ACCOUNTS RECEIVABLE

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ALLOWANCE FOR DOUBTFUL ACCOUNTS

CONTRA ASSET

CREDIT BALANCE

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JOURNAL ENTRY

DR BAD DEBT EXPENSE $XXXXX

CR ALLOWANCE FOR DOUBTFUL ACCOUNTS $XXXXX

After management analyzes accounts receivable or sales, an adjustment is made to account for anticipated bad debts. Shown above is an example of the format of the journal entry that would be posted to record an increase in allowance for doubtful accounts.

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WRITE OFF UNCOLLECTIBLES

DR ALLOWANCE FOR DOUBTFUL ACCOUNTS $XXXXX

CR ACCOUNTS RECEIVABLE $XXXXX

WHEN MANAGEMENT DETERMINES THAT PARTICULAR CUSTOMER BALANCES WILL NOT BE COLLECTED, AN ENTRY IN THE FORMAT SHOWN ABOVE IS POSTED. NOTE – THERE IS NO DEBIT TO EXPENSE.

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RECOVERY

DR ACCOUNTS RECEIVABLE $XXXXX

CR ALLOWANCE FOR DOUBTFUL ACCOUNTS $XXXXX

•

SOMETIMES, A CUSTOMER BALANCE THOUGHT TO BE UNCOLLECTIBLE BUT IS LATER COLLECTED. IN THAT CASE. YOU HAVE TO PUT THE RECEIVABLE BACK ON THE BOOKS.

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OBJECTIVE

MATCHINGAND

NET REALIZABLE VALUE

THE OBJECTIVE OF THESE ENTRIES IS TO MATCH EXPENSES WITH REVENUE IN THE PERIOD EARNED AND/OR TO REPORT THE ASSET (A/R) AT NET REALIZABLE VALUE (THE AMOUNT WE EXPECT TO COLLECT). .

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APPROACHES

INCOME STATEMENT

BALANCE SHEET

THERE ARE TWO WAYS THAT MANAGEMENT CAN ESTIMATE THE AMOUNT OF UNCOLLECTIBLE ACCOUNTS. ONE INVOLVES LOOKING AT SALES. THE OTHER LOOKS AT THE BALANCE DUE FROM CUSTOMERS.

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Income Statement ApproachFocus On

Sales

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Balance Sheet ApproachFocus On

A/R

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SALES DISCOUNTS

NET

OR

GROSS

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Ex: Sell $100,0002/10 net 30

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BOOK THE SALE

NET METHOD

DR A/R $98,000 CR SALES $98,000

GROSS METHOD

DR A/R $100,000 CR SALES $100,000

A 2% DISCOUNT ON A $100,000 SALE IS $2,000. UNDER THE NET METHOD YOU RECORD THE SALE AT THE AMOUNT AFTER THE DISCOUNT. THE THEORY IS THAT SINCE THE SELLER IS OFFERING THE DISCOUNT, THE NET AMOUNT IS THE TRUE SALE

PRICE.THE GROSS METHOD IGNORES THE DISCOUNT AT THE TIME OF SALE.

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COLLECT ON TIME

NET METHOD

DR CASH $98,000 CR A/R $98,000

GROSS METHOD

DR CASH $98,000DR DISC $2,000 CR A/R $100,000

IF WE COLLECT ON TIME, THE ENTRY UNDER THE NET METHOD IS STRAIGHT FORWARD. UNDER THE GROSS METHOD, A DEBIT TO SALES DISCOUNTS (CONTRA REVENUE) IS REQUIRED.

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COLLECT LATE

NET METHOD

DR CASH $100,000 CR SALES DISC $2,000 CR A/R $98,000

GROSS METHOD

DR CASH $100,000 CR A/R $100,000

IF THE CUSTOMER DOES NOT PAY ON TIME, THE ENTRY UNDER THE GROSS METHOD IS STRAIGHT FORWARD. UNDER THE NET METHOD, AN ADDITIONAL $2,000 IN INCOME IS REPORTED

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Gross Method NeedsAn Allowance Account

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PLEDGINGCollateral

Borrower Retains The A/R

Must DiscloseAccounts receivable are pledged when they are offered to a lender as security for a loan. Should the borrower default, the lender collects

the receivables. Pledges are disclosed in the financials (either on the statement or in the footnotes). The accounts receivable has not been sold and therefore remains on the books of the borrower. Lenders charge a financing fee which is recognized as an expense by the borrower.

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FACTORING

Sale Of A/R

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ISSUES

• Interest and Fees•Retainage

•Liability

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INTEREST & FEES

FACTOR HAS INCOME

SELLER HAS LOSS

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RETAINAGE

PROTECTSTHE FACTOR

Retainage is amount held back by the factor to cover any sales returns, discounts and/or allowances.

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LIABILITY

DEPENDSON RECOURSE

Liability is an issue for the seller of the receivables. With recourse means that the seller has to make good on any receivables that go uncollected. They are liable and have to estimate the potential exposure when receivables are factored.

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RISK & RECOURSE

WITH RECOURSE = SELLER AT RISK

WITHOUT RECOURSE = FACTOR AT RISK

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WITH RECOURSE

Seller Adds To Loss On Factoring

The estimated uncollectible accounts is recorded as a loss and a liability by the seller.

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Written Promise to Pay

Notes Receivable

The difference between accounts receivable and notes receivable is that one is verbal the other written.

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Interest Rates

Valuation

Many times notes are received pursuant to sale transactions. The value of the note receive is a function of the interest rate inherent in the note. You may have to discount to present value based on the applicable interest rate.

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Fair Value Transferred

Unstated Interest

Not all notes have a stated interest rate. In that case you have to back into the rate by using the other terms (i.e. the payment stream relative to the fair value of what you gave up in exchange for the note).

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Market Value

Unstated Interest

If you have trouble determining the fair value of what you gave up, it might be necessary to look at other factors such as market rates.

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PV Expected Cash Flows

Impairment

Notes receivable are impaired when it becomes likely that you will not be repaid according to the terms of the note. Most impairment questions provide a revised expected cash flow, which must be discounted to present value using the same rate that was used when the original note was discounted.

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