Estimation for doubtful debt Adjustment into SOCI dan SFP Week 8 RECEIVABLES ACCOUNTING SYSTEM Learning Objectives Writing-off bad debt Estimation for doubtful debt Adjustment into SOCI dan SFP P3

Goods can be sold either on cash basis or credit basis The practice of selling on credit, rather than by cash, is being commonly used to increase the volume of sales of business, since the purchaser may not have enough cash to make purchase. If cash basis Dr Bank/Cash Cr Sales If credit basis Dr Accounts Receivables/Debtor

Pros and Cons of Extending Credit Advantage Increases the seller’s revenues. Disadvantages Bad debt costs. Delayed receipt of cash. The advantage of extending credit is that it helps customers buy products and services, thereby increasing the seller’s revenues. The disadvantages of extending credit are the following additional costs introduced: Increased wage costs. If credit is extended, the company will have to hire people to (a) evaluate whether each customer is creditworthy, (b) track how much each customer owes, and (c) follow up to collect the receivable from each customer. Bad debt costs. Inevitably, some customers dispute what they owe ,or they run into financial difficulties and pay only a fraction of their account balances. These bad debt costs are considered an additional cost of extending credit. Delayed receipt of cash. Even if the company were to collect in full from customers, it will likely have to wait 30–60 days before receiving the cash. Similar advantages and disadvantages are considered when deciding whether to create notes receivable. A note receivable is created when a formal written contract is established outlining the terms by which a company will receive amounts it is owed. Notes receivable are viewed as a stronger legal claim than accounts receivable, but a formal document (note) needs to be created for every transaction. 8-3

Bad debts EXPENSES Possible scenarios concerning a bad debt eg: Financial difficulties Overseeing the debt Dishonesty

Bad debts EXPENSES When account receivables or customers not being able pay the amount they owes to the business  uncollectible = bad debt Accounting treatment for bad debt: Direct write-off method

Write-off method Simpler method At the date that Account receivables proven to be bad/uncollectible - Amount cannot be collected is removed from accounting records In SOCI  bad debt = expenses = decrease profit In SFP  remove bad debt to reduce asset (AR) SHOULD ONLY HAVE ONE BAD DEBTS ACCOUNT Example: Date Particulars Dr Cr June 30 Bad debt expenses (SOCI) 500 Accounts receivable (SFP) To record the write off of an uncollectible account from Jones

DOUBTFUL DEBT EXPENSE Through logic, common sense and experience, there is a possibility that some of existing Accounts receivables will not be collectible Thus, an estimation has to be made = Doubtful debts Charging potential bad debt for the year as expenses

Reasons Business will not overstate its profit figure Business will not understate its losses figure To present better picture of the state of affairs of the business Showing the figure for accounts receivable which is as close as possible to its true value at the balance sheet date CONSERVATISM

Difference between bad debts and doubtful debts Proven to be bad or uncollectible Not certain which accounts receivables are likely to be uncollectible Not certain what amounts are likely to be uncollectible

How to make ESTIMATION Several methods to determine amount for allowance of doubtful debt: Specific identification method Percentage of accounts receivables method Ageing (aging) of accounts method Percentage based on net credit sales method

Method 1 : Specific Identification Method By going through the individual accounts receivable, the business may be able to estimate the amount of doubtful debts by simply adding up the accounts that the business judge as most likely to go bad

Eg : Business has the following accounts receivable at the end of accounting period : After reviewing the accounts, the business thinks that Lee Mei Ling and Jason Mulu may not be able to settle because they have been owing for a long time and have not made any effort to settle them So, the amount of doubtful debts totaling RM780 (RM280+RM500) Accounts receivables Amount in RM Azahari Zain 300 Lee Mei Ling 280 David Matthew 320 Hamidah Salleh 800 Jason Mulu 500 David Quah 700

Method 2 : Percentage of accounts receivable method Estimated by multiplying the year end total accounts receivable figure by a certain percentage The percentage figure applied is percentage that deemed to be appropriate or reasonable based on past experience or what is customary in the type of business involved to represent the amount that likely to be uncollectible Eg : Business has the accounts receivable at the end of accounting period of RM150,000 and the estimated percentage is 2% so it will be likely RM150,000 X 2% = RM3,000

Method 3 : Ageing (Aging) of Accounts Method The business classifies individual accounts receivable into age groups based on length of time of their debt have been outstanding Eg : Age group Amount (RM) Estimated Percent Uncollectible (%) Estimated Amount Uncollectible (RM) Not yet due 80,000 ½ 400 1-30 days past due 70,000 1 700 31-60 days past due 40,000 2 800 61-90 days past due 30,000 5 1,500 91-120 days past due 20,000 10 2,000 > 120 days past due 10,000 30 3,000 250,000 8,400

Method 4 : Percentage based on net credit sales method The percentage figure applied is percentage of total net credit sales of a year to represent the amount that likely to be uncollectible based on past experience Eg : Bisnezz Trading has RM1,000,000 net credit sales for 2013. The business deemed that 1/2% will be uncollectible, then the estimated doubtful debts expense will be RM1,000,000 X ½% = RM5,000

provision for doubtful debt Accounting entries are: Implication: 1. Expenses should be increased by amount that maybe uncollectible - Profit will be decreased 2. Account Receivable will be reduced, otherwise, Accounts Receivable will be overstated Purpose of creating allowance for doubtful debts : Is to show more correct amount of accounts receivables that will better reflect the financial position of business Alternative names for allowance for doubtful debt (page 215) Date Particulars Dr Cr June 30 Doubtful debt expenses (SOCI) 25,500 Provision for doubtful debt (SFP) To provide for an allowance for uncollectible account from sales

SOCI SFP Revenue XX Less Cost of Goods Sold Gross Profit Add Other Revenues Less Expenses (Bad debts) (Doubtful debts expense) Net Profit Current Assets XX Accounts Receivable Less Provision for doubtful debt Net Accounts Receivable

Adjustment to provision for doubtful debt Accounts Receivables is likely to be different figure each year, thus, allowance for doubtful debt is also likely to change from year to year Eg : Hayati Enterprise wants to establish a provision for doubtful debts based on a percentage of accounts receivable. On 31 December 2013, the business has accounts receivable figure of RM100,000 and it estimates that 1% of accounts receivable will be bad/uncollectible 31/12/2013 Dr. Doubtful Debts (SOCI) RM1,000 Cr. Provision for Doubtful Debts (SFP) RM1,000

Adjustment to provision for doubtful debt 2014 Assume that RM700 of Accounts Receivable were proven to be bad on 3 January 2014 Dr. Provision for Doubtful Debts RM700 Cr. Accounts Receivable RM700 The provision for doubtful debts had a credit balance RM300.

Adjustment to provision for doubtful debt 31/12/2014 Assume that Accounts Receivable on 31 December 2014 was RM120,000 and it wanted to create provision for doubtful debts based on 1% of the outstanding Accounts Receivable Thus, new provision for doubtful debts amount is RM1,200

The provision for doubtful debts had a credit balance RM300. The new provision for doubtful debts is RM1,200 Note that the amount of RM1,200 is the required balance for provision for doubtful debts, Not the amount of doubtful debts expense Dr. Doubtful Debts (SOCI) RM900 Cr. Provision for Doubtful Debts (SFP) RM900

Adjustment to provision for doubtful debt 2015 Assume that RM100 of Accounts Receivable were proven to be bad on 8 January 2015 Dr. Provision for Doubtful Debts RM100 Cr. Accounts Receivable RM100 The balance provision for doubtful debts is RM1,100

Adjustment to provision for doubtful debt 31/12/2015 Assume that Accounts Receivable on 31 December 2015 was RM95,000 and it wanted to create provision for doubtful debts based on 1% of the outstanding Accounts Receivable Thus, provision for doubtful debts is RM950

The provision for doubtful debts had a credit balance RM1,100 The new provision for doubtful debts is RM950 Note that the new amount for provision is decreasing It means the provision has an excess of RM150 = RM1,100 – RM950 Dr. Provision for Doubtful Debts (SFP) RM150 Cr. Doubtful Debts (SOCI) RM150 Thus, it is treating doubtful debts expense as revenue

Adjustment to provision for doubtful debt 2016 Assume that RM1,150 of Accounts Receivable were proven to be bad on 15 February 2016 Note that the provision for doubtful debts had a balance of RM950, it means the balance of provision for doubtful debts is not enough to cover this bad debts. It is short by RM200. 15/2/2016 Dr. Provision for Doubtful Debts RM950 Dr. Bad Debts RM200 Cr. Accounts Receivable RM1,150

Adjustment to provision for doubtful debt 31/12/2006 Assume that Accounts Receivable on 31 December 2016 was RM110,000 and it wanted to create provision for doubtful debts based on 1% of the outstanding Accounts Receivable Thus, provision for doubtful debts is RM1,100 Dr. Doubtful Debts (SOCI) RM1,100 Cr. Provision for Doubtful Debts (SFP) RM1,100

Bad debts recovered If already written off as bad debts, then suddenly able to recover the debt 1. Directly record the bad debt recovered at the time of receipt of cash/bank Dr. Cash/bank (SFP) Cr. Bad debts recovered (SOCI) OR 2. Reinstate the Accounts Receivable first then record the receipt of payment of the bad debts Dr. Accounts Receivable (SFP) Dr. Cash/Bank (SFP) Cr. Accounts Receivable (SFP) Reinstate the debt making the following entries: Dr Accounts Receivable’s account Cr Bad debts recovered account (Revenue) When the payment is received in settlement of the debt:

Discounts allowED Discount allowed are cash discounts given to customers by a business for early payment Eg : In a situation where customers are given terms of, say, 1/10, net 30, it means that if the customer pays his debt within 10 days from the date of purchase, he gets 1% discount off the invoiced price involved If he does not pay within 10 days from the date of purchase, the last day to pay the invoice price is 30 days from the date the credit sale was made If a customer purchases goods on credit from a business on 1 January 2013 and the business offer credit terms of 1/10, the debtor will be able to get a 1% discount if he pays by the 10th of January 2013 If he does not want to take the discount, the last day to pay the invoice price will be the 31st January 2013

Discounts allowable On the basis of the conservatism concept, a firm tries to recognize all possible losses and does not realise profits unless they are actually earned. On the basis of matching concept, the firm may want to make an estimate of the amount of discount allowed to customers who may potentially pay within the discount period. In such case, the estimate of discount allowable will be treated as an expense. Dr. Discount Allowable xxx Cr. Provision for Discount Allowable xxx Eg : Malaysian Memories wants to make provision for discount allowable for 2% of Accounts Receivable on 31st December 2013 and provision for doubtful debts is 1% of RM100,000 of Accounts Receivable Dr. Discount Allowable RM 1,980 Cr. Provision for Discount Allowable RM1,980

End of Week 8