection. An account called Allowance for Sales Returns is set up based on management’s best estimate for returns.
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