Accounts Receivable

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Accounts Receivable
Generally, two major issues

• How to Record Sales Discounts
• How to Record Doubtful Receipts

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Accounts Receivable
Discounts
The most prevalent is the cash discount for early
payment on the account.
Example 2/10, n/30
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Accounts Receivable
Discounts
The most prevalent is the cash discount for early
payment on the account.
Example 2/10, n/30
2 discount if paid within 10 days
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Accounts Receivable
Discounts
The most prevalent is the cash discount for early
payment on the account.
Example 2/10, n/30
Net amount due in 30 days.
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Accounts Receivable
Discounts
Two methods to record the discount

• Gross Method record primary sale at gross amount

Usually for firms whose clients generally dont
take advantage of the discounts

• Net Method record primary sale at
  net-of-discount amount

Usually for firms whose clients generally take
advantage of the discounts
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Accounts Receivable
Discounts
Example Jan 1st, sell 10,000 of product under
2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000 Sales 10,000
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Accounts Receivable
Discounts
Example Jan 1st, sell 10,000 of product under
2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000 Sales 10,000
Recorded as if discount wont be taken
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Accounts Receivable
Discounts
Example Jan 1st, sell 10,000 of product under
2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000 Sales 10,000
Net Method
Jan 1 Accts Rec 9,800 Sales 9,800
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Accounts Receivable
Discounts
Example Jan 1st, sell 10,000 of product under
2/10, n/30 terms.
Gross Method
Jan 1 Accts Rec 10,000 Sales 10,000
Net Method
Jan 1 Accts Rec 9,800 Sales 9,800
Recorded as if discount will be taken
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Accounts Receivable
Discounts
Example Jan 9th, receive payment within
discount period
Gross Method
Jan 9 Cash 9,800 Sales Discs 200 Accts
Rec 10,000
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Accounts Receivable
Discounts
Example Jan 9th, receive payment within
discount period
Gross Method
Jan 9 Cash 9,800 Sales Discs 200 Accts
Rec 10,000
If the discount is actually realized, it is
recorded upon receipt of the cash payment. Sales
Discounts is a contra-revenue account.
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Accounts Receivable
Discounts
Example Jan 9th, receive payment within
discount period
Gross Method
Jan 9 Cash 9,800 Sales Discs 200 Accts
Rec 10,000
Net Method
Jan 9 Cash 9,800 Accts Rec 9,800
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Accounts Receivable
Discounts
Example Jan 9th, receive payment within
discount period
Gross Method
Jan 9 Cash 9,800 Sales Discs 200 Accts
Rec 10,000
Net Method
Jan 9 Cash 9,800 Accts Rec 9,800
Discount has already been recorded on sales date.
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Accounts Receivable
Discounts
Example Jan 29th, receive payment outside
discount period
Now assume instead that the payment was sent
after the discount period expired.
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Accounts Receivable
Discounts
Example Jan 29th, receive payment outside
discount period
Gross Method
Jan 29 Cash 10,000 Accts Rec 10,000
No correction needed, since we already assumed
the discount would not be taken.
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Accounts Receivable
Discounts
Example Jan 29th, receive payment outside
discount period
Gross Method
Jan 29 Cash 10,000 Accts Rec 10,000
Net Method
Jan 29 Cash 10,000 Accts Rec 9,800 Forfeited
Discount 200
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Accounts Receivable
Discounts
Example Jan 29th, receive payment outside
discount period
Gross Method
Jan 29 Cash 10,000 Accts Rec 10,000
Net Method
Jan 29 Cash 10,000 Accts Rec 9,800 Forfeited
Discount 200
Record the forfeited discount (a revenue account).
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Accounts Receivable
Doubtful Receipts
All receivables have some probability of default.
The default on payment needs to be recorded
appropriately.
One method of recording default is to record a
loss when actual default occurs. This is called
the direct write-off method.
Not considered an acceptable method because it
does not match revenues with costs effectively.
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Accounts Receivable
Doubtful Receipts
The accepted method is called the Allowance
Method.
An Allowance for Doubtful Accounts is set up as a
contra-receivable account (contra-asset). It
holds managements best estimate for the amount
of receivables that will default.
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Accounts Receivable
Doubtful Receipts
To determine managements best estimate for
default, use one of two methods

• Percentage of Sales Method a fixed percentage
• of sales will be considered doubtful

This is also called the income statement
approach, since the estimate is based on a
percentage of sales revenue.

• Percentage of Receivables Method a fixed
• percentage of the receivables balance will be
• considered doubtful

This is also called the balance sheet approach,
since the estimate is based on a percentage of a
balance sheet receivable account.
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Accounts Receivable
Doubtful Receipts Percentage of Sales Method
Example Assume Paterno Corp. has 200,000 in
sales during 2000. Of these sales, 30 are in
cash and 70 are on credit. They estimate that
4 of their credit sales will not be collected.
2000 Credit Sales 0.70 x 200,000 140,000
Estimate of doubtful collections 0.04 x
140,000 5,600
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Accounts Receivable
Doubtful Receipts Percentage of Sales Method
Example Assume Paterno Corp. has 200,000 in
sales during 2000. Of these sales, 30 are in
cash and 70 are on credit. They estimate that
4 of their credit sales will not be collected.
Journal entry Bad Debt Expense 5,600 Allowanc
e for Doubtful Accts 5,600
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables Method
Most firms know that the probability of default
is based on the staleness of accounts. For
example, credit card companies recognize that the
probability of default increases in the length of
the time a credit card account remains past
due. Firms facing this scenario usually set up
aging schedules that outline their estimates for
default, based on the age of balances in
receivable accounts.
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
Based on historical data, MBNA estimates the
following default rates on its outstanding credit
card receivables
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
Assume MBNA has the following outstanding
receivables balances
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
MBNA would compute its ending balance for
Allowance for Doubtful Accounts as follows
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
MBNA would compute its ending balance for
Allowance for Doubtful Accounts as follows
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
Note that the aging schedule computes the
Allowance for Doubtful Accounts ending balance.
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
Note that the aging schedule computes the
Allowance for Doubtful Accounts ending
balance. The journal entry to record bad debt
expense is for the difference between the AFDA
beginning balance and this new ending balance.
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
AFDA
Beg Bal 375,000
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
AFDA
Beg Bal 375,000
End Bal 445,000
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
AFDA
Beg Bal 375,000
70,000
End Bal 445,000
Bad-Debt Expense
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Accounts Receivable
Doubtful Receipts-Percentage of Receivables
Method Aging Schedule
AFDA
Beg Bal 375,000
70,000
End Bal 445,000
Bad Debt Expense 70,000 Allowance for Doubtful
Accts 70,000
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Accounts Receivable
Sales Returns and Allowances
Returns and allowances are handled in the same
manner as doubtful collection. An account called
Allowance for Sales Returns is set up based on
managements best estimate for returns.