Horngren's Financial & Managerial Accounting Nobles Mattison Matsumura Fourth Edition

Horngren's Financial & Managerial Accounting Nobles Mattison Matsumura Fourth Edition

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Once an account receivable is written off, the company stops pursuing the collection. Some companies might turn delinquent receivables over to an attorney or other collection agency to recover some of the cash for the company, but generally companies do not expect to receive any future payment. Recovery of Previously Written Off Direct Write-Off Method Occasionally after a company writes off an account, the customer will decide to make payment. To account for this recovery, the company must reverse the earlier write-off. For example, on September 10, Smart Touch earning unexpectedly receives $ cash from Dan King. The company will reverse the earlier write-off and then record the cash collection as follows: A E and Explanation Receivable Bad Debts Expense Sep. 10 Receivable King Reinstated previously written off account. A Cash Receivable E 10 Cash Receivable King Collected cash on account. In order to keep accurate records about the collection of cash for a previously written off account, the business should re-establish the Receivable by debiting the receivable account. Then the business can record the receipt of cash for the receivable by debiting Cash and crediting Receivable. This helps restore the credit history of the customer by showing that the customer did fulfill the promise of payment. imitations of the Direct Write-Off Method The direct write-off method, as stated earlier, is often used only by small, non-public companies. This is because the direct write-off method violates the matching principle. The matching principle requires that the expense of uncollectible accounts be matched with the related revenue. For example, when using the direct write-off method, a company might record sales revenue in 2014 but not record the bad debt expense until 2015. By recording the bad debts expense in a different year than when the revenue was recorded, the company is overstating net income in 2014 and understating net income in 2015. In addition, on the balance sheet in 2014, Receivable will be overstated because the company will have some receivables that will be uncollectible but are not yet written off. This method is only acceptable for companies that have very few uncollectible receivables. Most companies must use a method that does a better job of matching expenses to the associated sales revenue. This method is called the allowance method, and it is the method required by GAAP.

> Try It! Williams Company uses the direct write-off method to account for uncollectible receivables. On July 18, Williams wrote off a $6,800 account receivable from customer W. Jennings. On August 24, Williams unexpectedly received full payment from Jennings on the previously written off account. 3. Journalize Williams write-off on the uncollectible receivable. 4. Journalize Williams collection of the previously written off receivable. Check your answers at the end of the chapter. For more practice, see Short Exercises S-3 and S-4. MyAccountingab HOW ARE UNCOECTIBES ACCOUNTED FOR WHEN USING THE AOWANCE METHOD? Most companies use the allowance method to measure bad debts. The allowance method is based on the matching principle; thus, the key concept is to record bad debts expense in the same period as the sales revenue. The offset to the expense is a contra account called or the Allowance for Doubtful. The allowance account reduces accounts receivable. The business does not wait to see which customers will not pay. Instead, it records a bad debts expense based on estimates developed from past experience and uses the to hold the pool of unknown uncollectible accounts. Recording Allowance Method When using the allowance method, companies estimate bad debts expense at the end of the period and then record an adjusting entry. Suppose that as of December 31, 2015, Smart Touch earning estimates that $80 of its $4,400 accounts receivable are uncollectible. The accounting clerk will record the following adjusting entry: earning Objective 3 Apply the allowance method for uncollectibles and estimate bad debts expense based on the percentof-sales, percent-of-receivables, and aging-of-receivables methods Allowance Method A method of accounting for uncollectible receivables in which the company estimates bad debts expense instead of waiting to see which customers the company will not collect from. A contra account, related to accounts receivable, that holds the estimated amount of uncollectible accounts. 2015 Dec. 31 and Explanation 80 80 A Allowance for Bad Debts E Bad Debts Expense Recorded bad debts expense for the period. After posting the adjusting entry, Smart Touch earning has the following balances in its accounts: Receivable Dec. 31 4,400 80 Dec. 31 Dec. 31 80

Net Realizable Value The net value a company expects to collect from its accounts receivable. Receivable less Allowance for Bad Debts. Receivable will be reported on the balance sheet, but it will now be shown at the net realizable value. Net realizable value is the net value the company expects to collect from its accounts receivable ( Receivable less ). Smart Touch earning would report the following on its balance sheet: SMART TOUCH EARNING Balance Sheet (Partial) December 31, 2015 Assets Under IFRS, receivables are recognized and reported similarly to what is required by GAAP. Receivable must be reported at Net Realizable Value and the allowance method is used to accomplish the matching of bad debt expense to the sales of the period and to report receivables at net. Under IFRS, the Allowance for Bad Debts may be called the Provision for Bad Debts. IFRS provides more detailed criteria than GAAP for determining when an account is uncollectible. Current Assets: Receivable ess: $ 4,400 (80) $ 4,320 The balance sheet now reports the amount of accounts receivable that Smart Touch earning expects to collect, $4,320. The contra account,, is subtracted from Receivable showing that although $4,400 is owed to Smart Touch earning, the company estimates that $80 of accounts receivable will be uncollectible. Should the uncollectible accounts be > Ethics underestimated? Norah Wang is in the process of recording adjusting entries for her employer, Happy Kennels. She is evaluating the uncollectible accounts and determining the amount of bad debts expense to record for the year. Her manager, Gillian Tedesco, has asked that Norah underestimate the amount of uncollectible accounts for the year. Gillian is hoping to get a bank loan for an expansion of the kennel facility, and she is concerned that the net income of the company will be too low for a loan to be approved. What should Norah do? Solution It is important that accounts receivable be reported at the appropriate amount on the balance sheet. This involves determining an accurate estimate of uncollectible accounts and recognizing the associated bad debts expense. In understating the amount of uncollectible accounts, Norah would be misleading the bank on the amount of cash that Happy Kennels expects to collect in the future. Why isn t Bad Debts < Expense debited when writing off an account receivable when using the allowance method? Writing Off Uncollectible Allowance Method When using the allowance method, companies still write off accounts receivable that are uncollectible. However, instead of recording a debit to (as done when using the direct write-off method), the company will record a debit to. is not debited when a company writes off an account receivable when using the allowance method because the company has already recorded the Bad Debt Expense as an adjusting entry. The entry to write off an account under the allowance method has no affect on net income at the time of entry.

For example, on January 10, 2016, Smart Touch earning determines that it cannot collect a total of $ from its customer, Shawn Callahan. The accounting clerk would record the following entry to write off the account: 2016 Jan. 10 and Explanation Receivable Callahan Wrote off an uncollectible account. A E Allowance for Bad Debts Receivable Smart Touch earning s account balances after the write-off are: Receivable Jan. 1, 2016 4,400 Jan. 10, 2016 Bal. 4,375 80 Jan. 1, 2016 Jan. 10, 2016 55 Bal. The entry to write off a receivable reduces the amount of the Allowance for Bad Debts account and also the Receivable account, but it does not affect the net realizable value shown on the balance sheet. This is because both Allowance for Bad Debts (contra-asset) and Receivable (asset) were reduced by the amount of the write-off. In addition, the write-off of a receivable does not affect net income because the entry does not involve revenue or expenses. Receivable ess: Net Realizable Value Before Write-Off $ 4,400 (80) After Write-Off $ 4,375 (55) $ 4,320 $ 4,320 Recovery of Previously Written Off Allowance Method After a company has previously written off an account, the company stops attempting to collect on the receivable. Customers will occasionally make payment on receivables that have already been written off. A business will need to reverse the write-off to the account and then record the receipt of cash. In reversing the write-off, the business is re-establishing the receivable account and reversing the writeoff from the account. Recall that Smart Touch earning wrote off the $ receivable from customer Shawn Callahan on January 10, 2016. It is now March 4, 2016, and Smart Touch

earning unexpectedly receives $ cash from Callahan. The entries to reverse the write-off and record the receipt of cash are as follows: A E and Explanation Receivable Allowance for Bad Debts Mar. 4 Receivable Callahan Reinstated previously written off account. A E Cash Receivable 4 Cash Receivable Callahan Collected cash on account. Estimating and Recording Allowance Method How do companies determine the amount of bad debts expense when using the allowance method? Companies use their past experience as well as considering the economy, the industry they operate in, and other variables. In short, they make an educated guess, called an estimate. There are three basic ways to estimate uncollectibles: Percent-of-Sales Method A method of estimating uncollectible receivables that calculates bad debts expense based on a percentage of net credit sales. Percent-of-Sales Method The percent-of-sales method computes bad debts expense as a percentage of net credit sales. (Some companies will use all sales not just credit sales.) This method is also called the income-statement approach because it focuses on the amount of expense that is reported on the income statement. et s return to Smart Touch earning. Based on prior experience, the company s bad debts expense is normally 0.5% of net credit sales, which totaled $60,000 for the year. The accountant calculates bad debt expense using the percent-of-sales method as follows: Percent-of-Sales Method: Net credit sales % When using the allowance method, the only time Bad Debts Expense is recorded is as an adjusting entry. $60,000 0.005 $300 At December 31, Smart Touch earning records the following adjusting entry to recognize bad debts expense for the year: A E and Explanation Allowance for Bad Debts Bad Debts Expense 2016 Dec. 31 300 300 Recorded bad debts expense for the period.