Accounts Receivable and Bad Debts Expense

Introduction

• Business Transactions on Credit:
  • Companies sell goods/services on credit, increasing potential revenue and risk of losses.
  • Credit sales increase sales revenues and accounts receivable.
• Accrual Basis Accounting:
  • Sales on credit increase sales revenues on the income statement and accounts receivable on the balance sheet.
• If Buyer Defaults:
  • Report credit loss or bad debts expense on the income statement.
  • Reduce accounts receivable on the balance sheet.
• Reporting Credit Losses:
  • Use allowance method for financial statements, direct write-off method for tax purposes.

Recording Services Provided on Credit

• Example: Malloy Design Co. provides $4,000 of services on credit.
  • Increases accounts receivable and service revenues.

Recording Sales of Goods on Credit

• Income Statement Effects:
  • Increase in sales revenues and cost of goods sold.
• Balance Sheet Effects:
  • Increase accounts receivable; decrease inventory.
• FOB Terms:
  • FOB Shipping Point: Buyer responsible for shipping costs.
  • FOB Destination: Seller responsible for shipping costs.

Credit Terms with Discounts

• Example of discount terms: 2/10, net 30.
  • Offers customers a discount for early payment.
  • Calculations of amounts due under varying credit terms.
• Costs of Discounts:
  • High discount rates can be equivalent to high annual interest rates.

Credit Risk

• Accounts receivable are unsecured claims.
• Credit risks arise if customers fail to pay.
• Thorough credit checks can mitigate risks.

Allowance Method for Reporting Credit Losses

• Allowance for Doubtful Accounts:
  • A contra asset account estimating uncollectible receivables.
• Example Adjustments:
  • Adjusting entries to reflect estimated bad debts.
• Journal Entries:
  • Debiting Bad Debts Expense and crediting Allowance for Doubtful Accounts.

Writing Off Accounts under Allowance Method

• Write-off involves balance sheet accounts only.
• Adjust Allowance for Doubtful Accounts and Accounts Receivable.

Recovery of Account under Allowance Method

• Reinstatement and processing of recovered write-off amounts.

Bad Debts Expense as a Percent of Sales

• Percentage of credit sales approach for estimating bad debts.
• Focuses on matching bad debts expense with sales revenue.

Difference between Expense and Allowance

• Bad Debts Expense: Temporary account closed annually.
• Allowance for Doubtful Accounts: Permanent account, balance carries forward.

Aging of Accounts Receivable

• Aging Report:
  • Sorts unpaid invoices by age to monitor slow-paying accounts.
  • Estimates balance needed in Allowance for Doubtful Accounts.

Pledging or Selling Accounts Receivable

• Accounts receivable can be used as collateral or sold to a factor.

Accounts Receivable Ratios

• Key Ratios:
  • Accounts receivable turnover ratio
  • Days sales in accounts receivable

Direct Write-off Method

• Used for tax reporting, not financial reporting.
• Recording only when specific receivables are known to be uncollectible.

Conclusion

• Recommended actions: Practice quizzes and exploring further materials.
• Disclaimer on topics covered and professional advice.