Income Recognition At The Time Of Sale Ch. 7

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Accounts Receivables (Trade Receivables)

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is the amount owed to a seller by customers who have purchased goods and services on credit. Typically short time to collection of cash. It is a current asset. receivables greater than one year are a noncurrent asset.

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Uncollectable account

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A receivable that the seller never collects. A cost-benefit analysis of credit policy should dictate a strategy that results in uncollectable accounts of an amount that is reasonably predictable before the firm makes any sales.

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Two account issues for Accounts receivable are

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1. measurement of the amount on the balance sheet.
2. timing of recognition of the reduction in income caused by the uncollectability of some accounts.

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Measurement for balance sheet Accounts Receivable

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GAAP and IFRS require that sellers report accounts receivable net of the estimated uncollectable amount. The amount expected for collection.

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Timing of recognition for accounts receivable.

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GAAP and IFRS require that seller recognize expense for estimated uncollectable accounts receivable in the same period when it recognizes related revenue.

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Allowance Method for Uncollectable Accounts

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Estimates the amount of uncollectable accounts receivable associated with each accounting periods credit sales. The firm recognizes the estimated amount as an expense in the period of the sale matching expense with revenue.

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Contra Asset account
Allowance for Uncollectables

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Reduces total accounts receivable (Accounts Rec Gross) to the amount of cash the firm expects to collect from the customers (accounts receivable, net).

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Bad Debt Expense = Provision for Bad Debts = Provision for uncollectable accounts

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provision refers to expense not liability.

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Contra Asset Account

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appears among assets on the balance sheet as a subtraction

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Control Account
Accounts receivable gross

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It is a control account. it aggregates into a single account a group of like accounts.

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Estimating the Amount of Uncollectable Accounts.

Percentage of Sales Procedure

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Uses theory that uncollectable accounts will vary with the volume of credit business. Makes estimates based on experiencd or by comparison to similar firms. Default rates are generally 1 - 2% of credit sales.

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Estimating the Amount of Uncollectable Accounts.

Aging of Accounts Procedure

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1. Estimating the amount that the firm does not expect to collect from existing accounts receivable and

2. Adjusting the balance of Allowance for Uncollectables so the the balance of acct, netted against accts receivable, reflects the amount of cash the firm expects to collect.

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Allowance Method for of accounting for Uncollectible Accounts

Step 1

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1. Sale of Goods on credit
Accts Rec, gross (Deb)
Saels Rev (cred)

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Allowance Method for of accounting for Uncollectible Accounts

Step 2

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2. Collection of Cash from Customers
Cash (deb)
Accts Rec (gross) credit

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Allowance Method for of accounting for Uncollectible Accounts

Step 3

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3. Estimate of Uncollectable Accounts
Bad Debt Expense (deb)
Allowance for Uncollectables (cred)

The % of sales method estimates teh amount of bad debt expense with offsetting credit being the alllowance for uncollectibles. The aging of accounts rec. approach extimates the ending balance in the allowance for uncollectibles.

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Allowance Method for of accounting for Uncollectible Accounts

Step 4

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4. Write Off of uncollectable amounts using the allowance method.

allowance for uncollectables (deb)
Accounts rec (gross)

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Financial Statement Presentation for accounts receivable

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acc rec appear on the balance sheet at the amt the firm expects to collect. this net amt is the grss amt or rec - the amt in the allowance for uncollectables.

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Formula for ending balance accts rec gross

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Accts Rec Gross = Accounts Receivable Net + Allowance for Uncollectables

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Cash Collected from Credit Customers

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Ending Balance = Beginning Balance +New Credit Sales - Write Offs - Cash collected from credit customers

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Financial Ratios Involving Accts Rec

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accts rec turnover ratio, days receivable outstanding, write off percentage.

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Accts receivable turnover ratio

Days Receivable Outstanding

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captures the speed of cash collections from credit customers.

Sales Revenue/Average Accounts Receivable

DRO = average number of days between a credit sale and a cash collection.

DRO 365 days/accounts rec turnover ratio

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Bad Debt Expense/Sales Revenue Ratio

Allowance for Uncollectables/Accounts Receivable, Gross

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Ratios used to evaluate the allowance for uncollectibles.