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Week 5

Receivables and Payables

BUSN1002

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Reminder
• MYOB assignment – good time to start
• Mid-semester exam info, practice MCQ
questions and explanation video on Wattle

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Learning Objectives
1. Understand the accounting for receivables
2. Use the allowance and direct write off method to
account for bad debts
3. Account for current liabilities of known amount and
those that must be estimated.
4. Reporting receivables and current liabilities on the
financial statements

• For simplicity, BUSN1002 ignores GST for this type of
questions.

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Receivables Ch 9 4 .

Accounts Receivable Allow customers to buy goods & services without immediate payments • Benefits: – Increase sales (and profit) • Costs: – Providing free finance for customers at the seller’s expense – Risk of customers failing to pay (bad debt expense) Bad Debts • Overdue accounts .may (or may not) be recovered later • Uncollectible accounts • An expense 5 .

Receivables and sales revenue Balance Sheet Asset Liability Credit sales: Acc Rec 1000 Dr Accounts Receivable 1.000 Equity Cr Sales Revenue 1.000 Income Statement Sales Rev 1000 Expenses If we later learn that we cannot collect part of this $1000 accounts receivable… We should undo (part of) that transaction: 1. Reduce Account receivables (by offsetting using Allowance for Bad Debts) 6 . Reduce Sales (by recognising Bad Debt Expense) 2.

Estimation • ATO only accepts this approach for 1.% of Sales 1. Allowance method 2.e.2 . Direct write-off method • We make provision for bad debts • Write-off (i. For Bad debts 10 having $10 Equity Equity extra liability all of a sudden. cancel) the accounts before the bad debt events happen. I/S I/S Sales Rev 1000 Sales Rev 1000 Expenses Expenses Bad debt expenses 10 Bad debt expenses 10 7 . receivable when they are “proven” to be uncollectible.1 .Aging of accounts tax deduction purpose It is an Dr Bad debt expense 10 Dr Bad debt expense 10 expense to Cr Allowance for bad debts 10 (contra-asset) Cr Account receivable 10 us because B/S B/S we are now Asset Liability Asset Liability $10 worse Acc Rec 1000 Acc Rec 1000-10 off by All. Two methods to account for Bad Debts 1.

we estimate that $10 cannot be collected in the future • Under the allowance method. we go ahead and reduce our net receivables by $10 (to be conservative) before any of our clients has gone bankrupt or died etc. Based on experience. • So that.g. Our clients owe us $1000 in total.What do we mean by “providing for” or “allowing for” bad debts? • E. when any of our clients indeed cannot pay us back. there will be no (or less) impact on us: Dr Allowance for bad debts 10 Balance Sheet Cr Accounts Receivable 10 Asset Current Asset Accounts Receivable $1000 990 . later on.Allowance for bad debts (10) (0) Net Receivables 990 990 8 .

we are also going to have $4 more Allowance for bad Cr Allowance for bad debts 4 ($200 * 2%) debts Before: Adjustments: After: B/S B/S Asset Liability Asset Liability Bad debt expense Acc Rec 2000 Acc Rec 2000 . We’ll have $4 of bad debt exp Dr Bad debt expense 4 ($200 * 2%) for this year. For Bad debts (10) 0 .e. calculated as a % of credit sales Example: Credit sales for the year = $200 • Recorded as an adjusting entry at the end of the period Percentage of sales deemed uncollectable: 2% • Add to the balance of the allowance for bad debts account. i.1: Percentage of (credit) sales • Income statement approach — focuses on the amount of bad debt expense to be reported on the income statement for this period • Based on prior experience.All. For Bad debts (14) Net Receivables 1990 Equity 4 Net Receivables 1986 Equity I/S I/S Allowance for bad debts Sales Rev 200 10 Sales Rev 200 4 Profit Expenses Expenses Bad debt expense (4) . Allowance method – Percentage of Sales Method 1.All.

bad debt) – Mostly likely your clients are in financial difficulties. They decide the following bad debt likelihood for their accounts receivable according to their age: Age (days) Amount Bad debt likelihood 0-30 (not overdue) $1000 1% 31-90 (overdue) $5000 10% 91+ (overdue) $1225 40% Opening balance of Allowance for bad debts: $200 .e. comparing the opening balance. we can then work out the change. Allowance method – Ageing of accounts Method 1.2: Ageing of accounts receivable • Balance sheet approach — focuses on the age of the accounts receivable and on which determines the ending balance of Allowance for bad debts • Age – the older is an account (the longer an account is overdue). if they cannot pay you back • Having estimated the ending balance. • The change amount is what we need for our journal entries: Example: A business gives out 30 days credit period to clients. the more likely is it uncollectible (i.

000 .000 Bad debt expense (800) . Allow. opening balance of Allowance for bad debts = $200 • We estimated the ending balance to be $1000 • There is an increase in a contra-asset (~liability) account of $800 • An net increase in liability = an expense Dr Bad debt expense 800 Cr Allowance for bad debts 800 Balance Sheet Income Statement Accounts receivable $10.000 10. for bad debts (200) (1000) Expense: Net receivables 9.800 9. Est.000 Sales $10.Allow. for Age (days) Amount Bad debt likelihood bad debts 0-30 (not overdue) $1000 1% $10 31-90 (overdue) $5000 10% $500 91+ (overdue) $1225 40% $490 Total = $1000 • To recall.

Comparing the Percentage of Sales and Ageing Methods .

– See the example on slide #6 .When predictions come true (some debts turn bad as predicted)… • Under the allowance method. at least). some clients indeed cannot repay us ($1000): – The “allowance” (or “provision”) is no longer an allowance. we estimate the amount of bad debts that we may have in the future. Dr Allowance for bad debts 1000 Cr Accounts receivable 1000 • But since we have previously allowed (provided) for this event. • Say. some time in the future. – Our accounts receivable actually reduces. the impact on our financials will be none (or less.

Method 2: Direct Write-off • As its name suggests. • E.e. The client owes us $1000. Dr Bad debt expense 1000 Cr Accounts receivable 1000 • Simple . underestimate expense . We just learnt that one of our client has died in an accident. we record that as bad debt expense. • Whenever the bad debt event happens.But since bad debt events are very common.g. do something before it happens to warn investors).We do not allow or provide for such event (i. Knowing that it is likely. we directly write off (or cancel) the accounts receivable whenever we learn that they have become uncollectible. but not warning investors via financial reports may be inappropriate. 14 . and thus we do not have to predict the future •  Overstate asset.

Bad debt recovery Some times. The client who owed us $1000 and died in an accident.g. we are lucky… E. Their child unexpectedly took over the business and pay us back! To account for this recovery. the business must reverse the effect of the earlier write-off to the Allowance account and record the cash collection: Allowance method Direct write-off method: Re-establish Accounts Receivable: Dr Accounts Receivable Dr Accounts Receivable Cr Allowance for Bad Debts Cr Bad Debts Expense* What about the reversal of Cash collection: expense under the Dr Cash at Bank allowance method? Dr Cash at Bank Cr Accounts Receivable Cr Accounts Receivable * Assuming that the bad debt event and its recovery happen in the same period 15 .

5 Dr Credit Card Charge 2. service charge: 2.5 Cr Sales Revenue 100 We do not need to provide for bad debts .Credit & Debit card Sales – No bad debts • Fees applies for the retailer – Transferrable to customers • Essentially.5% To many businesses. the fee is an insurance premium against bad debt – Banks/financial institutions bear the bad debt risks Recording a $100 credit card sale with a 2.5% of sales is a whole lot! Dr Acc Receivable (credit card) 97.

(trade credits are interest-free) • May arise from a sale or may be given in settlement of an account receivable.Bills Receivable • Essentially a (short-term) loan • Very similar to accounts receivable except that: – Bills receivable are more formally a debt (it matters if your client went bankrupt) – Bills receivable attracts interest. • Credit is extended to customers by means of a bill of exchange or promissory note. .

a BoE may be “accepted” (guaranteed) by a financial institution • An “accepted” BoE has (almost) no risk of bad debt • E.Bills of Exchange (a form of bills receivable) • Essentially a (short-term) loan but it can be transferrable • A common example: Cheque (negotiable) – The one who writes the cheque promises to pay the holder of the cheque (need not to be the buyer) in some later date Sometimes.g. Bank cheque The seller may “factor” (cash-in) an BoE with a financial institution before the bill matures at a discount • Discount = interest + bad debt risk + admin fee .

Bills Receivable .

) • Duration: June 1.000 • Interest: 10% (p. 2016 90 days $10. 2016 to August 29.000 × 10% × 90/365 = $246.a.Example: Interest on a Bill • Interest = Principal × Rate × Duration • Principal: $10.58 .

58 .000 Cr Sales Revenue 10.000 Cr Accounts Receivable 10.58 Cr Bill Receivable 10.000 OR • If a bill is drawn for settlement of an account receivable: Dr Bill Receivable 10.000 • Collection at maturity: Dr Cash at Bank 10.000 Cr Interest Revenue 246.Recording Bills Receivable • If a bill is drawn on a sale: Dr Bill Receivable 10.246.

19 • Collection on maturity Dr Cash 10.19 * 30 days from June 1 to June 30 Dr Interest Receivable 82.39 .58 Cr Bill Receivable 10. Accruing Interest Revenue If the accounting period ended June 30: 90 days 1-Jun 30-Jun 29-Aug 30 days 60 days Year end: Payment day: recognize interest recognize interest revenue (60 days) revenue (30 days) Collect principal • Interest earned as of June 30 Collect interests payment (60+30) = $10.000 × 10% × (30* ÷ 365) = $82.19 Cr Interest Revenue 82.000.246.00 Cr Interest Receivable 82.19 Cr Interest Revenue 164.

81 (*70 days between June 21 and August 29) . rather than at maturity.58 × 12% × 70*/ 365 = $235. period = $10. Continue with the previous example: • The firm discounts the bill after 20 days on June 21. – The discount rate reflects: interest + bad debt risk + admin fees Discount = maturity value x discount rate x disc.).Discounting a Bill Receivable (factoring) • The drawer (who will receive the money) may sell a bill (at discount) to a financial institution so as to receive money now.246.a. discount rate applied by the finance company is 12% (p.

010.246.00 Cr Interest Revenue 10.77 Record the factoring of and the interest on a bill .58 .81 = 10.000.$235.010.discount • = $10.Discounting a Bill Receivable The seller of the bill may receive the discounted amount now: • = Amount at maturity .77 To record the discounting: June 21 Dr Cash 10.77 Cr Bill Receivable 10.

Payables Ch 11 pp.501-509 25 .

Accounts payable – amounts owed to suppliers for goods or services purchased on account – do not bear interest expense for the debtor 2. bill of exchange. payable within 1 year – Business must pay interest expense and record interest payable if any interest expense is accrued at the end of the period . Short-term Bills Payable – Promissory notes.Current Liabilities 1.

Current Liabilities 3. Current Liabilities that must be estimated . GST payable – Firms are collection agencies for the Australian Tax Office – GST amounts owed to ATO 4. Accrued Expenses & Unearned Revenue 5.

Estimating Current Liabilities The matching principle demands that the company recognises expense that are associated with the revenue earned for the same period E.g. Warranty is offered on goods sold this period • Provide (allow) for warranty • Recognise some warranty liability before warranty events happen Other examples: • Sick leave provision • Annual leave provision • Long service leave provision .

cost of fixing a product = $500. 1% of goods sold is faulty and returned for fixing under the 12-month warranty offered.000 products this year. we “provide for” it. We sold 1.Example: Estimating Warranty Provision Based on experience. Before any product is returned for warranty. opening balance = $1000 Dr Warranty Expense 4000 Cr Warranty Provision 4000 29 . we estimate that we have a our liability for warranty to be 1% x 1000 x $500 = $5000 Assume we have already recognized some Warranty Provision in the past.

Contingent Liability • A contingent liability is a potential liability that does not appear on the balance sheet • For an item to appear on balance sheet.g. an outstanding lawsuit • The AASB137 requires details of a contingent liability must be disclosed in the notes to the financial statements . AND – Reliable measurement • Contingent liability fails either or both of them • E. it needs to pass two criteria: – Probability.

000 – Credit Sales: $120.600 3.000 2. . Accounts Receivable (as at 30 September) – debit balance $28. bad debts expense by the allowance method based on % of sales method and write-offs of bad debts during October. Cash Collected in October $91. Sales for October $187.070 6. Bad debts expense estimated as 2% of credit sales Requirements • Prepare journal entries to record sales.000 5. Allowance for Bad Debts (as at 30 September) – credit balance $1. Write-offs of bad debts in October totalled $1.Class exercise The following information pertains to Prime Technology: 1.000 – Cash Sales: $ 67. collections.000 4.