CDA COLLEGE ACC101: INTRODUCTION TO ACCOUNTING Lecture 8 Lecture 8 Lecturer: Kleanthis Zisimos

Chapter Review In Today’s Lecture we Prepare estimates of uncollectible accounts receivable Prepare estimates of uncollectible accounts receivable Write off any accounts known to be uncollectible and record any later recoveries. Write off any accounts known to be uncollectible and record any later recoveries. Compare of the allowance method with the direct off method Compare of the allowance method with the direct off method

Accounts Receivables Accounts receivable refer to amounts due from customers for credit sales. Accounts receivable refer to amounts due from customers for credit sales. When a company directly grants credit to its customers, some customers do not always pay what they promised. The accounts of these customers are uncollectible accounts, commonly called Bad Debts When a company directly grants credit to its customers, some customers do not always pay what they promised. The accounts of these customers are uncollectible accounts, commonly called Bad Debts Why do companies sell on credit if they expect some accounts to be uncollectible? Why do companies sell on credit if they expect some accounts to be uncollectible?

Direct write off method Companies use two methods for the treatment of bad debts. The direct write off method and the Allowance method Companies use two methods for the treatment of bad debts. The direct write off method and the Allowance method A) Direct write off method: The method records the loss from an uncollectible account receivable when it is determined to be uncollectible. Example. TechCom Ltd determines that it cannot collect 520 euro from customer Kent. Bad Debt Expense 520 Customer Kent 520 Customer Kent 520

Allowance method B) Allowance method: The method requires an estimate of the total bad debts from the yearly sales. Example. TechCom Ltd had credit sales euro which had remain uncollectible. Based on experience TechCom estimates 1500 euro to be uncollectible. At the end of the year bad debts were 600 euro Bad Debts 1500 Provision for Bad Debts 1500 Provision for Bad Debts 1500 Provision for Bad Debts 600 Accounts receivables 600 Accounts receivables 600

Treatment of bad debts Advantages of the allowance method 1) It charges bad debts to the period when it recognized the related sales 2) It reports accounts receivable on the balance sheet at the estimated amount of cash to be collected Treatment of bad debts and Provision for Bad Debts. Bad Debts are expenses and go the income statement Provision for Bad Debts is a liability and goes to the Balance sheet as a reduction of accounts receivables

Bad Debts written off and subsequently paid A bad debt which has been written off might be unexpectedly paid. The amount recovered should be recorded as additional income in the profit and loss account A bad debt which has been written off might be unexpectedly paid. The amount recovered should be recorded as additional income in the profit and loss account The journal entries for the recovery of bad debts if the receipt was made in the same year are The journal entries for the recovery of bad debts if the receipt was made in the same year are Debit cash or bank Credit Bad Debts The journal entries for the recovery of bad debts if the receipt was made in the following year are The journal entries for the recovery of bad debts if the receipt was made in the following year are Debit cash or bank Credit Bad Debts recovery

Increasing the allowance Let us suppose that at the end of the year 31 December 2010, the allowance for doubtful debts needed to be increased. An allowance of 200 had been brought forward from the previous year, but we now want a total allowance of 240 All that is now needed is a provision for an extra 40. Let us suppose that at the end of the year 31 December 2010, the allowance for doubtful debts needed to be increased. An allowance of 200 had been brought forward from the previous year, but we now want a total allowance of 240 All that is now needed is a provision for an extra 40. The double entry will be: Income Statement 40 Provision for Bad Debts 40 Provision for Bad Debts 40

Estimating Bad Debts Expense The estimation of bad debts is based on 3 methods a) Percent on sales method. Example: Bad debts should be 0,6% of the total credit sales. b) Percent of accounts receivable method. Example: Bad debts should be 5% on the total accounts receivables. c) Aging of accounts receivable. It reviews each account receivable to estimate the amount uncollectible. Each receivable is classified by how long it is past its due date. Then estimates the bad debts assuming that the longer an amount is past due the more likely it will be bad debt

Revision Exercise. The balance b/d of the Provision for Bad Debts on 1/1/ 2010 is € 300. On 31/12/2010 debtors totaled €4000 and it was agreed to propose a 10% provision for Bad Debts on debtors The balance b/d of the Provision for Bad Debts on 1/1/ 2010 is € 300. On 31/12/2010 debtors totaled €4000 and it was agreed to propose a 10% provision for Bad Debts on debtorsShow 1. Bad Debts a/c 2. Provision for Bad Debts a/c 3. Draft Income Statement a/c 4. Draft Balance sheet

Revision Exercise. Bad Debts a/c Provision for Bad Debts. Bad Debts a/c Provision for Bad Debts. 31/12/10 Allowance for D.A 100 Income statement 100 1/1/10 B/ce b/d /12/10 Allowance for D.A 100 Income statement 100 1/1/10 B/ce b/d /12/10 Bad Debts /12/10 Bad Debts 100

Revision Exercise. Income Statement Balance Sheet Income Statement Balance Sheet Bad Debts 100 Debtors 4000 Bad Debts 100 Debtors 4000 less provision for B.D (400) less provision for B.D (400)

Accounts receivables Turnover Accounts receivables Turnover is a ratio measuring the quality and liquidity of accounts receivables. It indicates how often receivables are collected during a period of time Accounts receivables Turnover = Net Credit Sales Average accounts receivables Average accounts receivables