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Topic 6

Topic 6. Accounting for Accounts Receivable. Learning Objectives. Define the term accounts receivable. Understand why the firms sell on credit. Define the term bad debts. Understand how bad debts arise. Define the term doubtful debts.

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Topic 6

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  1. Topic 6 Accounting for Accounts Receivable

  2. Learning Objectives • Define the term accounts receivable. • Understand why the firms sell on credit. • Define the term bad debts. • Understand how bad debts arise. • Define the term doubtful debts. • Define and use different methods of estimating the amount of doubtful debts.

  3. Learning Objectives (cont’d) • Understand the use of the ageing of accounts. • Define and use the provision for doubtful debts. • Understand why the direct-off method is less preferable than other methods. • Account for the recovery of bad debts.

  4. Definition of accounts receivable • Claims against customers or buyers for goods or services, which have been sold or provided to them on credit.

  5. The need for selling on credit • To increase the volume of sales of a business. • To compete with other businesses in the same sector. • To increase the purchasing power of customers.

  6. 3 phases of credit sale Inventory Dr Accounts Receivable xxx Cr Sale xxx (To record credit sales.) sold Accounts Receivable Dr Cash xxx Cr Accounts Receivable xxx (To record cash collection from customer.) collected Cash

  7. Bad Debts Expense and Direct Write-Off Method • The amount of debt which is proven to be uncollectible. • Under the direct write-off method, the debt which is written off as bad must occur in the same period or year as the credit sale was made, the record will be as follows: Dr Bad Debts Expense xxx Cr A/c Receivable xxx (To write off debtors accounts proven to be bad.)

  8. Bad Debts Expense and Direct Write-Off Method (cont’d) • Closing journal entry at the end of accounting period: Dr Profit & Loss Summary xxx Cr Bad Debts Expense xxx (To transfer bad debts expense to profit and loss.)

  9. Doubtful Debt Expense and Allowance Method Two methods of estimating doubtful debts: • Percentage of net sales method • Percentage of accounts receivable method

  10. Percentage of Net Sales Method • Also known as income statement approach. • Procedures to apply the method: • The percentage of uncollectible amount to credit sales of several years are used as the basis. • Based on the rates experienced in the previous years, a decision is made as to the appropriate rate to be used for the current year.

  11. Percentage of Net Sales Method (cont’d) III. The total credit sales amount for the current year is first determined. • Based on the total credit sales, the percentage that has been decided is used to estimate the doubtful debts for the current year. • An adjusting entry is made at the end of the financial year in the general journal by: With this entry, the doubtful debt expense is matched against the sales in the same year, and in compliance with the matching principle Dr Doubtful Debts Expense A/c xxx Cr Provision/Allowance for Doubtful Debts xxx (To record doubtful debts expense.)

  12. Percentage of Net Sales Method (cont’d) vi. When it is known that a particular debtor is unable to settle his debts (doubtful debt), • Example: Uncollectible YearSalesAmount% 2004 100,000 2,000 2.0 2005 110,000 2,600 2.4 2006 140,000 2,500 1.8 2007 120,000 ? ? Dr Provision for Doubtful Debts xxx Cr A/c Receivable, ABC xxx (To record the written-off of doubtful debts.)

  13. Percentage of Net Sales Method (cont’d) • Based on the above scenario, 2% of sales might be used as the estimate of doubtful debts for the following year, in this case, 2007 because this rate is an average rate for the last 3 years. • Therefore, the doubtful debts for the year ended 31 December 2007, assuming the total net sales of RM120,000 for the year: 2% x 120,000 = RM2,400 • The journal entry: 2007 Dec 31 Dr Doubtful Debts Expense A/c 2,400 Cr Provision for Doubtful Debts A/c 2,400 (To record doubtful debt estimated @ 2% x RM120,000)

  14. Percentage of Net Sales Method (cont’d) • The accounts in general ledger: Doubtful Debts Expense Provision for Doubtful Debts

  15. Percentage of Net Sales Method (cont’d) • Financial reporting: Doubtful Debts Expense of RM2,400 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,400 will be reported in the Balance Sheet as follows: Balance Sheet (extract) as at 31 December 2007 Asset A/c Receivable xxxxx Less: Provision for Doubtful Debts 2,400 xxxxx

  16. Percentage of Net Sales Method (cont’d) • In the case that the Provision for Doubtful Debts A/c has a credit balance of RM400 after deducting bad debts of RM2,100 from RM2,500, the new credit balance of the account as at 31 December 2007 is RM400 + RM2,400 = RM2,800. • Journal entry: 2007 Dec 31 Dr Doubtful Debts Expense 2,400 Cr Provision for Doubtful Debts 2,400 (To record doubtful debts expense for for the year.)

  17. Percentage of Net Sales Method (cont’d) • The account in general ledger: Dr Provision for Doubtful Debts A/c Cr 2007 2007 Mar 1 A/c Receivable 2,100 Jan 1 Balance b/f 2,500 Dec 31 Balance c/f 2,800 Dec 31 Doubtful Debts Exp 2,400 4,900 4,900 === === 2008 Jan 1 Balance b/f 2,800

  18. Percentage of Net Sales Method (cont’d) • Financial Reporting: Doubtful Debts Expense of RM2,400 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,800 will be reported in the Balance Sheet as follows: Balance Sheet (extract) as at 31 Dec 2007 Assets A/c Receivable xxxxx Less: Provision for Doubtful Debts 2,800 xxxxx

  19. Percentage of Net Sales Method (cont’d) • In the case that the Provision for Doubtful Debts A/c has a debit balance of RM100 after deducting bad debts of RM2,600 from RM2,500, the new credit balance of the account as at 31 December 2007 is RM2,400 – RM100 = RM2,300. • Journal entry: 2007 Dec 31 Dr Doubtful Debts Expense 2,400 Cr Provision for Doubtful Debts 2,400 (To record doubtful debts expense for the year.)

  20. Percentage of Net Sales Method (cont’d) • The account in general ledger: Dr Provision for Doubtful Debts A/c Cr 2007 2007 Mar 1 A/c Receivable 2,600 Jan 1 Balance b/f 2,500 Dec 31 Balance c/f 2,300 Dec 31 Doubtful Debts Exp 2,400 4,900 4,900 === === 2008 Jan 1 Balance b/f 2,300

  21. Percentage of Net Sales Method (cont’d) • Financial Reporting: Doubtful Debts Expense of RM2,400 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,300 will be reported in the Balance Sheet as follows: Balance Sheet (extract) as at 31 Dec 2007 Assets A/c Receivable xxxxx Less: Provision for Doubtful Debts 2,300 xxxxx

  22. Percentage of Accounts Receivable • Also known as the accounts receivable ageing approach or the balance sheet approach. • Procedures to apply the method: • Accounts receivable are grouped according to age. • For each group, an estimate is made using a certain percentage based on experience to show the possibility of debts not being settled from the group. • Lastly, the amounts that are assumed not to be recoverable for all the age groups are added together to get the total of the amount which is not recoverable.

  23. Percentage of Accounts Receivable (cont’d) Accounts Receivable Ageing Schedule (extract) 31 December 2007

  24. Percentage of Accounts Receivable (cont’d) Estimate of Doubtful Debts 31 December 2007

  25. Percentage of Accounts Receivable (cont’d) • Journal entry: • Financial reporting: Doubtful Debts Expense of RM2,837 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,837 will be reported in the balance sheet as follows: Balance Sheet (extract) as at 31.12.2007 Assets RM A/c Receivable 120,000 Less: Provision for Doubtful Debts 2,837 117,163 2007 Dec 31 Dr Doubtful Debts Expense 2,837 Cr Provision for Doubtful Debts 2,837 (To record the doubtful debt expense for 2007)

  26. Percentage of Accounts Receivable (cont’d) • In the case that the provision for doubtful debts account has a credit balance of RM2,593, RM244 (doubtful debts expense) is needed to increase the amount of provision to RM2,837. • Journal entry: 2007 Dec 31 Dr Doubtful Debts Expense 244 Cr Provision for Doubtful Debts 244 (To record doubtful debts expense for the year.)

  27. Percentage of Accounts Receivable (cont’d) • The account in general ledger: Dr Provision for Doubtful Debts A/c Cr 2007 2007 Dec 31 Balance c/f 2,837 Jan 1 Balance b/f 2,593 _____ Dec 31 Doubtful Debts Exp 244 2,837 2,837 === === 2008 Jan 1 Balance b/f 2,837

  28. Percentage of Accounts Receivable (cont’d) • Financial reporting: Doubtful debts expense of RM244 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,837 will be reported in the Balance Sheet.

  29. Percentage of Accounts Receivable (cont’d) • In the case that the provision for doubtful debts account has a debit balance of RM600 after deducting bad debts of RM3,193 from RM2,593, RM3,437 (doubtful debts expense) is needed to increase the amount of provision to RM2,837. • Journal entry: 2007 Dec 31 Dr Doubtful Debts Expense 3,437 Cr Provision for Doubtful Debts 3,437 (To record doubtful debts expense for the year.)

  30. Percentage of Accounts Receivable (cont’d) • The account in general ledger: Dr Provision for Doubtful Debts A/c Cr 2007 2007 Mar 1 A/c Receivable 3,193 Jan 1 Balance b/f 2,593 Dec 31 Balance c/f 2,837 Dec 31 Doubtful Debts Exp 3,437 6,030 6,030 === === 2008 Jan 1 Balance b/f 2,837

  31. Percentage of Accounts Receivable (cont’d) • Financial reporting: Doubtful Debts Expense of RM3,437 will be reported in the Income Statement, and Provision for Doubtful Debts of RM2,837 will be reported in the Balance Sheet.

  32. Recovery of Bad Debts • Direct write off method: Dr Bad Debts Expense (to be closed to P & L A/c) XXX Cr A/c Receivable, XYZ XXX (To write off XYZ’s debts which cannot be collected.) Dr A/c Receivable, XYZ XXX Cr Bad Debts Recovered (to be closed to P & L A/c) XXX (To recover XYZ’s debts which had been written off.) Dr Cash/Bank XXX Cr A/c Receivable XXX (To record the full receipt settlement by XYZ.)

  33. Recovery of Bad Debts • Allowance method: Dr Provision for Doubtful Debts XXX Cr A/c Receivable, XYZ XXX (To write off XYZ’s debts that cannot be collected.) Dr A/c Receivable, XYZ XXX Cr Provision for Doubtful Debts XXX (To recover XYZ’s debts which had been written off.) Dr Cash/Bank XXX Cr A/c Receivable, XYZ XXX (To record the full receipt settlement by XYZ.)

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