Doubtful

z
Accounts
Methods of estimating doubtful accounts

 Doubtful accounts are recognized when the loss is probable and the amount can be
estimated reliably.

Three Methods of estimating doubtful accounts:

 Aging the accounts receivable or “statement of financial position approach”

 Percent of accounts receivable or also statement of financial position approach

 Percent of sales or “income statement approach”

AGING OF ACCOUNTS RECEIVABLE

 Involves an analysis where the accounts are classified into not due or past due

a. Not due
b. 1 to 30 days past due
c. 31 to 60 days past due
d. 61 to 90 days past due
e. 91 to 120 days past due
f. 121 to 180 days past due
g. 181 to 365 days past due
h. More than 1 year past due
i. Bankrupt or under litigation
 The allowance is then determined by multiplying the total of each classification
by the rate or percent of loss experienced by the entity for each category.

 The major argument for the use of this method is the more accurate and
scientific computation of the allowance for doubtful accounts, and
consequently, the accounts receivable are fairly presented in the statement of
financial position at net realizable value.

 The objection to the aging method is that it violates the matching process.
Moreover, this method could become prohibitively time consuming if a large
number of accounts are involved.
Illustration:
The following data summarized in aging the accounts receivable at the end of period:
(b) (a x b)
(a) Experience Required
Balance rate allowance
Not due 500,000 1% 5,000
1-30 days past due 300,000 2% 6,000
31 to 60 days past due 200,000 4% 8,000
61 to 90 days past due 100,000 7% 7,000
91 to 180 days past due 50,000 10% 5,000
181 to 365 days past due 30,000 30% 9,000
More than 1 year 20,000 50% 10,000
1,200,000 50,000

 The amount computed by aging of accounts receivable represents the required

allowance for doubtful accounts at the end of the period
 Thus, if the allowance for doubtful accounts has a credit balance of P10,000
before adjustment, the doubtful accounts expense is determined as follows:

Required allowance 50,000

Less: Allowance balance before adjustment 10,000
Doubtful accounts expense 40,000

 The journal entry to record the doubtful accounts expense is:

Doubtful accounts 40,000

Allowance for doubtful accounts 40,000
When is an account past due?

 The credit terms will determine whether an account is past due. For
example, if the credit terms were 2/10, n/30, and the account is 45 days
old, it is considered to be 15 days past due.

 Therefore, the phrase “past due” refers to the period beyond the
maximum credit term. In the example, the credit term or credit period is
30 days.
Percent of accounts receivable
 A certain rate is multiplied by the open accounts at the end of the period in
order to get the required allowance balance. The rate used is usually
determined from the past experience of the entity.

 This procedure has the advantage of presenting the accounts receivable at

estimated net realizable value. It is also simple to apply.

 However, the application of this approach violated the principle of matching

bad debt loss against the sales revenue.

 Moreover, the loss experience rate may be difficult to obtain and may not be
reliable.
Illustration:

The balance of accounts receivable is P2,000,000 and the credit balance in the
allowance for doubtful accounts is P10,000. Doubtful accounts are estimated
at 3% of accounts receivable.

Journal entry:

Doubtful accounts 50,000

Allowance for doubtful accounts 50,000

Required allowance (3% x 2,000,000) 60,000

Less: Credit balance in allowance 10,000
Doubtful accounts expense 50,000
Percent of sales
 The amount of sales for the year is multiplied by a certain rate to get the
doubtful accounts expense. The rate may be applied on credit sales or total
sales.

 When the percent of sales method is used in computing doubtful account

proper matching of cost against revenue is achieved.

 This is so because the bad debt loss is directly related to sales and reported
in the year of sale.

 This method is an income statement approach because it favors the income

statement
Illustration:

The following accounts are gathered from the ledger:

Accounts receivable 1,000,000

Sales 5,050,000
Sales return 50,000
Allowance for doubtful accounts 20,000

If doubtful accounts are estimated at 1% of net sales, the doubtful accounts

expense is P50,000 (1% x 5,000,000) and recorded as follows:

Doubtful accounts 50,000

Allowance for doubtful accounts 50,000
 If this method is used, the resulting amount of the computation is already
the amount to the doubtful accounts expense and not the required
allowance, in contradistinction with the aging method and the percent of
accounts receivable method.

 The allowance balance before adjustment is ignored in determining the

doubtful accounts expense to be recorded.

 However, the allowance for doubtful accounts should have an adjusted

balance of P70,000, the beginning allowance of P20,000 plus the
adjustment of P50,000
Correction in allowance for doubtful accounts

 The percent of sales method of estimating doubtful accounts has the disadvantage
of the allowance for doubtful accounts being inadequate or excessive. Aging the
accounts is then necessary to test the reasonableness of the allowance.

 The correction is to be reported in the income statement either as an addition to or

subtraction from doubtful accounts expense.

 Change in estimate are treated currently and prospectively.

Correction in allowance for doubtful accounts

Accordingly, an inadequate allowance is adjusted as follows:

Doubtful accounts xxx

Allowance for doubtful accounts xxx

An excessive allowance is recorded as follows:

Allowance for doubtful accounts xxx

Doubtful accounts xxx
 When the allowance is excessive, there is a corollary problem when the discrepancy is
more than the debit balance in the doubtful accounts expense account.
 For example, if the amount of correction due to excessive allowance is P30,000 and
the doubtful accounts expense account has a debit balance of P20,000, following the
above procedure will result to a credit balance in the doubtful accounts expense
account of P10,000. Such balance is obviously abnormal.
 It is believed that in such case, the P10,000 difference shall not be treated as a prior
period error but included in the determination of the income of the current period.
Journal entry:
Allowance for doubtful accounts 30,000
Doubtful accounts 20,000
Miscellaneous income 10,000
Debit balance in allowance account
 Normally allowance for doubtful account has credit balance.
 However, in certain instances, it may have a debit balance because it may be the
policy of the entity to adjust the allowance at the end of the period and record
accounts written off during the year.
Example: On January 1, the allowance account before adjustment has a credit
balance of P30,000 and during the year an account of P50,000 is written off and
recorded as follows:

Allowance for doubtful accounts 50,000

Accounts receivable 50,000

Thus, on December 31, the allowance account has debit balance of P20,000 before
adjustment.
<

 The debit balance does not indicate that the allowance is inadequate because the
accounts written off during the year and charged to the allowance may have arisen
from the current year sales.

 Thus, the charge to the allowance account simply predates the recording of doubtful
accounts. At the end of the period, when adjustments are made, the debit balance
should be considered.

 To continue the example – if on December 31, the required allowance is P40,000 the
adjustment should be:

Doubtful account 60,000

Allowance for doubtful account 60,000

Required allowance 40,000

Add: Debit balance in allowance 20,000
Doubtful accounts expense 60,000
Impairment of accounts receivable
 Accounts receivable considered uncollectible are deemed to be impaired.

 PFRS 9, paragraph 5.2.2 provides that an entity shall apply the impairment
requirements in paragraphs 58 to 65 of PAS 39 for financial asset measured at
amortized cost.

 PAS 39 paragraph 58, provides that an entity shall assess at every year-end whether
there is an objective evidence that a financial asset or group of financial assets is
impaired.

 Financial asset is impaired if there is objective evidence of impairment as a result of one

or more loss events having an impact on the estimated cash flows of the financial asset
that can be measured reliably.

 Accounts receivable is considered impaired if a loss event indicates a “negative effect”

on the estimated cash flows to be recovered from the customer
Loss events
 Significant financial difficulty of the customer

 Breach of contract, such as default in payment of principal and interest

 Restructuring or renegotiation of the terms of the accounts receivable due to the

financial distress of the customer

 Measurable decrease in the estimated cash flows from a group of accounts

receivable, although the decrease cannot yet be identified with individual accounts
receivable.
Impairment assessment
PAS 39, paragraph 64, provides the following detailed guideline in assessing whether
accounts receivable should be considered impaired:

 Individually significant account receivable should be considered for impairment

separately and if impaired, the impairment loss is recognized.

 Accounts receivable not individually significant should be collectively assessed for

impairment.

 Accounts receivable not considered impaired should be included with other

accounts receivable with similar credit-risk characteristics and collectively
assessed for impairment.
Illustration:
An entity had the following accounts receivable at year-end:
Customer A 1,000,000
Customer B 1,500,000
Customer C 2,500,000
Customer D 3,000,000
Customer E 2,000,000
Other customers’ accounts 4,000,000
14,000,000
All of the accounts receivable are individually significant, except the other customers’ accounts
receivable.
The entity has determined the impairment loss as follows:
Customer A not impaired 0
Customer B not impaired 0
Customer C partly impaired 1,500,000
Customer D partly impaired 1,000,000
Customer E partly impaired 2,000,000
Computation of impairment loss

It is reliably determined that a composite rate of 5% is appropriate to measure impairment on all

other accounts receivable
The impairment loss is computed as follows:
Customer C 1,500,000
Customer D 1,000,000
Customer E 2,000,000
Other accounts receivable (5% x 6,500,000) 325,000
Total impairment loss 4,825,000

Customer A 1,000,000
Customer B 1,500,000
Other customers’ accounts 4,000,000
Total other accounts receivable 6,500,000
The impairment loss is recorded as follows:

Doubtful accounts 4,825,000

Allowance for doubtful accounts 4,825,000

 The accounts receivable from customers A and B which are not considered impaired should be
included in the collective assessment of all other accounts receivable.

 This is the controversial part of the computation but the inclusion of unimpaired accounts
receivable in the collective assessment for impairment is prescribed by the standard. The rule
is principally prescriptive rather than principle – based.

 The percentage of accounts receivable and percentage of sales method can be considered
“collective assessment approach” of measuring impairment.

 On the other hand, the aging method is an individual assessment approach.

DAGHANG
SALAMAT