Cash, Accounts Receivable, and Bad Debts Expense

1
Chapter 7

• Cash, Accounts Receivable, and Bad Debts Expense

Thought for the day, Keep your friends healthy!
Dont lend money, it causes amnesia.
2
In Chapter 6

• You learned
• How to Calculate the cost of Inventory and Cost
  of Goods Sold
• Using the four inventory cost flow assumptions
• FIFO
• LIFO
• Average Cost
• Specific Identification

3
In Chapter 7

• You will learn how to record and account for
• Cash
• Receivables
• Bad Debts

4
Extending Credit
Accounts Receivable is a Current Asset
Its balance represents the amounts owed by
customers for goods or services they have already
received
Stop Billing
Start Billing
Balance due from Customers
5
Just because the balance in Accounts Receivable
is 60,000
Doesnt Mean well collect all 60,000
Our customers may be unwilling or unable to pay
the amount due.
6
Allowance for Uncollectible Accounts is a
Contra-Asset Account
Its purpose is to reduce Accounts Receivable
Assets are reduced with credits
7
in a way that preserves the original information
We continue to bill the entire 60,000
Experience tells us that 5,000 will probably not
be collected.
8
What are the A/Rs really worth?
Balance Sheet Presentation
Accounts Receivable
60,000
Less Allowance for Uncollectible Accounts (
5,000)
Net Realizable Value
55,000
Of which we expect to write-off 5,000
And ultimately realize 55,000
Customers owe us 60,000
9
As learned in Chapter 4, the Revenue Recognition
Principle.

• Requires that revenues be recorded in the time
  period when the work is performed, and the
  earnings process is complete.

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Matching Principle

• Requires that expenses be recorded in the same
  time period as the revenues they helped generate.
• Governs the Timing of Expenses

(COOK the BOOKS!)
11
Bad Debts Expense needs to be recorded in the
same time period as the sale
Revenue Recognition Principle
Matching Principle
Bad Debts Expense
12
The Adjusting Entry to record Bad Debts
Bad Debts Expense
Allowance for Uncollectible Accounts
Is an end of period adjusting entry. As such, it
affects one Income Statement Account, Bad Debts
Expense And one Balance Sheet Account, Allowance
for Uncollectible Accounts. Is required by the
Matching Principle Is an ESTIMATED amount
13
Impact of estimate on T accounts
Bad Debts Expense
Allowance for Uncollectible Accounts
Reduces Income
Reduces Assets
14
The Journal Entry to Write-off a customers
account receivable
Allowance for Uncollectible Accounts
Accounts Receivable
Occurs when the account is deemed
uncollectible Only Affects Balance Sheet
Accounts Accounts Receivable
and Allowance
for Uncollectible Accounts. Leaves Net Income,
and the Net Realizable Value of Accounts
Receivable UNCHANGED
15
Impact of write-offs on T accounts
Allowance for Uncollectible Accounts
Accounts Receivable
This is an advantage of the allowance method.
Write-offs do NOT affect income, even if recorded
in a subsequent period.
No Impact
Net A/R is unchanged
No Impact on Income
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The Journal Entry to reinstate a receivable that
had been previously been written off.
Accounts Receivable
Allowance for Uncollectible Accounts
Writes the account back ON Only Affects Balance
Sheet Accounts Accounts
Receivable and
Allowance for Uncollectible Accounts. Leaves Net
Income, and the Net Realizable Value of Accounts
Receivable UNCHANGED Journal Entry for the
collection of account is a debit to cash and a
credit to Accounts Receivable
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Balance Sheet Approach
Focuses on two Balance Sheet Accounts,
Accounts Receivable and Allowance for
Uncollectible Accounts The balance in Accounts
Receivable is the Starting Point The estimate is
either a fixed percentage of Accounts Receivable,
or a Series of percentages, based on the age of
the Receivables. The older the Receivable, the
greater the chance that it is UNCOLLECTIBLE
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Aging of Accounts Receivable

• Lets assume the following balances
• Year 1
• Accounts Receivable 42,550
• Allowance for Uncollectible Accounts 0
• Year 2
• Accounts Receivable 50,000
• Allowance for Uncollectible Accounts 78 credit

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Aging of Accounts Receivable
Total Accounts Receivable are distributed by age
40,600
42,550
20
Aging of Accounts Receivable Thought for the day,
Keep your friends healthy! Dont lend money, it
causes amnesia.
The uncollectible amount is then estimated based
on the receivables in each age category The older
the receivable, the higher the uncollectible
percentage
Total 2,078
Total
42,550
X

21
Balance Sheet Approach Year 1
To Calculate the Amount of Bad Debts Expense
1) Calculate the Desired Ending Credit Balance
in Allowance for Uncollectible Accounts
2,078
0
2) Compare to the existing Balance in Allowance
for Uncollectible Accounts
3) Prepare a Journal Entry for the Difference!
2,078
Bad Debts Expense
2,078
The Balance in the Allowance Account is Zero in
Year 1 Only
From Aging Schedule
2,078
Allowance for Uncollectible Accounts
0
2,078
2,078
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T accounts Year 1
To Balance Sheet
12-31-06
0
42,550
Unadjusted
2,078
Estimate
2,078
Estimate
To Income Statement
Adjusted
2,078
2,078
Adjusted
Notice that the ENDING Balance Calculation from
Aging Schedule
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Balance Sheet Approach Year 2
To Calculate the Amount of Bad Debts Expense
1) Calculate the Desired Ending Credit Balance
in Allowance for Uncollectible Accounts
2,500
78 Credit
2) Compare to the existing Balance in Allowance
for Uncollectible Accounts
3) Prepare a Journal Entry for the Difference!
2,422
Bad Debts Expense
2,422
Beginning 2,078 less 2,000 write-offs in Year 2
Assume a New Aging Schedule is prepared for 2007
Allowance for Uncollectible Accounts
2,422
78
2,422
2,500
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T accounts Year 2
42,550
2,078
Closed 12-31-06
1-1-07
1-1-07
0
To Balance Sheet
Sales
100,000
2,000
Write-offs
2,000
Write-offs
90,550
Collections
50,000
Unadjusted
Unadjusted
78
Estimate
2,422
To Income Statement
2,422
Estimate
Adjusted
2,422
2,500
Adjusted
Notice that the ENDING Balance Calculation from
Aging Schedule
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Income Statement Approach The estimate is a
percentage of Sales
Focuses on two Income Statement Accounts,
Sales and
Bad Debts
Expense The balance in Sales is the Starting
Point The estimate is a
percentage of Sales
This is a VERY easy method!
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Income Statement Approach Bad Debts are
estimated to be 5 of Sales of 100,000
To Calculate the Amount of Bad Debts Expense
1) Calculate the Desired Ending Debit Balance in
Bad Debts Expense
5,000
0
2) Compare to the existing Balance in Bad Debts
Expense
3) Prepare a Journal Entry for the Difference!
5,000
Bad Debts Expense
5,000
Expenses are closed at year-end. Unadjusted
Balance will always be 0
100,000 X 5 5,000
Allowance for Uncollectible Accounts
5,000
0
5,000
5,000
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T accounts Estimate Bad Debts 5 of 100,000
Sales
42,550
2,078
Closed 12-31-06
1-1-07
1-1-07
0
To Balance Sheet
Sales
2,000
100,000
Write-offs
2,000
Write-offs
90,550
Collections
50,000
Unadjusted
Unadjusted
78
Estimate
5,000
To Income Statement
5,000
Estimate
Adjusted
5,000
5,078
Adjusted
Notice that the ENDING Balance 5 of Sales.
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Comparing the Two Methods..
To Calculate the Amount of Bad Debts Expense
Focus on Balance Sheet
Focus on Income Statement
of Receivables Method
of Sales Method
Bad Debts Expense
Allowance for Uncollectible Accounts
1) Calculate the Desired Ending Balance in
Balance will be Zero. Expenses are closed at the
end of each year.
2) Compare to the Existing Balance
Balance may be either a debit (if previous
estimate was too low), or a credit (if previous
estimate was too high)
3) Prepare a journal entry for the difference.
Calculation or - existing balance in the
Allowance account
Calculation - 0 Bad Debts Expense Calculation!
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Direct write-off method- rarely used
There must be an easier way!
Bad Debts Expense is recorded at the time of the
write-off
It doesnt use Estimates, or an Allowance account.
Which is fine if your Write-offs are an
immaterial amount, but
Theres the Direct Write-off Method
GAAP
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Notes Receivable
Promissory Notes are written promises to pay a
specific amount, at a specific point in time. The
person or firm making the promise to pay is
called the Maker. The person or firm receiving
the amount is called the Payee.
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The Journal Entry to record Receipt of a Note
Receivable in Settlement of an Account Receivable
A/R Balance
Notes Receivable
5,000
A/R Balance
Accounts Receivable
5,000
Suppose that on May 1, Proctor and Gamble allowed
Pops Grocery to renegotiate an overdue account
by issuing a 5,000 note, due in 90 days, at an
interest rate of 8
The balance owed on the Account Receivable
Becomes the Principal of the Note Receivable
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Calculating Interest on a Note Receivable
Formula for Interest Interest Principal x
Rate x Time
Time is expressed as Fraction of Year
Balance in Notes Receivable
Always expressed as an Annual rate
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Interest on the Pops Grocery 5,000, 8, 90-day
Note
Interest Principal x Rate x Time
X 90/360
98.63
5,000
x .08
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The Journal Entry to Record Collection of Note
Plus Interest
5,098.63
Cash
Principal Interest
5,000.00
Notes Receivable
Principal
Interest Revenue
98.63
Interest
5,098.63 5,000 Principal 90 days interest _at_
8
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Controlling Cash
Cash is often the target of misappropriations. A
key control of cash is Segregation of Duties A
properly designed system of internal controls
decreases both Errors and Fraud A crucial part of
controlling cash is the timely preparation of a
Bank Reconciliation
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Reconciling the Cash Account

• Start with the balance on the monthly bank
  Statement. This is called the Balance per Bank

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Format for Bank Reconciliation
Subtract Items Subtracted by the Bank but not
yet subtracted by the company
Equals Adjusted Book Balance. This is the True
Cash Balance
Add or Subtract Corrections of Bank Errors
Add or Subtract Corrections of Firms errors
Subtract Items Subtracted by the Firm but not
yet subtracted by the Bank
Equals Adjusted Bank Balance This is the True
Cash Balance
Now Lets Begin with the Book Portion of the bank
Reconciliation
Add Items Added by the Bank but not yet added
by the company
Add Items Added by the Firm but not yet added
by the Bank
Start with the balance on the monthly bank
Statement. This is called the Balance per Bank
12,000
From Bank Statement
Balance per Bank
Cash Balance per General Ledger
12,490
Deposits in Transit
4,200
Collections made by the bank on the firms
behalf
3,475
- Outstanding Checks
(1,600)
Interest Earned
25
- Service Charges
(100)
(210)
- Customer NSF checks
or - Bank Errors
90
or - Firm Errors
( 10)
15,180
True Cash Balance
True Cash Balance
15,180