4. Accounts Receivable Flashcards

1
Q

where do bad debt losses generally come from

A
  • 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
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2
Q

what is one way of minimizing bad debt losses

A
  • to permit sales on accounts only to credit–worthy customers
  • but this can be hard to determine in advance
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3
Q

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

A
  • it should be matched to the period in which the sale occurred
  • so x date
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4
Q

what is the allowance for doubtful accounts

A
  • its a contra account to accounts receivable in the general ledger
  • its purpose is to record estimated uncollectible receivables
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5
Q

how does the allowance for doubtful accounts influence the balance sheet

A
  • it is subtracted from accounts receivable
  • to give the estimated net realizable accounts receivable
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6
Q

what are the two methods for estimating uncollectible accounts

A
  • 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
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7
Q

how does the income statement method work

A
  • 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
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8
Q

how does the balance sheet method work

A
  • 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
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9
Q

how is the bad debt expense calculated in the balance sheet method

A
  • bad debt expense = estimated uncollectible amount - allowance for doubtful accounts from the previous period
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10
Q

what is a write-off

A
  • when a specific account is deemed to be uncollectible
  • so its removed from the accounts receivable account
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11
Q

if you had to write off x amount from an account receivable, which accounts would be affected and how

A
  • 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
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12
Q

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

A
  • 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
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13
Q

how would you then calculate the bad debt expense

A
  • 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
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14
Q

how would you finally fully journal the write-off

A
  • in the journal entry, bad debt expense is debited (+expense to -Equity)
  • AFDA is credited the same amount (+contra asset to -asset)
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15
Q

explain two earning manipulation techniques related to sales and allowance for bad debt you should check out for as an auditor

A
  • 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)
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16
Q

what is bad debt expense

A
  • the amount of expected default losses associated with the balance of accounts receivable
  • it is typically the adjustment needed to change the allowance for bad debt from period to period
  • often done with an ageing schedule
17
Q

why do investors care about a companys bad debt rate

A
  • because investors ultimately care about cash flows more so than earnings
  • earnings needs to generate cash flows or the company cant remain liquid
18
Q

what are some ways companies can avoid recording slight losses and record slight gains instead

A
  • the company can cancel some unnecessary costs at the end of year (legitimate way of doing things)
  • the company can delay some costs like waiting til next year to buy supplies or anticipate future gains like close deals before year end
  • the company can generate artificial revenue by selling assets
  • the company can manipulate the accounts via creative accounting using complex financial structures
19
Q

what is the big bath concept

A
  • the big bath in accounting is an earnings management technique
  • whereby a one-time charge is taken against income to reduce assets
  • which results in lower expenses in the future