Accounts Receivable and Bad Debts Expense

Introduction to Accounts Receivable and Bad Debts Expense
If we imagine buying something, such as groceries, it's easy to picture ourselves standing at the checkout, writing out a personal check, and taking possession of the goods. It's a simple transaction—we exchange our money for the store's groceries. In the world of business, however, many companies must be willing to sell their goods (or services) on credit. his would be e!uivalent to the grocer transferring ownership of the groceries to you, issuing a sales invoice, and allowing you to pay for the groceries at a later date. "henever a seller decides to offer its goods or services on credit, two things happen# ($) the seller boosts its potential to increase revenues since many buyers appreciate the convenience and efficiency of making purchases on credit, and (%) the seller opens itself up to potential losses if its customers do not pay the sales invoice amount when it becomes due. &nder the accrual basis of accounting (which we will be using throughout our discussion) a sale on credit will# $. Increase sales or sales revenues, which are reported on the income statement, and %. Increase the amount due from customers, which is reported as accounts receivable —an asset reported on the balance sheet. If a buyer does not pay the amount it owes, the seller will report# $. ' credit loss or bad debts expense on its income statement, and %. ' reduction of accounts receivable on its balance sheet. "ith respect to financial statements, the seller should report its estimated credit losses as soon as possible using the allowance method. (or income tax purposes, however, losses are reported at a later date through the use of the direct write-off method.

Recording Services Provided on Credit
'ssume that on )une *, +alloy ,esign -o. provides ./,000 of graphic design service to one of its clients with credit terms of net *0 days. (1roviding services with credit terms is also referred to as providing services on account.) &nder the accrual basis of accounting, revenues are considered earned at the time when the services are provided. his means that on )une * +alloy will record the revenues it earned, even though +alloy will not receive the ./,000 until )uly. 2elow are the accounts affected on )une *, the day the service transaction was completed# Date June Account Name Accounts Receivable Service Revenues Debit !"### Credit !"###

In this transaction, the debit to 'ccounts 3eceivable increases +alloy's current assets, total assets, working capital, and stockholders' (or owner's) e!uity—all of which are reported on its balance sheet. he credit to 4ervice 3evenues will increase +alloy's revenues and net income—both of which are reported on its income statement.

Recording Sales of $oods on Credit
"hen a company sells goods on credit, it reports the transaction on both its income statement and its balance sheet. 5n the income statement, increases are reported in sales revenues, cost of goods sold, and (possibly) expenses. 5n the balance sheet, an increase is reported in accounts receivable, a decrease is reported in inventory, and a change is reported in stockholders' e!uity for the amount of the net income earned on the sale.

If the sale is made with the terms %&B S'ipping Point, the ownership of the goods is transferred at the seller's dock. If the sale is made with the terms %&B Destination, the ownership of the goods is transferred at the buyer's dock.

In principle, the seller should record the sales transaction when the ownership of the goods is transferred to the buyer. 1ractically speaking, however, accountants typically record the transaction at the time the sales invoice is prepared and the goods are shipped.
%&B S'ipping Point

6uality 1roducts -o. his transaction affects the following accounts in . "ith its cost of goods at 809 of sales value.estination.) (52 4hipping 1oint means the ownership of the goods is transferred to the buyer at the seller's dock. and will factor in the cost of shipping when it sets its price for the goods. herefore.em +erchandise assumes all the risks and costs associated with transporting the goods.800.em's general ledger# Account Name Accounts Receivable Sales Cost of $oods Sold Inventor* Debit ("#+# )## )## Credit ("#+# 2ecause . makes a sale to a customer that has a sales value of .em chooses to ship its goods (52 .$. 6uality makes the following entries in its general ledger# Account Name Accounts Receivable Sales Cost of $oods Sold Inventor* Debit ("### Credit ("### )## )## ("hile there may be additional expenses with this transaction—such as commission expense—we are not considering them in our example. the ownership of the goods transfers at the buyer's dock. all shipping costs (as well as any damage that might be incurred during transit) are the responsibility of the buyer %&B Destination (52 .0<0 and a cost of goods sold at . his means the seller is responsible for transporting the goods to the customer's dock.000 worth of goods using the terms (52 4hipping 1oint. .$.em +erchandise -o. :et's assume that . his means that the buyer is responsible for transporting the goods from 6uality 1roduct's shipping dock. herefore.estination means the ownership of the goods is transferred at the buyer's dock. 7ust sold and shipped . .

%reig't.em within $0 days of the invoice date. or -ransportation. If the customer pays .$. In order to speed up these payments.?00@ the customer's net purchase will also be . the term /0(#" net # allows a customer to deduct %9 of the net amount owed if the customer pays within $0 days of the invoice date.em +erchandise -o. In fact. some companies give credit terms that offer a discount to those customers who pay within a shorter period of time. &sing the example from above. let's illustrate how the credit term of %A$0. he customer contacts . and the shorter period of time is known as the discount period. the net amount for the sales transaction is due *0 days after the sales invoice date. o illustrate the meaning of net. the money.em records the . the customer is allowed to deduct .it' Discounts "hen a seller offers credit terms of net 30 days. companies who sell on credit often find that they don't receive payments from customers on time.000 of goods and the customer returns . assume that . he discount is referred to as a sales discount or cash discount.?00. .?00 (. If a customer does not pay within the discount period of $0 days.$8 (%9 of .000 of goods to a customer. on average. If the shipping company allows . the net purchase amount (without the discount) is due *0 days after the invoice date.$.em and is instructed to return the unacceptable goods.em pays an independent shipping company . 't that point.$. his means that .=ow let's assume that .em's net sale ends up being . &pon receiving the goods the customer finds that . arrived /< days after the invoice date. . one study found that if the credit term is net *0 days. It also means that .em within a few days.$00 of the goods are not acceptable.?00. (or example. the net amount owed by the customer is . &nfortunately.$00 of unacceptable goods to .?00) from the net purchase of .<0 as an operating expense or selling expense (in an account such as Deliver* Expense.<0 to transport the goods from its warehouse to the buyer's dock.em +erchandise -o. In other .?00. net *0 works.$00 returned).&ut Expense). .000 minus the .&ut Expense Accounts Pa*able Debit +# Credit +# Credit -erms .em's net receivable from this customer will be .em to pay in > days.em will make the following entry in its general ledger# Account Name %reig't. ships .&ut Expense. sells .

)une $.ances Accounts Receivable Inventor* Cost of $oods Sold Cas' Sales Discounts (%9 of ?00) Accounts Receivable June 1 (## (## )# )# ))/ () 2## June 1 June (( If the customer waits *0 days to pay .words. the . 5n )une C . :et's assume that the sale above took place on the first day that . In its place will be the following entry on )uly $# Date Jul* ( Account Name Cas' Accounts Receivable Debit 2## Credit 2## Examples of Amounts Due 3nder 4ar*ing Credit -erms .?00 amount can be settled for .em receives the returned goods and restocks them.em's cost of goods is 809 of their original selling prices (before discounts). he above transactions are reflected in .88% if it is paid within the $0Bday discount period.em was open for business. the )une $$ entry shown above will not occur. and on )une $$ it receives .000) Debit ("### Credit ("### June ( )## )## Inventor* Sales Returns and Allo.em's general ledger as follows# Date June ( Account Name Accounts Receivable Sales Cost of $oods Sold (809 of $.em. .88% from the buyer.

) who are paid first from the sale of the assets. the buyer may deduct $9 from the net amount.he following chart shows the amounts a seller would receive under various credit terms for a merchandise sale of . the resultant account receivable is normally considered to be an unsecured claim against the buyer's assets.?00 . (. the buyer may deduct %9 from the net amount.$8) If paid in *0 days of the invoice date.?00 minus .?00 .?00 receivable is settled for . net *0 because of these high percentage e!uivalents. In this situation the customer typically owes money to lending institutions as well as to its suppliers of goods and services. Credit Ris5 "hen a seller provides goods or services on credit. nAC0 Brief Description he net amount is due within $0 days of the invoice date. etc.88% (simply because the customer pays %0 days early) the seller is.$00 of goods. in effect. his makes the seller (the supplier) an unsecured creditor.?) If paid in C0 days of the invoice date. nA*0 %A$0. the net amount is due.?00 .?00 he net amount is due within $0 days after the end of the =et E5+ month (E5+). 4ometimes a supplier's customer gets into financial difficulty and is forced to li!uidate its assets.000 and an authoriDed return of .8?$ . net *0 is far too generous. 5ther sellers are discouraged to find that some customers take the discount and ignore the obligation to pay within the stated discount period. 4ome sellers won't offer terms such as %A$0. In such cases. he net amount is due within *0 days of the invoice date. Amount -o be Received . it's the secured creditors (the banks and other lenders that have a lien on specific assets such as cash. 5ften there is .?00 minus . inventory. payment for any sale made in $0 )une is due by )uly $0. If paid within $0 days of the invoice date. hey argue that when a . nAC0 $A$0. Costs of Discounts 4ome business people believe that the credit term of %A$0. In other words. (. meaning it does not have a lien on any of the buyer's assets—not even on the goods that it 7ust sold to the buyer. Credit -erms =et $0 days =et *0 days =et C0 days %A$0. the net amount is due. he net amount is due within C0 days of the invoice date.88% . e!uipment.?00 . nA*0 $A$0.?00 .$. If paid within $0 days of the invoice date. giving the buyer the e!uivalent of a *C9 annual interest rate (%9 for %0 days e!uates to *C9 for *C0 days). receivables.

the account 'llowance for . his method of anticipating the uncollectible amount of receivables and recording it in the 'llowance for . June 's we stated above.%.ebts Expense.em +erchandise -o. a company's balance sheet could overstate its accounts receivable (and therefore its working capital and stockholders' e!uity) if any part of its accounts receivable is not collectible.%. it will probably experience some credit losses along the way. sellers typically perform a thorough credit check on any new customer before selling to them on credit.000 at )une *0. a firstBrate customer may experience an unexpected financial hardship caused by one of its customers.oubtful 'ccounts. however. .) Allo. which is discussed later. . he accounting entry to ad7ust the balance in the allowance account will involve the income statement account 2ad . it is following the direct write-off method. some suppliers may decide not to sell anything on credit.ance 6et'od for Reporting Credit 7osses 'ccounts receivable are reported as a current asset on a company's balance sheet.000 in 'llowance for . whichever is longer). o minimiDe losses.$00. however. something that could not have been known when the credit check was done. In other words. Allo. o guard against overstatement. a company will estimate how much of its accounts receivable will never be collected.) 'ny increases to 'llowance for . 4ince current assets by definition are expected to turn to cash within one year (or within the operating cycle. hey obtain credit reports and check furnished references.'s 'ccounts 3eceivable has a debit balance of . o avoid this kind of risk.000 of this is not likely to turn to cash.not enough money to pay what is owed to the secured lenders. a credit loss can still occur. 4uch a company. (4ome companies call this account 1rovision for . .ance for Doubtful Accounts and Bad Debts Expense . (If a company does not use an allowance account.oubtful 'ccounts is a contra asset account containing the estimated amount of the accounts receivable that will not be collected. but re!uire instead that all of its goods be paid for with cash or a credit card.ebts Expense (or &ncollectible 'ccounts Expense). much less the unsecured creditors. the suppliers will never be paid what they are owed. he point is this# any company that sells on credit to a large number of customers should assume that.oubtful 'ccounts.em anticipates that approximately . (or example.em reports a credit balance of . his estimate is reported in a balance sheet contra asset account called 'llowance for . sooner or later. may lose out on sales to competitors who offer to sell on credit.oubtful 'ccounts are also recorded in the income statement account 2ad .oubtful 'ccounts or 'llowance for &ncollectible 'ccounts. and as a result.oubtful 'ccounts is known as the allowance method. let's assume that . Even when a credit check is favorable. (or example.

000 )une *0 2alance Bad Debts Expense June ( .em's first month in business. . 4ince this net amount of . his is acceptable because accountants believe it is better to report an approximate amount that is uncollectible rather than imply that every penny of the accounts receivable will be collected.%.000.ance for Doubtful Accounts Debit /"### Credit /"### 8ere are some of t'e accounts in a -.?8. it is referred to as the net reali<able value of the accounts receivable.000 2alance "ith 'llowance for .000 )une -ollections Allo.000 <.oubtful 'ccounts now reporting a credit balance of .000 $00. does not need to know specifically which customer will not pay. . its 'llowance for .000 is the amount that is likely to turn to cash. Balance June # /"### Ad:ust )une *0 %. when it issues its first balance sheet and income statement.%. its 'llowance for .account format9 Accounts Receivable )une $ F 2alance )une 4ales )une *0 2alance $0<.?8.ance for Doubtful Accounts F )une $ 2alance /"### June # Ad:ust %.em +erchandise -o. nor does it need to know the exact amount.oubtful 'ccounts will have a credit balance of .000.oubtful 'ccounts began )une with a Dero balance. 't )une *0. &nder the allowance method.em's balance sheet will report a net amount of .000 and 'ccounts 3eceivable reporting a debit balance of . the . his is done using the following ad7usting 7ournal entry# Date June # Account Name Bad Debts Expense Allo.$00.000.4ince )une was .

has a debit balance in 'ccounts 3eceivable of . Jul* =ow let's assume that at )uly *$ the .%*0.000 of the .000.$0. .oubtful 'ccounts so that its ending balance is a credit of .$0.oubtful 'ccounts). .. his re!uires the following ad7usting entry# Date Jul* ( Account Name Bad Debts Expense Allo.%. his expense is being reported even though none of the accounts receivables were due in )une.) . ( he balance increased during )uly by the amount of its credit sales and it decreased by the amount it collected from customers.account form9 . (3ecall the credit terms were net 30 days.000 (.%.em's 2ad .%*0.000).000 minus .em is attempting to follow the matching principle by matching the bad debts expense as best it can to the accounting period in which the credit sales took place.%%0.%.$0. his means .000 (.000 from the ad7ustment on )une *0. .ance for Doubtful Accounts and Bad Debts Expense . In other words.%%0.000 on its )une income statement.%*0.000 minus .em's general ledger accounts before the )uly *$ ad7ustment to 'llowance for &ncollectible 'ccounts will be reporting a net realiDable value of .em must ad7ust the 'llowance for .000 (.%.000 credit balance in 'llowance for .) he 'llowance for &ncollectible 'ccounts still has the credit balance of . 8ere=s a recap in -.000). the net realiDable value (or net cash value) of its accounts receivable as of )uly *$ is only .000).ance for Doubtful Accounts Debit )"### Credit )"### 'fter this 7ournal entry is recorded.em reviews the details of its accounts receivable and estimates that as of )uly *$ approximately .ebts Expense will report credit losses of .%%8.$0.em's )uly *$ balance sheet will report the net realiDable value of its accounts receivables at . 2efore the )uly *$ financial statements are released. Since t'e net reali<able value of a compan*=s accounts receivable cannot be more t'an t'e debit balance in Accounts Receivable" t'e balance in t'e Allo.000 debit balance in 'ccounts 3eceivable minus the .000 will not be collectible.em +erchandise -o.%*0.ance for Doubtful Accounts must be a credit balance or a <ero balance> Allo.%*0.000 (instead of the present credit balance of .

000 <.$0. .000 ?<.$0. .000 credit balance in 'llowance for .000 %*0. nor will .em will not know the precise amount of actual bad debts. In other words. the matc'ing principle is better met by . It is likely that as of )uly *$ .em's accountant Hbreaks the tieH by choosing the alternative that reports a smaller amount of .000.000 2alance )"### %%<.000 of credit losses or no credit losses.000 Bad Debts Expense )une $ F 2alance June # /"### Ad:ust )une *0 %.Accounts Receivable )une $ F 2alance )une 4ales )une *0 2alance )uly 4ales )uly *$ 2alance $0<.oubtful 'ccounts. .000 2alance Jul* ( )"### Ad:ust )uly *$ $0.ance for Doubtful Accounts )une $ F 2alance June # Ad:ust )une *0 %.000 )uly -ollections )une -ollections Allo.em making these estimates and recording the credit loss as close as possible to the time the sales were made.000 $00.em estimated that the total bad debts expense for the first two months of operations ()une and )uly) is . 2y reporting the .em know which customers are the ones that won't be paying their account balances. Gowever.000 2alance 's seen in the Baccounts above. if there is some doubt as to whether there are .em is also adhering to the accounting principle of conservatism.$0.000 2alance /"### Jul* ( Ad:ust )uly *$ $0.

000 instead of the . (It is reporting a net realiDable value of . he customer states that its bank has a lien on all of its assets.em concludes that it should remove.em +erchandise -o. the principle of conservatism re!uires that there be a credit balance in 'llowance for . a customer purchases .000 $00.$.em +erchandise -o. he entry to write off a bad account affects only balance sheet accounts# a debit to 'llowance for .ance for Doubtful Accounts )une $ F 2alance )une *0 'd7ust )une *0 %.em will receive nothing toward its .000 2alance %. Gowever.oubtful 'ccounts. the customer's account balance of .000 )une -ollections Allo. =o expense or loss is reported on the income statement because this writeBoff is HcoveredH under the earlier ad7usting entries for estimated bad debts expense. if it is likely that some of the accounts receivable will not be collected in full.000 of accounts receivable.ance for Doubtful Accounts Accounts Receivable Debit ("!## Credit ("!## -'e t.em's entry to write off the customer's account balance is as follows# Date Aug /! Account Name Allo. . then the 'llowance for . 5n )une *. 5n 'ugust %/. 'fter confirming this information.%%0.profit and a smaller amount of assets.000 <.ance 6et'od &nder the allowance method.o accounts affected b* t'is entr* contain t'is information9 Accounts Receivable )une $ F 2alance )une 4ales )une *0 2alance $0<.) If a company knows with certainty that every penny of its accounts receivable will be collected. ./00 accounts receivable./00. that same customer informs .%*0. if a specific customer's accounts receivable is identified as uncollectible.oubtful 'ccounts will report a Dero balance. ?riting &ff an Account under t'e Allo.000 . :et's illustrate the writeBoff with the following example. and as a result . It also states that the li!uidation value of those assets is less than the amount it owes the bank. that it has filed for bankruptcy.$.oubtful 'ccounts and a credit to 'ccounts 3eceivable./00 of goods on credit from . &nder the allowance method of recording credit losses. it is written off by removing the amount from 'ccounts 3eceivable. or write off.$.

if such a payment is received (whether directly from the customer or as a result of a court action) the seller will take the following two steps# $.000 %*0./00 written off on 'ug %/ is collected on 5ctober $0. the reinstatement of the account looks like this# Date &ct (# Account Name Accounts Receivable Debit ("!## Credit .000 credit balance in 'llowance for .000@ it is not directly affected by the 7ournal entry writeBoff. he 2ad . It would be double counting for .)uly 4ales )uly *$ 2alance 'ug 4ales 'ug %* 2alance %%<.$0. Recover* of Account under Allo.000 )uly *$ 'd7ust $0.ebts Expense remains at .%*8.C00 credit balance in 'llowance for .%*0./00 to write off the uncollectible amount. &nder the allowance method.%/0. 'fter writing off the bad account on 'ugust %/. 3einstate the account that was written off by reversing the writeBoff entry.000 'ug -ollections $0.000 ?<.C00 debit balance in 'ccounts 3eceivable and . the net realiDable value of the accounts receivable is still . If we assume that the .8.&ff =ote that prior to the 'ugust %/ entry of . the net realiDable value of the accounts receivables was .000 debit balance in 'ccounts 3eceivable and .000 %/0.000 )uly -ollections 8.C00 'ug %/ 2alance 'ug %* 2alance ("!## 'ug %/ 2alance %*8. he bad debts expense recorded on )une *0 and )uly *$ had anticipated a credit loss such as this.ance 6et'od 'fter a seller has written off an accounts receivable.$.$.oubtful 'ccounts). it is possible that the seller is paid part or all of the account balance that was written off.000 $?/.oubtful 'ccounts).em to record both an anticipated estimate of a credit loss and the actual credit loss.C00 Aug /! ?. ("!## &ff 8.000 )uly *$ 2alance %0/.000 (.000 (.%*0.000 Aug /! ?.$0.

It estimates its bad debts expense to be .ebts Expense is a temporary account on the income statement. it might calculate its bad debts expense by using an industry average until it develops its own experience rate. meaning it is closed at the end of each accounting year.*9 of its sales on credit will never be collected.oubtful 'ccounts is ignored at the time of the weekly entries.<00 (0. Bad Debts Expense as a Percent of Sales 'nother way sellers apply the allowance method of recording bad debts expense is by using the percentage of credit sales approach.Allo.ebts Expense and credits 'llowance for .oubtful 'ccounts for 0./00 received on 5ctober $0# Date &ct (# Account Name Cas' Accounts Receivable Debit ("!## ("!## Credit ("!## he seller's accounting records now show that the account receivable was paid.00* x .*9 of each week's credit sales.ance he account 2ad .$. he balance in the account 'llowance for .000 of goods on credit. his approach automatically expenses a percentage of its credit sales based on past history.ebts Expense reports the credit losses that occur during the period of time covered by the income statement. this company automatically debits 2ad . &sing the percentage of credit sales approach. If the seller is a new company. Difference bet. (or example.<00. let's assume that a company prepares weekly financial statements. so that the balance sheet will report the correct net realiDable value. 2ad . Gowever. 4ales revenues of .<00. 1ast experience indicates that 0. ( Closed means .000) and records the following 7ournal entry# Date &ct (# Account Name Bad Debts Expense Allo. the balance in the allowance account must be reviewed and perhaps further ad7usted.<00 of bad debts expense. :et's assume that in the current week this company sells .000 are immediately matched with . 1rocess the .ance for Doubtful Accounts %.$.<00.ance for Doubtful Accounts Debit ("+## Credit ("+## he percentage of credit sales approach focuses on the income statement and the matching principle.$. making it more likely that the seller might do future business with this customer.een Expense and Allo. at some later date.

oubtful 'ccounts is not. he detailed information in the accounts receivable subsidiary ledger is used to prepare a report known as the aging of accounts receivable. these two balances will most likely not be e!ual after the company's first year of operations. 2ad .*.oubtful 'ccounts had a credit balance of .000. let's assume that at the end of its first year of operations a company's 2ad . they are not closed and their balances are not reset to Dero. meaning their balances carry forward to the next accounting period.000 debit balance. while the 'llowance for . while 'llowance for .ebts Expense for the second year of operations is . he details for the control account—each credit sale for every customer—is found in the subsidiar* ledger for 'ccounts 3eceivable.000 and its 'llowance for . It is also useful in determining the balance amount needed in the account 'llowance for . the company's opening balance in 2ad .$/. (or example. Aging of Accounts Receivable he general ledger account 'ccounts 3eceivable usually contains only summary amounts and is referred to as a control account. and %) 'llowance for . perhaps through an income summary account.000 in 'llowance for .oubtful 'ccounts. he 'llowance for . he total amount of all the details in the subsidiary ledger must be e!ual to the total amount reported in the control account.$/. he credit balance of . 'gain.ebts Expense will report a . carries forward to the second year.oubtful 'ccounts is a permanent account that reports an estimated amount for all of the uncollectible receivables reported in the asset 'ccounts 3eceivable as of the balance sheet date. however.000 is made during year %.the account balance is transferred to retained earnings.ebts Expense is a temporary account that reports credit losses only for the period shown on the income statement.oubtful 'ccounts reports on the balance sheet the estimated amount of uncollectible accounts that are included in 'ccounts 3eceivable. In other words.ebts Expense account is closed each year. the reasons for the account balance differences are $) 2ad . 2ecause the income statement account balances are closed at the end of the year. 2ecause the 2ad .$/.ebts Expense and resetting its balance to Dero.0.) 2y closing 2ad . his report directs management's attention to accounts that are slow to pay. 2alance sheet accounts are almost always permanent accounts.$>. If an ad7usting entry of .oubtful 'ccounts might report a credit balance of .oubtful 'ccounts.ebts Expense had a debit balance of . the account is ready to receive and tally the credit losses for the next accounting year. .*.000.

<?. F .60 days past due. (or example. 'ny unpaid invoices with a date in )uly are classified as 1 . and the accounts *$BC0 days past due have a ?09 . Extreme -o. his puts the seller at risk since an older.em +erchandise -o. it may take advantage by further postponing payment in order to pay more demanding suppliers on time.%$0 . F . Aging 3sed in Calculating t'e Allo. $. rifect ::-otals . most accounting software will provide the aging of accounts receivable report./<C . If we assume the report is dated 'ugust *$ and that .em's credit terms are net *0 days. (or example.$8. F . unpaid accounts receivable is more likely to end up as a credit loss. F .$%$ . . # Da*s ( . a company might make the assumption that accounts not past due have a ??9 probability of being collected in full.'s software looks at each of its customer's accounts receivable activity and compares the date of each unpaid sales invoice to the date of the report. this report will indicate how much of its accounts receivable is past due. F . /8.%00 .$. If a company sells merchandise (or provides services) and allows customers to pay *0 days later. F . C%. F . It also reports how far past due the accounts are. he sorted information is present in a report that looks similar to the following# $em 6erc'andise Co> Aging of Accounts Receivable As of August (" /##) Past Due Past Due Past Due ( . 1# Da*s 1(@ Da*s .ance he aging of accounts receivable can also be used to estimate the credit balance needed in a company's 'llowance for . 'ny unpaid invoices with a date of )une are classified as 31 . F . /8. F .he aging of accounts receivable report is typically generated by sorting unpaid sales invoices in the subsidiary ledger—first by customer and then by the date of the sales invoices. +ain -orp. "ith the click of a mouse. F A(#)"#B+ A " + A("/## A()"/(# Customer Name -otal Receivable Current '2. and so on. F .?</ .**< . he aging of accounts receivable report helps management monitor and collect the accounts receivable in a more timely manner.%$0 . 'ccounts that are $B*0 days past due have a ?>9 probability of being collected in full. $8.-o.?</ .%00 A( #")/# If a customer realiDes that one of its suppliers is lax about collecting its account receivable on time.30 days past due. based on past experience.oubtful 'ccounts. any unpaid sales invoices with an 'ugust date will be classified as current.*.

the probability of not collecting is $9.een Expense and Allo. *9. 6ailing Statements to Customers o improve the probability of collection (and avoid bad debts expense) many sellers prepare and mail monthly statements to all customers that have accounts receivable balances. If we multiply the totals from the aging of accounts receivable report by the probabilities of not collecting. *.ue# *$ B C0 . If worded skillfully.ance .<9 per month). and /09 respectively.%$0 /09 AB"/)! otals . $.probability. "ith these probabilities of collection.8%0 A)"+)+ his computation estimates the balance needed for 'llowance for .8.**< *9 A (## 1ast .0>< $9 A("#)( 1ast .$*0. he company estimates that accounts more than C0 days past due have only a C09 chance of being collected. $09. o further prompt customers to pay in a timely manner. some customers use the statement as a means to compare its records with those of the seller.<8<.oubtful 'ccounts at 'ugust *$ to be a credit balance of . $8. Difference bet.$08. we arrive at the expected amount of uncollectible receivables. 2ecause transactions are usually itemiDed on the statement.ue# $ B *0 days .ue# C$I days . the statement may indicate that past due accounts are assessed interest at an annual rate of $89 ($. his is illustrated below# $em 6erc'andise Co> Expected Amount of Accounts Receivable -'at is 3ncollectible As of August (" /##) Age of Accounts Accounts Probabilit* of Not Expected Receivables Receivable Amount Collecting 3ncollectible Amount -urrent . the seller can use the statement to say Hthank you for your continued businessH while at the same time HremindingH the customer that receivables are being monitored and payment is expected.%00 $09 A (/# days 1ast .

ebts Expense had a debit balance of .oubtful 'ccounts might report a credit balance of . If an ad7usting entry of . 2alance sheet accounts are almost always permanent accounts.$/.000. his report directs management's attention to accounts that are slow to pay.$>. and %) 'llowance for . 2ecause the income statement account balances are closed at the end of the year. 2ecause the 2ad .oubtful 'ccounts.ebts Expense will report a .000 and its 'llowance for .$/. while the 'llowance for . these two balances will most likely not be e!ual after the company's first year of operations. they are not closed and their balances are not reset to Dero.000. carries forward to the second year. the reasons for the account balance differences are $) 2ad . he details for the control account—each credit sale for every customer—is found in the subsidiar* ledger for 'ccounts 3eceivable. however.ebts Expense and resetting its balance to Dero.$/. 2ad .oubtful 'ccounts is a permanent account that reports an estimated amount for all of the uncollectible receivables reported in the asset 'ccounts 3eceivable as of the balance sheet date. let's assume that at the end of its first year of operations a company's 2ad . he detailed information in the accounts receivable subsidiary ledger is used to prepare a report known as the aging of accounts receivable.000 debit balance. meaning their balances carry forward to the next accounting period.) 2y closing 2ad . he 'llowance for . In other words. perhaps through an income summary account.*. ( Closed means the account balance is transferred to retained earnings. (or example.000 in 'llowance for .ebts Expense is a temporary account on the income statement. the company's opening balance in 2ad . 2ad .0.oubtful 'ccounts had a credit balance of . It is also useful in determining the balance amount needed in the account 'llowance for .ebts Expense is a temporary account that reports credit losses only for the period shown on the income statement.oubtful 'ccounts is not.*. Aging of Accounts Receivable he general ledger account 'ccounts 3eceivable usually contains only summary amounts and is referred to as a control account. 'gain. meaning it is closed at the end of each accounting year. he credit balance of . the account is ready to receive and tally the credit losses for the next accounting year.he account 2ad . .ebts Expense account is closed each year. he total amount of all the details in the subsidiary ledger must be e!ual to the total amount reported in the control account.ebts Expense for the second year of operations is .000 is made during year %.oubtful 'ccounts.oubtful 'ccounts reports on the balance sheet the estimated amount of uncollectible accounts that are included in 'ccounts 3eceivable. while 'llowance for .ebts Expense reports the credit losses that occur during the period of time covered by the income statement.

%$0 . 'ny unpaid invoices with a date of )une are classified as 31 . and so on.$%$ . (or example. his puts the seller at risk since an older. 'ny unpaid invoices with a date in )uly are classified as 1 . F . C%.60 days past due.%$0 . # Da*s ( . this report will indicate how much of its accounts receivable is past due. F . ./<C .em +erchandise -o. F .$8. most accounting software will provide the aging of accounts receivable report.-o.%00 . he aging of accounts receivable report helps management monitor and collect the accounts receivable in a more timely manner. F .**< .em's credit terms are net *0 days. F . $8. /8. F . $. F . If we assume the report is dated 'ugust *$ and that .?</ . Aging 3sed in Calculating t'e Allo. +ain -orp. F .$.*. 1# Da*s 1(@ Da*s . <?. Extreme -o.%00 A( #")/# If a customer realiDes that one of its suppliers is lax about collecting its account receivable on time. /8. it may take advantage by further postponing payment in order to pay more demanding suppliers on time. he sorted information is present in a report that looks similar to the following# $em 6erc'andise Co> Aging of Accounts Receivable As of August (" /##) Past Due Past Due Past Due ( . unpaid accounts receivable is more likely to end up as a credit loss.ance . rifect ::-otals . F . It also reports how far past due the accounts are.?</ .30 days past due. F A(#)"#B+ A " + A("/## A()"/(# Customer Name -otal Receivable Current '2. F . If a company sells merchandise (or provides services) and allows customers to pay *0 days later.he aging of accounts receivable report is typically generated by sorting unpaid sales invoices in the subsidiary ledger—first by customer and then by the date of the sales invoices. any unpaid sales invoices with an 'ugust date will be classified as current. "ith the click of a mouse.'s software looks at each of its customer's accounts receivable activity and compares the date of each unpaid sales invoice to the date of the report.

o further prompt customers to pay in a timely manner. *. we arrive at the expected amount of uncollectible receivables. *9. and the accounts *$BC0 days past due have a ?09 probability.**< *9 A (## 1ast .ue# $ B *0 days .ue# *$ B C0 .%$0 /09 AB"/)! otals . If worded skillfully.oubtful 'ccounts. 'ccounts that are $B*0 days past due have a ?>9 probability of being collected in full. If we multiply the totals from the aging of accounts receivable report by the probabilities of not collecting. the statement may indicate that past due accounts are assessed interest at an annual rate of $89 ($. a company might make the assumption that accounts not past due have a ??9 probability of being collected in full. (or example.$*0.ue# C$I days . $09.%00 $09 A (/# days 1ast . and /09 respectively. he company estimates that accounts more than C0 days past due have only a C09 chance of being collected.he aging of accounts receivable can also be used to estimate the credit balance needed in a company's 'llowance for . the probability of not collecting is $9. his is illustrated below# $em 6erc'andise Co> Expected Amount of Accounts Receivable -'at is 3ncollectible As of August (" /##) Age of Accounts Accounts Probabilit* of Not Expected Receivables Receivable Amount Collecting 3ncollectible Amount -urrent . $8.8.0>< $9 A("#)( 1ast .<9 per month).$08.<8<. the seller can use the statement to say Hthank you for your continued businessH while at the same time HremindingH the customer that receivables are being monitored and payment is expected. $. 6ailing Statements to Customers o improve the probability of collection (and avoid bad debts expense) many sellers prepare and mail monthly statements to all customers that have accounts receivable balances. 2ecause transactions are usually itemiDed on the .oubtful 'ccounts at 'ugust *$ to be a credit balance of . based on past experience.8%0 A)"+)+ his computation estimates the balance needed for 'llowance for . "ith these probabilities of collection.

he use of the allowance method is not permitted. and as such can be pledged as collateral for a loan. for purposes of reporting income taxes in the &nited 4tates because the Internal 3evenue 4ervice (I34) does not allow companies to anticipate these credit losses.off 6et'od $enerall* accepted accounting principles C$AAPD re!uire that companies use the allowance method when preparing financial statements. 'ccounts receivable turnover ratio. however. &se the following link to learn how to calculate these ratios# %inancial Ratios.ays sales in accounts receivable. . In the direct writeBoff method.statement. Pledging or Selling Accounts Receivable ' company's accounts receivable are considered to be a type of asset. 4ometimes the factor will purchase the accounts receivables with recourse. Accounts Receivable Ratios here are two commonly used financial ratios that address the relationship between the amount of a company's accounts receivable as reported on the balance sheet and the amount of credit sales as reported on the income statement. a company will not use an allowance account to reduce its 'ccounts 3eceivable. 'ssetBbased lenders will often lend a company an amount e!ual to 809 of the value of its accounts receivable. ' factor buys the accounts receivables at a discount and then goes about the business of collecting and keeping the money owed through the receivables. companies must use the direct write-off method for income tax reporting. Direct ?rite. his means the company that sold the receivables remains financially responsible if a customer does not remit the full amount to the factor. hese ratios are# $. and %. 's a result. 'ccounts 3eceivable is only reduced if and when a company . "hen the factor purchases the receivables without recourse. the company selling the receivables is not responsible for unpaid amounts. 4ome companies sell their accounts receivable to a factor. some customers use the statement as a means to compare its records with those of the seller.

$. is convinced that a specific customer's account receivable originating on )une < in the amount of . let's assume that on 5ctober %$.knows with certainty that a specific amount will not be collected from a specific customer. (or example. .em +erchandise -o. his is why. companies should use the allowance method rather than the direct writeBoff method. It is difficult to adhere to the matching principle and the concept of conservatism when a significant amount of time elapses between the time of the sales revenues and the time that the bad debts expense is reported. for purposes of financial reporting (not tax reporting). . the following entry is made# Date &ct> /( Account Name Bad Debts Expense Accounts Receivable Debit ("/ ) Credit ("/ ) &sually many months will pass between the time of the sale on credit and the time that the seller knows with certainty that a customer is not going to pay.%*8 is definitely uncollectible. &sing the direct writeBoff method.

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