Accounting for Bad Debts Chapter 12 Accounting for Bad Debts © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 1 Describing how the Bad Debts Expense account and the Allowance for Doubtful Accounts account are used to record bad debts LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts Debts that come from credit customers who do not pay their bills Affects a company’s credit policy Cannot grant credit to just any company LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts On December 1, 2008, Corey Co. sold merchandise on account for $5,000. On July 1, 2009, Corey Co. determines that the $5,000 will never be collected. 2008 2009 Dec 1 Sales of $5,000 recorded Dec 31 End of fiscal year Jul 1 Debt determined to be bad LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts Bad debts expense should be recognized in the accounting period in which the sales were made. 2008 2009 Dec 1 Sales of $5,000 recorded Dec 31 End of fiscal year Jul 1 Debt determined to be bad LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts Solution: Estimate how many of the current sales will be uncollectible Prepare an adjusting entry 2008 2009 Dec 1 Sales of $5,000 recorded Dec 31 End of fiscal year Jul 1 Debt determined to be bad LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Allowance for Doubtful Accounts Is a contra-asset account Is subtracted from accounts receivable Accumulates expected amount of uncollectibles as of a given date Contra account. An account with a balance that is the opposite of the normal balance. For example, Accumulated Depreciation is a contra asset account, because its credit balance is contra to the debit balance for an asset account. LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Adjusting Entry for Bad Debts General Journal Page 8 Date Account Titles and Description PR Dr. Cr. Dec 31 Bad Debts Expense XXXX Allowance for Doubtful Accounts XXXX Contra-Asset Account LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Balance Sheet Presentation Corbin Company Partial Balance Sheet December 31, 200X Net Realizable Value Gross Amount Estimated to be Uncollectible Current Assets: Cash $ 10,400 Accounts receivable $100,000 Less: Allowance for doubtful accounts 6,000 94,000 Merchandise inventory 300,000 Total current assets $404,400 Total Current Assets LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Net Realizable Value The amount of Accounts Receivable that is expected to be collected Calculated by subtracting Allowance for Doubtful Accounts from Accounts Receivable LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Account Titles and Description Writing off an account General Journal Page 8 Date Account Titles and Description PR Dr. Cr. Jul 1 Allowance for Doubtful Accounts 5,000 Accounts Receivable-Discello 5,000 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 2 Using the income statement approach and the balance sheet approach to estimate the amount of Bad Debts Expense LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

How is this amount determined? Estimating the Amount General Journal Page 8 Date Account Titles and Description PR Dr. Cr. Dec 31 Bad Debts Expense XXXX Allowance for Doubtful Accounts XXXX How is this amount determined? LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Income Statement Approach Bad Debts Expense = Percentage of net credit sales Focus is on measuring the expense, which is reported on Income Statement. Matching requirement- ignores previous balance of Allowance for Doubtful Accounts when estimating Bad Debts Expense for current period. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater 7

Exercise Compute Net Sales: Sales $110,000 Sales Returns & Allowances (500) Sales Discounts (9,500) Net Sales $100,000

Exercise LO-2

Account Titles and Description Exercise 13-2 General Journal Page 8 Date Account Titles and Description PR Dr. Cr. Dec 31 Bad Debts Expense 4,000 Allowance for Doubtful Accounts 4,000 LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Any existing balance in the Allowance account is ignored. Accounts Receivable Bal. 30,000 Allowance for Doubtful Accounts 5,000 4,000 Adj. $9,000 Bal. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Balance Sheet Approach Adjusting entries are based on bringing the Allowance account to a required amount. Method is based on the Accounts Receivable amount and the aging process. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater 7

Balance Sheet Approach Net realizable value - The amount (accounts receivable – Allowance for doubtful accounts) that is expected to be collected. Focus is on determining the net realizable value of Accounts Receivable, which is reported on Balance Sheet LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater 7

Learning Objective 3 Preparing an Aging of Accounts Receivable LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Example Mayfair Co. has the following balances in its accounts at the end of 2008 Accounts Receivable Bal. 30,000 Allowance for Doubtful Accounts 500 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

The following aging schedule is prepared for the end of the year The following aging schedule is prepared for the end of the year. Complete the schedule. LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Example Accounts Receivable Bal. 30,000 Allowance for Doubtful Accounts 500 2,179 Desired balance 2,679 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

What if the Allowance account had a debit balance of $500 before adjustment? Accounts Receivable Bal. 30,000 Allowance for Doubtful Accounts 500 3,179 Desired balance 2,679 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 4 Writing off an account using the Allowance for Doubtful Accounts method LO-4

Allowance for Doubtful Accounts When a company deems an account uncollectible, it is written off and no longer considers it an asset. When the journal entry is made, allowance for doubtful accounts and accounts receivable are reduced. Example: J. Monaco’s account balance of $500 is deemed uncollectible on June 1, 20X8. General Journal Page 8 Date Account Titles and Description PR Dr. Cr. 20X8 Jun 1 Allowance for Doubtful Accounts 500 Accounts Receivable, J. Monaco LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Recording Recovered Debts using Allowance for Doubtful Accounts Example: Assume J. Monaco paid half of his account balance of $500 on January 3, 20X9. General Journal Page 8 Date Account Titles and Description PR Dr. Cr. 20X9 Jan 3 Accounts Receivable, J. Monaco 250 Allowance for Doubtful Accounts Restores collectible portion Cash Records payment received LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Writing off an account using the Allowance for Doubtful Accounts account LO-2, 4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Accts. Rec., Angie Ring Accts. Rec., Mike Catuc LO-2, 4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Accts. Rec., Mike Catuc Accts. Rec., Mike Catuc LO-2, 4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 5 Using the direct write-off method LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Used when a company cannot reasonably estimate bad debt expense Uncollectible accounts are directly written off to current year’s bad debt expense The year sale was made does not matter Allowance for doubtful accounts is not used LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Example: T. DeStadio’s account balance of $400 is deemed to be uncollectible on May 15, 20X7. General Journal Page 8 Date Account Titles and Description PR Dr. Cr. 20X7 May 15 Bad Debts Expense 400 Accounts Receivable, T DeStadio Wrote off account LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Recording Recovered Debts in same year Assume T. DeStadio paid $200 of his balance July 3, 20X7. Reverse the entry made prior by $200 General Journal Page 8 Date Account Titles and Description PR Dr. Cr. 20X7 July 3 Accounts Receivable, T DeStadio 200 Bad Debts Expense LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Recording Recovered Debts in different year A new account- Bad Debts Recovered is used Assume T. DeStadio paid $200 of his balance on July 3, 20X8. General Journal Page 8 Date Account Titles and Description PR Dr. Cr. 20X8 July 3 Accounts Receivable, T DeStadio 200 Bad Debts Recovered Restores collectible portion Cash Records payment received LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Accts. Rec., Angie Ring Accts. Rec., Mike Catuc LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise Accts. Rec., Mike Catuc Accts. Rec., Mike Catuc LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

End of Chapter 12 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater