Accounts Receivable
Key Things to Know
Key Things To Know
Revenue is “recognized” when:
1) the goods or service has been provided, and
2) the collection of funds the seller is entitled to is reasonably assured (expected)
Sales Returns:
Customer has the right to return merchandise after the purchase
Returns are very common in some industries.
Expected returns must be estimated and recorded during the period the sale occurs.
The amount recorded for sales returns
Sales dollars x historical % expected
Inventory/CGS amount is the gross profit on the expected return sale
Record estimated returns in the period of the sale:
| Sales Returns $XX Allowance for Sales Returns $XX Inventory – Est $XX |
“Sales returns” is a decrease to net sales.
“Allowance for sales returns” is a decrease to accounts receivable, net.
Record actual returns when the return occurs at the actual value
Record Inventory and Cost of Goods Sold only when inventory is resold
| Allowance for Sales Returns $actual Accounts Receivable $actual Inventory $actual Cost of Goods Sold – Est $actual |
Accounts Receivable:
Amounts the customer owes to the company for goods or services provided on credit
Accounts receivable is reported:
|
On the Balance Sheet: Accounts Receivable |
Means: Total amount customers owe |
The asset reported on the balance sheet, net accounts receivable, must be the amount
expected to be a future benefit.
Uncollectible accounts receivable have no future economic benefit.
Accounts used to record transactions related to accounts receivable:
Sales – represents the amount (price) of goods or services provided
Accounts receivable – represents the amount the customer owes (not yet paid)
Allowance for uncollectible accounts – represents the total amount you do not
expect to collect – it is an estimate, you don’t know who won’t pay or how much
Bad debt expense – the change in the estimate of uncollectible accounts for the current period
4 key accounts receivable transactions to record:
1) Credit sale (increase A/R)
2) Collect from customer (decrease A/R)
3) Write-off an account when you know who and won’t pay and the amount
4) Estimate bad debt expense (to match with current period sales)
Transactions 1, 2, and 3 are recorded during the period at the time occurs.
Transaction 4 is an adjusting entry made at the end of the period.
Journal entries for the 4 transactions:
| Sales on credit Collect accounts receivable
Accounts Receivable Cash
Estimate bad debt expense: Write – off accounts receivable: Bad debt expense* Allowance for uncollectible accounts |
* (or may reverse debit and credit accounts when overestimated bad debt expense)
The accounts are changed by the following transactions:
Accounts Receivable:
Increases when a sale is made on credit
Decreases when the customer pays
Decreases when an account is written off; you know who won’t pay and amount
Allowance for Uncollectible Accounts:
Increases when estimating bad debt expense using % sales method
Increases or decreases when estimating bad debt expense using % of accounts
(adjusting the cumulative estimate)
Decreases when an account is written off
The allowance account represents the total estimate of what won’t be collected.
The company is not sure who won’t pay or exactly how much.
Remove the amount from the allowance account, the accounts receivable list, and the accounts receivable account when the customer and amount is known.
Bad Debt Expense:
Changes ONLY when bad debt expense is ESTIMATED at end of the period
Overestimates in prior periods are reduced in the current period. Underestimates required more to be added.
The 4 transactions change the accounts:
Bad Debt Expense:
Occurs when a receivable is not expected to be collected.
Record in the same period the sale is made.
Always an estimate (based on past history) because the company does not know who and how much will not be collected at the time of the sale
Two common ways to estimate the amount of bad debt expense for the current period:
Income Statement Approach: % of Sales Method:
Used internally for monthly financial statements.
Ignores probably future economic benefit when valuing A/R on the balance sheet
Balance Sheet Approach: % of Accounts Receivable (aging method):
The journal entry for the “plug” amount will either be:
| Allowance for uncollectible accounts Bad debt expense or Bad debt expense |
Use an aging report:
1) Multiply the balance in each aging category x the % given for each category
2) Add all estimated uncollectible amounts to get the total amount not expected to collect
3) The total must be the final ending balance for allowance for uncollectible accounts.
% A/R Method:
The expense for the current period is the change in the cumulative amount not expected to be collected
Considers all sales and accounts receivables (cumulative) in the current and prior periods
When an account written off is subsequently collected
| 1st Accounts Receivable Allowance for Uncollectible Accounts 2nd Cash |
Record the customer owes and then record the payment to pay the receivable.
Receivables as Collateral for a Loan
The bank is repaid plus interest/fees as cash is collected from accounts receivables
Journal Entries:
| Cash Finance Charge (% fee) Notes Payable – financing arrangement Cash Notes Payable – financing arrangement |
Factoring Accounts Receivable
The buyer of the accounts receivables collects the receivables and charges a fee for this service.
The seller receives less than 100% of the face amount of the receivable to cover risk
The seller gives up the right to the collect the accounts receivable
Factoring receivables is accounted for as either a sale or a secured borrowing
Sale:
Account for as a sale when control of the asset is surrendered and each of the following occurs:
1. The asset is isolated beyond the reach of the company that transferred the receivable to the buyer.
2. The transferee (buyer) has the right to pledge or factor the assets it receives.
3. The transferor (seller) does not maintain effective control over the transferred assets; the assets are not going to return to the transferor.
If all of the above does not occur, the accounts receivable continues to be reported on the balance sheet of the seller and the transaction is accounted for as a secured borrowing (a loan with the accounts receivable as collateral).
2 Types of Secured borrowings:
1) Factor with Recourse
2) Factor without Recourse
Sell Accounts Receivable with Recourse:
The seller retains all the risk of bad debt expense and guarantees the buyer (factor) will be paid if the customer does not pay the buyer.
An estimate of uncollectible amounts is recorded as a liability on the seller’s balance sheet (called a recourse liability.)
Journal Entry:
Seller:
| Cash $net cash received Receivable from factor $buyer keeps to cover adjustments Loss on sale of receivables $fee + estimated bad debt expense Recourse liability $estimated bad debt expense Accounts receivable $total gross accounts sold |
Buyer:
| Accounts receivable $total gross accounts purchased Payable to seller $potential sales adjustments Financing revenue $interest Cash $net cash paid |
Sell Accounts Receivable without recourse:
The company that buys the accounts receivable (the factor) is responsible
for bad debt expense
The fee is higher to cover the potential bad debt expense
Journal entries:
Seller:
| Cash $net cash received Receivable from factor $buyer keeps to cover adjustments Loss on sale of receivables $fee Accounts receivable $total gross accounts sold |
(same debits and credits as with recourse except no recourse liability credit and different terms give different amounts)
Buyer:
| Accounts receivable $total gross accounts purchased Payable to seller $potential sales adjustments Financing revenue $interest Cash $net cash paid |
(same entry as a purchase with recourse – different amounts)
| Bad debt expense Allowance for Doubtful Accounts |