PROOF OF CASH

Proof of Cash
A proof of cash is basically a roll forward of each line item in a bank reconciliation from one month to another, which
includes separate columns for cash receipts and cash disbursements.

Basically, what we are reconciling in a proof of cash are the beginning balances (previous month’s ending balance),
cash receipts, cash disbursements, and ending balances (current month’s ending balance).

Two-Date Bank Reconciliation

The foundation of proof of cash is basically two-date bank reconciliation.

The bank reconciliation is so-called “two-date” because it literally involves two dates (i.e. two months). The procedure
followed for a one-date reconciliation are the same for a two-date bank reconciliation.

Consider the following illustration below:

Illustrative Problem 1
Efficient Company showed the following information:

Cash in bank balance, March 31 P200,000

Book credits for April 720,000
Book debits for April 800,000

Bank statement balance, March 31 330,000

Bank debits 530,000
Bank credits 700,000

Note collected by bank:

March 60,000
April 100,000

Service charge
March 8,000
April 2,000

NSF Check:
March 20,000
April 30,000

Deposit in transit:
March 80,000
April 220,000

Outstanding checks:
March 178,000
April 372,000

Requirement: Prepare a two-date bank reconciliation.

Solution:
BOOK
March April
Unadjusted balance 200,000 280,000
CM - Note collected by bank 60,000 100,000
DM - service charge (8,000) (2,000)
DM - NSF check (20,000) (30,000)
Adjusted balance 232,000 348,000

BANK
March April
Unadjusted balance 330,000 500,000
Deposit in transit 80,000 220,000
Outstanding checks (178,000) (372,000)
Adjusted balance 232,000 348,000

Notes:
Since a two-date bank reconciliation is still a bank reconciliation, the reconciling items discussed in bank reconciliation
are still applicable; that is, the credit memos are still added to the cash in bank balance, debit memos are still deducted,
deposits in transit are still added to the bank statement balance, and outstanding checks are still deducted.

If you try to cover one column in the two-date bank reconciliation, let’s say April, then what you are left with is the
March bank reconciliation. In other words, as long as you are familiar with the process of bank reconciliation, then a
two-date bank reconciliation is nothing new.

However, one thing to point out here is the computation of the April unadjusted balances for the book and the bank.

Note that the P280,000 April unadjusted balance per book, and the P500,000 April unadjusted balance per bank, are
not provided in the problem. However, we were given the book debits and credits, and the bank debits and credits to
work with.

For the April unadjusted balance per book, we simply start with the March 31 ending balance (which will serve as the
beginning balance for April), then add the book debits (since debits to cash in bank account are additions), and deduct
the book credits (since credits to cash in bank account are deductions). The solution would be as follows:
Cash in bank balance, March 31 200,000
Book debits for April 800,000
Book credits for April (720,000)
Cash in bank balance, April 30 280,000

As for the April unadjusted balance per bank, we start with the March 31 ending balance, then we add the bank credits
(since, if you recall, the depositor’s deposit is a liability of the bank, thus, it has credit balance as its normal balance),
then we deduct the bank debits. The solution would be as follows:
Bank statement balance, March 31 330,000
Bank credits 700,000
Bank debits (530,000)
Bank statement balance, April 30 500,000
As mentioned, proof of cash reconciles not just the ending balances for two months, but also the cash receipts and
cash disbursements.

If you go back to the Illustrative Problem 1, the cash receipts would actually refer to the Book Debits and the Bank
Credits. Under the proof of cash, these two should have the same adjusted balance after reconciliation. Cash
disbursements on the other hand would refer to the Book Credits and the Bank Debits.

The following 4-column format is used in proof of cash:

BOOK
Beginning Ending
Balance Receipts Disbursements Balance
Unadjusted balances xxx xxx xxx xxx
Credit memos
Previous month (a) xxx (xxx)
Current month (b) xxx xxx
Debit memos
Previous month (c) (xxx) (xxx)
(d)
Current month xxx (xxx)
Errors (e) xxx(xxx) xxx(xxx) xxx(xxx) xxx(xxx)
Adjusted balances xxx xxx xxx xxx

BANK
Beginning Ending
Balance Receipts Disbursements Balance
Unadjusted balances xxx xxx xxx xxx
Deposits in transit
(f)
Previous month xxx (xxx)
Current month (g) xxx xxx
Outstanding checks
(h)
Previous month (xxx) (xxx)
(i)
Current month xxx (xxx)
Errors (e) xxx(xxx) xxx(xxx) xxx(xxx) xxx(xxx)
Adjusted balances xxx xxx xxx xxx

(a) The credit memo in the previous month is a previous month’s reconciling item, thus, it is added to the previous
month’s unadjusted cash balance. This is consistent with what is discussed in bank reconciliation. This amount
is also deducted from the current month’s receipt since this credit memo should have been added in the
previous month, and not during the current month. Note that banks usually send bank statements every end
of the month, so the previous month’s bank statement will be sent to the depositor in the current month.
Upon receiving the bank statement, the company will be able to see previous month’s credit memo. In turn,
the depositor will add this amount in the current month. So, to adjust the current month’s receipts, the
previous month’s credit memo will be deducted.
(b) The credit memo in the current month is a current month’s reconciling item, thus, it is added to the current
month’s unadjusted cash balance. This amount is also added to the cash receipts since this amount has not
yet been recognized in the books when it should have been recorded.
(c) The debit memo in the previous month is a previous month’s reconciling item, thus, it is deducted from the
previous month’s unadjusted cash balance. Since this amount should have been recorded in the previous
month, and was only recorded (as a disbursement) in the current month, the adjustment would include a
deduction from the current month’s disbursements.
(d) The debit memo in the current month is a current month’s reconciling item, thus, it is deducted from the
current month’s unadjusted cash balance. Since this amount should be recorded in the current month (as a
disbursement), and no recording has been made yet, the adjustment would include an addition to the current
month’s disbursements.
 (e) The effect of the errors must be analyzed on a per-error basis.
(f) The explanation of the deposit in transit is very similar to the explanation in the credit memos. If you’ve
noticed, the adjustments are also the same.
(g) Similar explanation as to (b).
(h) Similar explanation as to (c).
(i) Similar explanation as to (d).

Continuing now the Illustrative Problem 1:

Illustrative Problem 1 (continued)

Additional requirement: Prepare a proof of cash.

Solution:
BOOK
Ending Balance, Ending Balance,
March Receipts Disbursements April
Unadjusted balances 200,000 800,000 720,000 280,000
CM - note collected by bank
March 60,000 (60,000)
April 100,000 100,000
DM - service charge
March (8,000) (8,000)
April 2,000 (2,000)
CM - NSF check
March (20,000) (20,000)
April 30,000 (30,000)
Adjusted balances 232,000 840,000 724,000 348,000

BANK
Ending Balance, Ending Balance,
March Receipts Disbursements April
Unadjusted balances 330,000 700,000 530,000 500,000
Deposit in transit
March 80,000 (80,000)
April 220,000 220,000
Outstanding checks
March (178,000) (178,000)
April 372,000 (372,000)
Adjusted balances 232,000 840,000 724,000 348,000
 RECEIVABLES (ACCOUNTS RECEIVABLE)

Definition
Receivables are financial assets that represent a contractual right to receive cash or another financial asset from
another entity.

Classifications
There are two classifications of receivables:
1. Trade receivables; and
2. Nontrade receivables

Trade Receivables
These are receivables arising from sale of goods or services in the ordinary course of business. These include accounts
receivables, and even notes receivables that arise from sale of goods or services.

Nontrade Receivables
Nontrade receivables, on the other hand, are simply those receivables that are not classified as trade receivables.
Examples:
• Advances to or receivables from shareholders, directors, officers, or employees
• Advances to affiliates – usually treated as a long-term investment
• Accrued income
• Subscriptions receivables – if collectible within one year, presented as receivables under current assets,
otherwise, it is presented as a deduction from subscribed share capital
• Special deposits on contract bids – normally classified as noncurrent assets; however, if currently collectible,
it is classified under current assets

Presentation
Receivables are presented under the following:
• Current assets – this applies to trade receivables and nontrade receivables collectible within one year.
• Noncurrent assets – this applies to nontrade receivables not collectible within one year.
• Equity – this applies only to subscriptions receivables not collectible within one year as a deduction from
subscribed share capital.

Initial Measurement
PFRS 9 provides that a financial asset shall be recognized initially at fair value plus transaction costs that are directly
attributable to the acquisition.

Fair value is usually the transaction price. For short-term receivables, fair value is normally equal to the face amount
or original invoice amount.

Accordingly, accounts receivable shall be measured initially at face amount or original invoice amount.

Subsequent Measurement
PFRS 9 states that after initial recognition, accounts receivable shall be measured at amortized cost.

The amortized cost is actually the net realizable value of accounts receivable. The term “amortized cost” is more
relevant when we are talking about long-term receivables; thus, the term “net realizable value” is preferred in relation
to accounts receivable.
Accounting for Accounts Receivable
In order to account for accounts receivable properly, we must familiarize ourselves with the transactions that affect
the account. Below is the T-account for accounts receivable, with the corresponding transactions that affect it:
Accounts Receivable
Beginning balance xxx xxx Collections (b)
(a)
Credit sales xxx xxx Sales returns and allowances (c)
Recoveries (f) xxx xxx Sales discounts (d)
xxx Write-off (e)
Ending balance xxx

(a) Credit Sales

Credit sales represent the main driver of accounts receivable, such that, without credit sales, there would be no
accounts receivable to begin with.

Credit sales are simply sales on account. The journal entry to record credit sales is as follows:
Accounts Receivable xxx
Sales xxx

(b) Collections
Collections represent the payment of customers. This is the main cause of the decrease in accounts receivable. The
entry to record collections is as follows:
Cash xxx
Accounts Receivable xxx

(c) Sales Returns and Allowances

Sales returns represent those goods that were sold, but were returned by customers because of defects, erroneous
delivery, and the like. The journal entry to record such transaction is as follows:
Sales Returns xxx
Accounts Receivable xxx

(d) Sales Discounts

Sales discounts represent those discounts availed by the customers because of prompt payment.

Companies normally sell on account with credit terms, such as 2/10, n/30, wherein the customer has 30 days to pay,
but if the customer pays within 10 days, he can avail of a 2% discount.

There are two ways on how to account for sales discounts:

1. Gross method; and
2. Net method

Consider the following example:

ABC Company sold goods to XYZ Company for P100,000, with terms 2/10, n/30. XYZ Company paid ABC Company:
a) Within the discount period
b) Outside of the discount period

Gross Method
Under the gross method, the sale is recorded at the gross amount or the full amount of credit sale, which is P100,000.
The journal entry to record the sale is as follows:
Accounts Receivable 100,000
Sales 100,000
 a) Collected within the discount period – if the receivable is collected within the discount period, the customer
is given a discount, which is deducted from the whole amount of receivable. The amount to be collected would
be net of the cash discount. In this case, the discount is P2,000, which is 2% of P100,000. The journal entry is
as follows:
Cash 98,000
Sales Discount 2,000
Accounts Receivable 100,000

b) Collected outside the discount period – if the receivable is collected outside the discount period, the whole
amount is collected. The journal entry is as follows:
Cash 100,000
Accounts Receivable 100,000

Net Method
Under the net method, the sale is already recorded at the net amount. The journal entry is as follows:
Accounts Receivable 98,000
Sales 98,000

a) Collected within the discount period – if the receivable is collected within the discount period, the customer
is entitled to the discount. Since the sale was already recorded at net of the discount, the collection would be
recorded as follows:
Cash 98,000
Accounts Receivable 98,000

b) Collected outside the discount period – if the receivable is collected outside the discount period, the whole
amount is collected. However, since the receivable was recorded at net, and the amount to be collected is at
the gross amount of sales, the journal entry is as follows:
Cash 100,000
Accounts Receivable 98,000
Sales Discount Forfeited 2,000
The Sales Discount Forfeited account is presented under Other Income.

(e) Write-Off
This refers to those uncollectible accounts that are already considered to be worthless.

This will be further discussed under “Bad Debts Expense”. To give you an overview, the journal entry to record this
transaction is as follows:
Allowance for Bad Debts xxx
Accounts Receivable xxx

(f) Recoveries
These refer to those accounts that were previously considered worthless (i.e. written-off) but were subsequently
collected by the entity.

The same as (e), this will be further discussed under “Bad Debts Expense”. The journal entry to record this transaction
is as follows:
Accounts Receivable xxx
Allowance for Bad Debts xxx

Then the eventual collection of the recovery is recorded as follows:

Cash xxx
Accounts Receivable xxx
 Illustrative Problem 2
CONSEQUENCE Corporation presented the following items related to its accounts receivable:
Accounts receivable, January 1 P500,000
Credit sales 8,600,000
Collections, including collections from recoveries 8,200,000
Sales returns 50,000
Sales discounts 120,000
Accounts written off 10,000
Recoveries 15,000

Requirement: What is the balance of accounts receivable on December 31?

Solution:
Accounts receivable, January 1 500,000
Add:
Credit sales 8,600,000
Recoveries 15,000 8,615,000
Total 9,115,000
Less:
Collections, including collections from recoveries 8,200,000
Sales returns 50,000
Sales discounts 120,000
Write-off 10,000 8,380,000
Accounts receivable, December 31 735,000

Net Realizable Value

The initial amount for accounts receivable shall be reduced by adjustments, which, in the ordinary course of business,
will reduce the amount recoverable from the customer.

The computation of the net realizable value of accounts receivable is as follows:

Accounts receivable xxx
Allowance for freight charge (xxx)
Allowance for sales return (xxx)
Allowance for sales discount (xxx)
Allowance for doubtful accounts (xxx)
Net realizable value xxx

Allowance for Freight Charge

In order to give a proper accounting recognition to freight charges in relation to accounts receivable, we have to
understand the following terms:
• In relation to ownership of the goods:
o FOB Destination – under this, when goods are shipped, the ownership of the goods is transferred to
the buyer upon receipt. This means that during the time the goods are still in transit, the seller retains
ownership of the goods.
o FOB Shipping Point – under this, the ownership of the goods is transferred to the buyer upon shipment.
• In relation to the party who pays for the freight charges:
o Freight Prepaid – under this, the seller pays for the freight charges before the goods are shipped, thus
the term “prepaid”.
o Freight Collect – under this, the buyer pays for the freight charges once the goods have been received.
That is why the term is freight “collect” since, in effect, the courier collects for the freight charges from
the buyer once the goods have been received by the buyer.
The accounting for these has already been discussed in your basic accounting subject. The main focus of this discussion
is the accounting for allowance for freight charges.

The only transaction that would result to the allowance for freight charges would be shipments under FOB Destination
– Freight Collect.

The main idea here is, whoever owns the goods during the time that the goods are still in transit should recognize the
expense related to the freight charge.

Under FOB – Destination, the seller owns the goods during the time the goods are still in transit, thus, the seller should
recognize the expense related to the freight charges (i.e. Freight Out). Meanwhile, under Freight Collect, the buyer
pays for the freight charges. In other words, the expense to be recognized by the seller is paid for by the buyer. In
effect, the seller actually has a liability to the buyer; however, since the seller also has a receivable (i.e. accounts
receivable) from the buyer, the seller’s liability to the buyer is simply offset against his receivable from the buyer,
through the allowance for freight charge account.

For instance, an entity sold goods to a buyer for P100,000. The term is FOB destination, however, the buyer paid for
the freight charges. The journal entry to record the sale transaction would be as follows:
Accounts Receivable 100,000
Freight Out 5,000
Sales 100,000
Allowance for Freight Charges 5,000

Upon collection of the amount, the buyer can then offset the payment he made for the freight charges against his
payable to the seller. The seller then records the collection as follows:
Cash 95,000
Allowance for Freight Charges 5,000
Accounts Receivable 100,000

Allowance for Sales Return

This refers to those estimated returns that will be recognized in the future that should be recognized in the current
period.

For instance, an entity sold goods on December 31, 2020 for P100,000. Based from past experiences, 5% of sales are
returned. The journal entries would be as follows:
Accounts Receivable 100,000
Sales 100,000

Sales Returns 5,000

Allowance for Sales Returns 5,000

Despite the fact that there were no actual returns made yet, the expected returns should be recorded in the current
period to avoid recognizing in the future a return that pertains to a sale in the current period.

Upon the actual return in the future, the allowance for sales returns would be debited. If the actual return is more
than the estimated return, the difference is debited to the sales returns account

Continuing with the example, let’s say the customer returned some goods on January 8, 2021, the following are the
journal entries for each independent case:

Journal Entry – Actual Return is P5,000

Allowance for Sales Returns 5,000
Accounts Receivable 5,000
Journal Entry – Actual Return is P8,000
Allowance for Sales Returns 5,000
Sales Returns 3,000
Accounts Receivable 8,000

Journal Entry – Actual Return is P4,500

Allowance for Sales Returns 4,500
Accounts Receivable 4,500

Allowance for Sales Discounts

The same concept as sales returns, future sales discounts are recorded in the same period that the sales were
recorded. For instance, on December 31, 2020, an entity sold P1,000,000 worth of goods, with terms 2/10, n/30. Based
from past experiences, discounts are availed for 30% of the sales, while the rest are collected outside the discount
period. This means that P300,000 of the P1,000,000 sales would avail of the 2% discount, resulting to a sales discount
of P6,000.

The journal entries at year-end to record the sale transaction and the estimate are as follows:
Sales Discounts 6,000
Allowance for Sales Discounts 6,000

When the customers actually avail of the discount the following year, the allowance for sales discounts account is
debited. If the actual discount is greater than the estimated discount, the difference is debited to the sales discounts
account.

Continuing with the example, let’s say some customers paid in 2021 within the discount period. The following are the
journal entries for each independent case:

Journal Entry – 30% availed of the discounts

Cash 294,000
Allowance for Sales Discounts 6,000
Accounts Receivable 300,000

Journal Entry – 50% availed of the discounts

Cash 490,000
Allowance for Sales Discounts 6,000
Sales Discounts 4,000
Accounts Receivable 500,000

The actual sales discounts availed total to P10,000 (i.e. 2% of P500,000, which is 50% of P1,000,000). Since only P6,000
was estimated in 2020, the difference is debited to sales discounts.

Journal Entry – 20% availed of the discounts

Cash 196,000
Allowance for Sales Discounts 4,000
Accounts Receivable 200,000
Allowance for Doubtful Accounts
Allowance for doubtful accounts, or allowance for bad debts, represents the estimated amount that is uncollectible.

During the course of business, it is quite normal for some accounts to be uncollectible. That is why companies perform
procedures, such as credit investigation, before they can sell on account to a party. This would lessen the risk that the
sale on account would be uncollectible. However, despite the performance of these procedures, uncollectible accounts
cannot be totally eradicated, thus, companies still estimate a portion of their accounts receivable to be uncollectible
and set up an allowance for doubtful accounts.

Full discussion is presented under “Bad Debts Expense”

Illustrative Problem 3
LION Corporation’s accounts receivable on December 31, 2020 amounted to P850,000. Information related to the
account are as follows:
• Freight charges worth P10,000 were incurred by the entity, but paid for by the buyer (i.e. FOB Destination,
Freight Collect)
• Sales of P70,000 were made on December 30, 2020, the last day of operations for the year. Out of this amount,
P2,000 is expected to be returned, while P20,000 are expected to be paid within the discount period. The
entity sells with terms 1/5, n/20.
• Uncollectible accounts are estimated to be P40,000

Requirement: What is the net realizable value of LION Corporation’s accounts receivable on December 31, 2020?

Solution:
Accounts receivable 850,000
Allowance for freight charges (10,000)
Allowance for sales returns (2,000)
Allowance for bad debts (P20,000 * 1%) (200)
Allowance for doubtful accounts (40,000)
Net realizable value 797,800

BAD DEBTS EXPENSE

Accounting for Bad Debts

Business entities sell on credit rather than only for cash to increase total sales and thereby increasing income.
However, an entity that sells on credit assumes the risk that some customers will not pay their accounts.

When an account becomes uncollectible, the entity has sustained a bad debts loss. This loss is simply one of the
costs of doing business on credit.

Two methods are followed in accounting for bad debts:

1. Allowance method
2. Direct write-off method

Allowance Method
Under the allowance method, the recognition of a doubtful accounts expense (or bad debt expense) is required if
accounts are doubtful of collection. The journal entry to recognize the doubtful accounts is:
Doubtful Accounts Expense xxx
Allowance for Doubtful Accounts xxx
As discussed earlier, the “allowance for doubtful accounts” is a deduction from accounts receivable to arrive at its
net realizable value.

If the doubtful accounts are subsequently found out to be worthless or uncollectible, the accounts are written off as
follows:
Allowance for Doubtful Accounts xxx
Accounts Receivable xxx

Recoveries
If a collection is made on account previously written off as uncollectible, the customary procedure is first to recharge
the customer’s account with the amount collected and possibly with the entire amount previously charged off if it is
now expected that collection will be received in full.

The collection is then recorded normally by debiting cash and crediting accounts receivable.

The recharging of the customer’s account is usually followed because it is an evidence of the attempt of the
customer to reestablish his credit with the entity.

As mentioned in the previous topic, the journal entries pertinent to recoveries are as follows:

• Recharging of the customer’s account:

Accounts Receivable xxx
Allowance for Bad Debts xxx

• Collection of the recharged customer’s account:

Cash xxx
Accounts Receivable xxx

Direct Write-Off Method

Under the direct write-off method, the recognition of bad debts expense is only required if the accounts proved to
be worthless. The journal entry is as follows:
Doubtful Accounts Expense xxx
Accounts Receivable xxx

Method Permitted by Standards

The Allowance Method is required by generally accepted accounting principles because it conforms with the
matching principle. Moreover, accounts receivable would be properly measured at net realizable value.

The direct write-off method is often used by small businesses because it is simple to apply. Also, the Bureau of
Internal Revenue (BIR) actually only recognizes this method for income tax purposes.

Illustrative Problem 2
MORNING Corporation started its operations on January 2, 2020. Its operations include selling of car parts and car
accessories, both in cash and on account.

During its first year of operations, the company has made a lot of sales. However, due to the rising number of
customers purchasing on account, the company decided to make an estimate of accounts that are doubtful of
collection.

On September 1, 2020, the company estimated that P100,000 of its total accounts receivable are doubtful of
collection. On September 15, the company identified Customer X’s account to be worthless, amounting to P8,000.

However, on October 5, 2020, Customer X paid his balance, prompting the entity to record a recovery.
Requirement: Provide the journal entries related to the transactions mentioned, using:
1. Allowance method
2. Direct write-off method

Solution:
Requirement 1
Sept. 1 Bad Debts Expense 100,000
Allowance for Bad Debts 100,000

Sept. 15 Allowance for Bad Debts 8,000

Accounts Receivable 8,000

Oct. 5 Accounts Receivable 8,000

Allowance for Bad Debts 8,000

Cash 8,000
Accounts Receivable 8,000

Requirement 2:
Sept. 15 Bad Debts Expense 8,000
Accounts Receivable 8,000

Oct. 5 Accounts Receivable 8,000

Bad Debts Expense 8,000

Cash 8,000
Accounts Receivable 8,000

Notes:
• The bad debts expense under the allowance method is based from the estimated uncollectible accounts, while
under the direct write-off method, the bad debts expense is based from the actual worthless accounts.
• The allowance method is what is required by generally accepted accounting principles.

T-Account of Allowance for Doubtful Accounts

To summarize, the following is the t-account for allowance for doubtful accounts:
Allowance for Doubtful Accounts
Write-off xxx xxx Beginning balance
xxx Doubtful accounts expense
xxx Recoveries
xxx Ending balance

Methods of Estimating Doubtful Accounts

There are three methods of estimating doubtful accounts, namely:
1. Aging of accounts receivable
2. Percentage of accounts receivable
3. Percentage of sales

Aging of Accounts Receivable

Under this method, the accounts receivables are classified into their specific age. This method is also considered as a
“statement of financial position approach”, since the basis of the computation is a statement of financial position
account (i.e. accounts receivable).

Since the basis is a statement financial position account, the resulting figure should also be the amount for a statement
of financial position account, specifically, the required ending balance of the allowance for doubtful accounts. This is
also the reason why, in most cases, the term used is the required allowance.
 Illustrative Problem 3
AMIEL Corporation’s accounts receivable has a balance of P1,200,000 on December 31, 2020. The entity is currently
estimating how much should be the allowance at year-end. The January 1, 2020 balance of its allowance for bad debts
account is P10,000.

In determining the required allowance, the entity used the aging of accounts receivable method. The following data
are summarized in aging the accounts at year-end:

Balance Experience rate

Not due 500,000 1%
1-30 days past due 300,000 2%
31-60 days past due 200,000 4%
61-90 days past due 100,000 7%
91-180 days past due 50,000 10%
181-365 days past due 30,000 30%
More than one year 20,000 50%
Total 1,200,000

The experience rate represents the percentage of doubtful accounts per age group based from the entity’s past
experiences.

Requirements:
1. Determine the required allowance at December 31, 2020.
2. Determine the bad debts expense for 2020.
3. Determine the net realizable value of accounts receivable at December 31, 2020.
4. Prepare the pertinent journal entry/ies.

Solution:
Requirement 1
Required
Balance Experience rate Allowance
Not due 500,000 1% 5,000
1-30 days past due 300,000 2% 6,000
31-60 days past due 200,000 4% 8,000
61-90 days past due 100,000 7% 7,000
91-180 days past due 50,000 10% 5,000
181-365 days past due 30,000 30% 9,000
More than one year 20,000 50% 10,000

Totals 1,200,000 50,000

Requirement 2
Required allowance 50,000
Allowance for bad debts, Jan. 1, 2020 (10,000)
Bad debts expense 40,000

Alternatively, you may use the t-account to squeeze the bad debts expense.
Allowance for Bad Debts
Write-off 0 10,000 Beginning balance
40,000 Bad debts expense (SQUEEZED)
0 Recoveries
50,000 Ending balance
Requirement 3
Accounts receivable 1,200,000
Allowance for bad debts (50,000)
Net realizable value 1,150,000

Requirement 4
Bad Debts Expense 40,000
Allowance for Bad Debts 40,000

Percentage of Accounts Receivable

This is a much more straightforward approach, wherein a single percentage is multiplied by the balance of accounts
receivable; compared to the aging of accounts receivable approach where each age group has its own specific
percentage.

This is also a “statement of financial position approach” since the basis is accounts receivable. Accordingly, the
resulting amount would also be the required allowance.

Illustrative Problem 4
JAMIE Company’s accounts receivable has a balance of P2,000,000 on December 31, 2020. In determining its allowance
for bad debts, the company has been using percentage of accounts receivable.

Based from experience, 8% of accounts receivable are doubtful of collection. The January 1, 2020 balance of the
entity’s allowance for bad debts is P90,000.

Requirements:
1. Determine the required allowance at December 31, 2020.
2. Determine the bad debts expense for 2020.
3. Determine the net realizable value of accounts receivable at December 31, 2020.
4. Prepare the pertinent journal entry/ies.

Solution:
Requirement 1
Accounts receivable 2,000,000
Multiply: percentage of doubtful accounts 8%
Allowance for bad debts 160,000

Requirement 2
Allowance for bad debts, Dec. 31, 2020 160,000
Allowance for bad debts, Jan. 1, 2020 (90,000)
Bad debts expense, 2020 70,000

Requirement 3
Accounts receivable, Dec. 31, 2020 2,000,000
Allowance for bad debts, Dec. 31, 2020 (160,000)
Net realizable value 1,840,000

Requirement 4
Bad Debts Expense 70,000
Allowance for Bad Debts 70,000
Percentage of Sales
Under this method, a percentage is multiplied by the amount of sales for the period. The resulting figure determined
is actually the bad debts expense. This is because the basis is the company’s sales, which is an income statement
account; therefore, the resulting figure should also be of an income statement account (i.e. bad debts expense).
Furthermore, this is consistent with the matching principle.

It is for this reason that percentage of sales is also called the “income statement approach”.

Illustrative Problem 5
ZOE Company’s accounts receivable has a balance of P3,500,000 on December 31, 2020. The company is currently
using the percentage of sales in determining its bad debts expense.

The percentage used by the entity is 1%, and the sales of the company for 2020 amounted to P12,000,000. The January
1, 2020 balance of its allowance for bad debts is P90,000.

Requirements:
1. Determine the bad debts expense for 2020.
2. Determine the balance of allowance for bad debts at December 31, 2020.
3. Determine the net realizable value of accounts receivable at December 31, 2020.
4. Prepare the pertinent journal entry/ies.

Solution:
Requirement 1
Sales, 2020 12,000,000
Multiply: percentage of sales 1%

Bad debts expense 120,000

Requirement 2
Allowance for bad debts, Jan. 1, 2020 90,000
Bad debts expense, 2020 120,000
Allowance for bad debts, Dec. 31, 2020 210,000

Requirement 3
Accounts receivable, Dec. 31, 2020 3,500,000
Allowance for bad debts, Dec. 31, 2020 (210,000)
Net realizable value 3,290,000

Requirement 4
Bad Debts Expense 120,000
Allowance for Bad Debts 120,000
Arguments for and Against the Different Methods
Aging of accounts receivable:
• For: this method has the advantage of presenting fairly the accounts receivable in the statement of financial
position at net realizable value.
• Against: it violates the matching principle. This can also become prohibitively time consuming if a large number
of accounts are involved.
Percentage of accounts receivable:
• For: similar to aging, this also presents the accounts receivable at estimated net realizable value. Also, this is
very simple to apply.
• Against: it violates the matching principle. The loss experience rate may be difficult to obtain and may not be
reliable.
Percentage of sales:
• For: it follows the matching principle since it matches the bad debts expense against the sales.
• Against: the accounts receivable may not be shown at estimated realizable value because the allowance
account may prove excessive or inadequate.

All three are permitted by GAAP; however, it is important to note that the aging of accounts receivable is mostly used
in practice as it is the most accurate, especially for annual reporting.