4. Accounts Receivable Flashcards
where do bad debt losses generally come from
- extending credit to customers
- there is a risk that some accounts receivable will not be collected
- this is what is referred to as an uncollectible account
what is one way of minimizing bad debt losses
- to permit sales on accounts only to credit–worthy customers
- but this can be hard to determine in advance
if a corp issues a credit sale to a company on x date, and a year later at y date it is determined that the credit receivable would never be collected, which date would you record this bad debt arising from the credit sale
- it should be matched to the period in which the sale occurred
- so x date
what is the allowance for doubtful accounts
- its a contra account to accounts receivable in the general ledger
- its purpose is to record estimated uncollectible receivables
how does the allowance for doubtful accounts influence the balance sheet
- it is subtracted from accounts receivable
- to give the estimated net realizable accounts receivable
what are the two methods for estimating uncollectible accounts
- income statement method: estimating bad debt expense on the income statement
- balance sheet method: estimating the desired balance in allowance for doubtful accounts on the balance sheet
how does the income statement method work
- bad debt expense is calculated by applying an estimated loss percentage on credit sales for the period
- the percentage is based on actual losses experienced in prior years
how does the balance sheet method work
- it uses a process called aging of accounts receivable
- at the end of the period, the total of estimated uncollectible accounts is calculated by analyzing accounts receivable according to how long each account has been outstanding
- an aging analysis approach assumes that the longer a receivable is outstanding, the less likely it is to be collected
how is the bad debt expense calculated in the balance sheet method
- bad debt expense = estimated uncollectible amount - allowance for doubtful accounts from the previous period
what is a write-off
- when a specific account is deemed to be uncollectible
- so its removed from the accounts receivable account
if you had to write off x amount from an account receivable, which accounts would be affected and how
- the accounts receivable would decreases by x
- the allowance for doubtful accounts would also decrease by x
- the net realizable accounts receivable would not decrease because it is the difference between the two
- bad debts expense would also not be affected
if you were using the balance sheet method for estimating uncollectible amounts, how would you first go about recording a journal entry for the write-off of a clients account of x amount
- first you would need to acknowledge that the accounts receivables balance has decreased by x and therefore the allowance for doubtful accounts has also decreased by x
- in a journal entry, this is shown by a debit of x into AFDA (-contra asset to +Asset
- and a credit of x into accounts receivables (-Asset)
- the brackets are the notes in the journal, dont forget
how would you then calculate the bad debt expense
- calculate the estimated uncollectible amount using the accounts receivable * estimate bad debt percentage
- this is your ending AFDA balance
- dont forget to subtract x from its matching accounts receivable
- then draw a T-account for AFDA with the write-off on the left, the beginning balance (credit) on the right and the ending AFDA balance at the bottom
- do some math to get the missing value in the credit section, this is the bad debt expense
how would you finally fully journal the write-off
- in the journal entry, bad debt expense is debited (+expense to -Equity)
- AFDA is credited the same amount (+contra asset to -asset)
explain two earning manipulation techniques related to sales and allowance for bad debt you should check out for as an auditor
- check that the probability of default for each existing category is accurate and not estimated too low
- check that the company is not engaging in channel stuffing activities (selling to insolvent customers, forcing sales, offering very large rebates)