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OVERVIEW OF ACCOUNTS RECEIVABLECOLUMBIA CORE ACCOUNTING�REVIEW SESSION�ANTHONY LE�

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WHAT ARE ACCOUNTS RECEIVABLES?

  • Accounts Receivables represent the obligation of another party to pay us sometime in the future
    • We call this as making sales on “credit” – we extend “credit” to a customer and allow them to pay in the future for a good/service we’ve already provided them�
  • But, when we extend credit, there is always a risk that we never receive the amount (or a portion of the amount) if the customer cannot pay in the future�
  • Due to this risk, GAAP requires that we set up an Allowance for Doubtful Accounts(or “Allowance for Bad Debts” or “Allowance for Uncollectible Accounts,” etc.)
    • This represents a ”reserve” amount (i.e., a backup account) that we can pull out of in the scenario that our customer does not pay us
    • If it becomes true that our customer does not pay us (and will never pay us), we have to write-off the accounts receivable

  • Every year, we will estimate how many of our (new) accounts receivables from that year are uncollectible. This leads to new Bad Debt Expense

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ACCOUNTS RECEIVABLE TRANSACTIONS

(1) Transfer Goods

+ $900 in credit

Company A

Customer B

Initial Transaction (January 1, 2018)

Journal Entry:

Dr Accounts Receivable 900

Cr Sales 900

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ACCOUNTS RECEIVABLE TRANSACTIONS

Company A

Customer B

Estimating Bad Debts (December 31, 2018)

Assume that Company A had no accounts receivable prior to this year and that by the end of the year, they are estimating that 30% of the $900 (credit) sales will not be collectible.

�Journal Entry:

Dr Bad Debt Expense (30% * 900) 270

Cr Allowance for Doubtful Accounts 270

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ACCOUNTS RECEIVABLE TRANSACTIONS

Company A

Customer B

Customer B Pays a Portion (December 31, 2018)

Assume that at the end of the year, Customer B also pays Company A $550 back.

�Journal Entry:

Dr Cash 650

Cr Accounts Receivable 650

$650

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A/R ACCOUNTS OVER THE YEARS

Credit Sales

Bad Debt

Estimation

Collections

End (Total)

Cash Accounts Receivable Allowance for Doubtful Account Retained Earnings (Revenue/Bad Debt Expense)

+900

Assets Equity

+900

-270

-270

+250

-270

+630

+650

-650

+650

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ACCOUNTS RECEIVABLE TRANSACTIONS

Company A

Customer B

Write-off (December 31, 2019)

Assume that in 2019, Customer B goes bankrupt and can no longer pay company A the remainder of what they owe (i.e., the 250).

�Journal Entry:

Dr Allowance for Doubtful Accounts 250

Cr Accounts Receivable 250

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A/R ACCOUNTS OVER THE YEARS

Credit Sales

Bad Debt

Estimation

Collections

Write-Off

End (Total)

Cash Accounts Receivable Allowance for Doubtful Account Retained Earnings (Revenue/Bad Debt Expense)

+900

Assets Equity

+900

-270

-270

+0

-20

+630

+650

-650

+650

2018

2019

-250

+250

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ACCOUNTS RECEIVABLE TRANSACTIONS

Company A

Customer B

Reversal of Write-off (December 31, 2020)

In 2020, we find out that Customer B is somehow able to pay Company back $100 of what it had owed!

�Journal Entry:

Dr Accounts Receivable 100

Cr Allowance for Doubtful Accounts 100

Dr Cash 100

Cr Accounts Receivable 100

$100

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A/R ACCOUNTS OVER THE YEARS

Credit Sales

Bad Debt

Estimation

Collections

Write-Off

Reversal of

Write off

End (Total)

Cash Accounts Receivable Allowance for Doubtful Account Retained Earnings (Revenue/Bad Debt Expense)

+900

Assets Equity

+900

-270

-270

+0

-120

+630

+650

-650

+750

2018

2019

-250

+250

2020

+100

- 100

-100

+100

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ESTIMATING BAD DEBT EXPENSE

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THE BALANCE SHEET METHOD

Days

Percentage of 2021 A/R Collectible

Amount of A/R

0-30 Days

95%

4,000,000

31 – 60 Days

80%

2,000,000

61 – 90 Days

75%

3,000,000

91 – 120 Days

50%

1,000,000

The idea behind the ”balance-sheet” method is to use a percentage of accounts that are uncollectible. It is called the “balance sheet” method because it relies on the following relationship:

Ending Allowance for Doubtful Accounts = Beginning Allowance for Doubtful Accounts + Bad Debt Expense – Write-Offs

Usually, the question is asking us to solve for the Bad Debt Expense for that year. That means they usually give us the other three pieces in some way.

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THE BALANCE SHEET METHOD

Days

Percentage of 2021 A/R Collectible

Amount of A/R

0-30 Days

95%

4,000,000

31 – 60 Days

80%

2,000,000

61 – 90 Days

75%

3,000,000

91 – 120 Days

50%

1,000,000

Say that this company has $10,000,000 in (gross) accounts receivable in 2021.* They started the year (i.e., the 2020 ending balance) with $1,000,000 in allowance for doubtful accounts and had write-offs of $500,000. What is the Bad Debt Expense?

What do we know with this information?

Ending Allowance for Doubtful Accounts = Beginning Allowance for Doubtful Accounts + Bad Debt Expense Write-Offs

We can’t get at Bad Debt Expense if we don’t know the ending allowance for doubtful accounts!

*Note: We refer to Gross Accounts Receivable as just the raw amount of A/R, while Net Accounts Receivable are the Gross Accounts Receivables – Allowance for Doubtful Accounts

Hint: we’ll solve for the ending balance of allowance for doubtful accounts using this

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THE BALANCE SHEET METHOD

Days

Percentage of 2021 A/R Collectible

Amount of A/R

Percentage of 2021 A/R Uncollectible

0-30 Days

95%

4,000,000

5%

31 – 60 Days

80%

2,000,000

20%

61 – 90 Days

75%

3,000,000

25%

91 – 120 Days

50%

1,000,000

50%

This table tells us the percentage of our current accounts receivable that are collectible (and similarly, the portion that are uncollectible). Thus, once we figure out how much of our A/R are uncollectible, we’ll have Ending Allowance for Doubtful Accounts.

Therefore, the ending 2021 amount of A/R allowance for doubtful accounts should be:

Ending Allowance of Doubtful Accounts = (0.05)*4,000,000 + (0.2)*2,000,000 + (0.25)*3,000,000 + (0.5)*1,000,000 = $1,850,000

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THE BALANCE SHEET METHOD

Days

Percentage of 2021 A/R Collectible

Amount of A/R

0-30 Days

95%

4,000,000

31 – 60 Days

80%

2,000,000

61 – 90 Days

75%

3,000,000

91 – 120 Days

50%

1,000,000

What do we know now?!

Ending Allowance for Doubtful Accounts = Beginning Allowance for Doubtful Accounts + Bad Debt Expense Write-Offs

We can now sole for 2021 Bad Debt Expense:

2021 Bad Debt Expense = 1,850,000 – 1,000,000 + 500,000 = $1,350,000

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THE BALANCE SHEET METHOD

Days

Percentage of 2021 A/R Collectible

Amount of A/R

0-30 Days

95%

4,000,000

31 – 60 Days

80%

2,000,000

61 – 90 Days

75%

3,000,000

91 – 120 Days

50%

1,000,000

Lastly, to record in journal entries:

To Record BDE:

Dr Bad Debt Expense 1,350,000

Cr Allowance for Doubtful Accounts 1,350,000

To Record Write-Off:

Dr Allowance for Doubtful Accounts 500,000

Cr Accounts Receivable 500,000

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THE INCOME STATEMENT METHOD

The company’s 2021 credit sales were $3,000,000. The company estimates that the percentage of credit sales that won’t be collected is 15%.

In these questions, you directly estimate bad debt expense (in contrast to the “Balance Sheet” method where we estimate the Allowance for Doubtful Accounts first):

Bad Debt Expense = (0.15)*3,000,000 = $450,000

To record in journal entries:

To Record BDE:

Dr Bad Debt Expense 450,000

Cr Allowance for Doubtful Accounts 450,000

To Record Write-Off:

Dr Allowance for Doubtful Accounts 500,000

Cr Accounts Receivable 500,000

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