chap 12- bad and doubtful debts Flashcards
(16 cards)
What is a Balance Day Adjustment?
A change made to a revenue or expense account on balance day so that revenue accounts show revenues earned and expense accounts show expenses incurred in a particular period
Purpose of BDAs?
Balance day adjustments are made to ensure that profit is calculated accurately by matching revenues earned against expenses incurred in the current Period.
What is a bad debt?
A debt that must be written off as irrecoverable or uncollectable because it has been confirmed that the Accounts Receivable is unable to pay due to liquidation or bankruptcy.
What is a doubtful debt?
A debt that is unlikely to be collected in the future but has not yet been written off as it has not been confirmed that the Accounts Receivable is unable to pay.
Why is it necessary to record a BDA for Bad debts expense in the period in which the credit sale was made? (AA?)
Accrual basis assumption:
* Making a BDA allows the expense to be recognised in the period in which the credit sale was made
* thereby upholding the accrual basis assumption and ensuring profit is calculated accurately
* by matching expense incurred (bad debt) in the same period as the revenue earned (credit sale)
Period assumption:
* reports are prepared for a particular period of time
* only those revenues and expenses occurring within that Period should be used to calculate profit.
Why is it neccesary to recognise and report bad debts expense? (QC)
- recognising bad debts ensures that Income statement and Balance sheet provides a more faithful representation of the firm’s performance and position
- and the owner has all relevant information that may affect decision-making
Why is recognising bad debts expense in the accounting reports an ethical consideration?
- may be argued that omitting effects of bad debts expense from the income statement and the balance sheet is unethical as it would mean reports would represent firm’s profit and position in a more favourable manner
- but one that is ultimately inaccurate
- The reports may be misleading so any decisions made based on the info they contained could be false and ultimately damaging to business and its owner
How is doubtful debts estimated?
Uses historical data to estimate the percentage of the firm’s net credit sales that is likely to be uncollected
How are doubtful debts calculated?
Estimated rate * net credit sales (sales less sales returns)
Referring to the accrual basis assumption, explain the purpose of making a BDA for bad debts?
- Making a balance day adjustment for bad debts ensures that the Accrual basis assumption is upheld
- and that profit is calculated accurately by
- matching the expense incurred (Bad Debts) in the same Period as the revenue earned (Credit Sales)
Explain why the BDA for bad debts does not affect the Accounts Receivable account.
The BDA does not affect the Accounts Receivable account, as no specific debt – and no specific Account Receivable – has been written off as uncollectable so no accounts can be written off yet.
Why is it neccesary to report allowance for doubtful debts? (QC)
- Reporting Allowance for Doubtful Debts ensures that the Balance Sheet provides a Faithful representation of the amount owed by Accounts Receivable, as the information is not only accurate but also complete
- In turn, this ensures that the report contains all the information that may be Relevant to decision-making
Strategies that might be used to reduce the likelihood of bad debts.
- hiring an Accounts Receivable clerk/officer
- maintaining good relationship with customers
- performing extensive credit screenings
- threatening legal action
- hiring debt collecting agency
- denying access to credit facilities
- offering discount to incentivise early payment
- sending invoices promptly
- sending reminder notices
Explain why there is no expense to record when a debt is written off as ‘bad’.
- Bad debts expense is recognised and recorded in the Period when the credit sale is made (to ensure profit is accurate)
- so in the next Period, when the debt is confirmed as ‘bad’ and must be written off, there is actually no expense to record.
Explain the circumstances that would lead to Bad debts expense being overstated in one Period.
If the business over-estimates the percentage of credit sales that will end up as uncollectable, the BDA for Bad debts will be greater than the amount that ends up being ‘written off’.
Explain how an existing balance in the Allowance for doubtful debts account can affect the BDA for Bad debts expense.
- Where there is an existing balance in the Allowance for doubtful debts account, this will decrease the amount of the BDA to record the Bad debts expense
- by the difference between the amount calculated as Doubtful debts and the balance of the Allowance for doubtful debts account.
