Accounts Receivable

Front 1

Allowance for doubtful accounts ("AFDA")

Back 1

A reduction of the total amount of AR appearing on a company’s balance sheet, and is listed as a deduction immediately below the AR line item. This deduction is classified as a conta asset account.

A change to the balance also affects bad debt expense on the income statement.

The allowance presents a more realistic picture of how much of the AR will be turning to cash.

Front 2

Direct Write Off Method

Back 2

involves charging bad debts to expense in the period when individual invoices have been clearly identified as bad debts. The method does not involve a reduction in the amount of recorded sales, only the increase of the bad debt expense.

*This is NOT GAAP

Ex: For example, a business records a sale on credit of $10K, and records it with a debit to AR and a credit to Sales. After 3 months, the customer is only able to pay $8K of the open balance, so the seller must write off $2K. It does so with a $2K credit to AR and an offsetting debit to bad debt expense. Thus, the revenue amount remains the same, the remaining receivable is eliminated, and an expense is created in the amount of the bad debt.

Front 3

Bad debt

Back 3

Bad debt is AR that will not be collected. It is reported on the income statement as Bad Debts Expense .

Under accrual based accounting, if a buyer does not pay the amount it owes, the seller will report:

1. A bad debts expense on its income statement, and
2. A reduction of AR on its balance sheet.

The seller should report its estimated credit losses as soon as possible using the allowance method. For income tax purposes, however, losses are reported at a later date through the use of the direct write-off method.

Front 4

AR Aging Report

Back 4

All outstanding AR balances are compiled into the AR aging, which is typically structured to show invoices that are current, overdue by 0 to 30 days, by 31 to 60 days, 61 to 90 days, or 90+ days.

This report is used to derive the allowance for bad debts.

Front 5

Accounts Receivable ("AR")

Back 5

Accounts receivable ("AR") results from sales on credit and is the money that a company has a right to receive because it had provided customers with goods and/or services. It is recorded as a current asset on the balance sheet.

Under the accrual basis of accounting a sale on credit will:

1. Increase sales, which is reported on the income statement, and
2. Increase the amount due from customers, which is reported as AR—an asset on the balance sheet.

Front 6

Days Sales Outstanding ("DSO")

Back 6

DSO = AR/(Revenue/days in period)

measures the number of days it takes a company to collect cash from its credit sales. This calculation shows the liquidity and efficiency of a company's collections department.

Front 7

Allowance Method

Back 7

Under the allowance method, if a specific customer's AR is identified as uncollectible, it is written off by removing the amount from AR. The entry to write off a bad account affects only balance sheet accounts: a debit to Allowance for Doubtful Accounts and a credit to AR. No expense or loss is reported on the income statement because this write-off is "covered" under the earlier adjusting entries for estimated bad debts expense.

** This method is GAAP and follows the matching principle