CDA COLLEGECDA COLLEGE

ACC101: INTRODUCTION TO ACC101: INTRODUCTION TO ACCOUNTINGACCOUNTING

Lecture 8Lecture 8

Lecturer: Kleanthis Zisimos Lecturer: Kleanthis Zisimos

Chapter ReviewChapter Review

In Today’s Lecture weIn Today’s Lecture we

Prepare estimates of uncollectible accounts Prepare estimates of uncollectible accounts receivablereceivable

Write off any accounts known to be Write off any accounts known to be uncollectible and record any later recoveries. uncollectible and record any later recoveries.

Compare of the allowance method with the Compare of the allowance method with the direct off methoddirect off method

Accounts ReceivablesAccounts Receivables

Accounts receivable refer to amounts due from Accounts receivable refer to amounts due from customers for credit sales.customers for credit sales.

When a company directly grants credit to its When a company directly grants credit to its customers , some customers do not always pay what customers , some customers do not always pay what they promised. The accounts of these customers are they promised. The accounts of these customers are uncollectible accounts , commonly called uncollectible accounts , commonly called Bad DebtsBad Debts

Why do companies sell on credit if they expect some Why do companies sell on credit if they expect some accounts to be uncollectible?accounts to be uncollectible?

Direct write off methodDirect write off method Companies use two methods for the treatment of Companies use two methods for the treatment of

bad debts. The direct write off method and the bad debts. The direct write off method and the Allowance method Allowance method

A) Direct write off method: The method records the A) Direct write off method: The method records the loss from an uncollectible account receivable loss from an uncollectible account receivable when it is determined to be uncollectible.when it is determined to be uncollectible.

Example. TechCom Ltd determines that it cannot Example. TechCom Ltd determines that it cannot collect 520 euro from customer Kent.collect 520 euro from customer Kent.

Bad Debt Expense 520Bad Debt Expense 520 Customer Kent 520Customer Kent 520

Allowance methodAllowance method

B) Allowance method: The method requires an B) Allowance method: The method requires an estimate of the total bad debts from the yearly estimate of the total bad debts from the yearly sales.sales.

Example. TechCom Ltd had credit sales 300 000 Example. TechCom Ltd had credit sales 300 000 euro which 20 000 had remain uncollectible. euro which 20 000 had remain uncollectible. Based on experience TechCom estimates 1500 Based on experience TechCom estimates 1500 euro to be uncollectible. At the end of the year euro to be uncollectible. At the end of the year bad debts were 600 eurobad debts were 600 euro

Bad Debts 1500Bad Debts 1500 Provision for Bad Debts 1500Provision for Bad Debts 1500Provision for Bad Debts 600Provision for Bad Debts 600 Accounts receivables 600Accounts receivables 600

Treatment of bad debtsTreatment of bad debts

Advantages of the allowance methodAdvantages of the allowance method1)1) It charges bad debts to the period when it It charges bad debts to the period when it

recognized the related salesrecognized the related sales2)2) It reports accounts receivable on the balance sheet It reports accounts receivable on the balance sheet

at the estimated amount of cash to be collectedat the estimated amount of cash to be collected

Treatment of bad debts and Provision for Bad Debts .Treatment of bad debts and Provision for Bad Debts .Bad Debts are expenses and go the income statementBad Debts are expenses and go the income statementProvision for Bad Debts is a liability and goes to the Provision for Bad Debts is a liability and goes to the

Balance sheet as a reduction of accounts Balance sheet as a reduction of accounts receivablesreceivables

Bad Debts written off and Bad Debts written off and subsequently paidsubsequently paid

A bad debt which has been written off might be A bad debt which has been written off might be unexpectedly paid. The amount recovered should unexpectedly paid. The amount recovered should be recorded as additional income in the profit and be recorded as additional income in the profit and loss account loss account

The journal entries for the recovery of bad debts The journal entries for the recovery of bad debts if the receipt was made in the same year areif the receipt was made in the same year are

Debit cash or bank Debit cash or bank Credit Bad DebtsCredit Bad Debts The journal entries for the recovery of bad debts The journal entries for the recovery of bad debts

if the receipt was made in the following year areif the receipt was made in the following year areDebit cash or bank Debit cash or bank Credit Bad Debts recoveryCredit Bad Debts recovery

Increasing the allowanceIncreasing the allowance

Let us suppose that at the end of the year 31 Let us suppose that at the end of the year 31 December 2010, the allowance for doubtful December 2010, the allowance for doubtful debts needed to be increased. An allowance debts needed to be increased. An allowance of 200 had been brought forward from the of 200 had been brought forward from the previous previous year, but we now want a total year, but we now want a total allowance of 240 All that is now needed is a allowance of 240 All that is now needed is a provision for an extra 40. provision for an extra 40.

The double entry will be:The double entry will be:Income Statement 40Income Statement 40 Provision for Bad Debts 40Provision for Bad Debts 40

Estimating Bad Debts ExpenseEstimating Bad Debts Expense

The estimation of bad debts is based on 3 methodsThe estimation of bad debts is based on 3 methodsa)a) Percent on sales method. Example: Bad debts Percent on sales method. Example: Bad debts

should be 0,6% of the total credit sales.should be 0,6% of the total credit sales.b)b) Percent of accounts receivable method. Percent of accounts receivable method.

Example: Bad debts should be 5% on the total Example: Bad debts should be 5% on the total accounts receivables.accounts receivables.

c)c) Aging of accounts receivable. It reviews each Aging of accounts receivable. It reviews each account receivable to estimate the amount account receivable to estimate the amount uncollectible. Each receivable is classified by uncollectible. Each receivable is classified by how long it is past its due date. Then estimates how long it is past its due date. Then estimates the bad debts assuming that the longer an the bad debts assuming that the longer an amount is past due the more likely it will be bad amount is past due the more likely it will be bad debtdebt

Revision Exercise .Revision Exercise .

The balance b/d of the Provision for Bad The balance b/d of the Provision for Bad Debts on 1/1/ 2010 is Debts on 1/1/ 2010 is € € 300. On 31/12/2010 300. On 31/12/2010 debtors totaled debtors totaled €€4000 and it was agreed to 4000 and it was agreed to propose a 10% provision for Bad Debts on propose a 10% provision for Bad Debts on debtorsdebtors

ShowShow1. Bad Debts a/c 1. Bad Debts a/c 2. Provision for Bad Debts a/c 2. Provision for Bad Debts a/c 3. Draft Income Statement a/c 3. Draft Income Statement a/c 4. Draft Balance sheet 4. Draft Balance sheet

Revision Exercise .Revision Exercise .

Bad Debts a/c Provision for Bad DebtsBad 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 30031/12/10 Allowance for D.A 100 Income statement 100 1/1/10 B/ce b/d 300

31/12/10 Bad Debts 31/12/10 Bad Debts

100100

Revision Exercise .Revision Exercise .

Income Statement Balance SheetIncome Statement Balance Sheet

Bad Debts 100 Debtors 4000Bad Debts 100 Debtors 4000

less provision for B.D less provision for B.D (400) (400) 36003600

Accounts receivables TurnoverAccounts receivables Turnover

Accounts receivables Turnover is a ratio Accounts receivables Turnover is a ratio measuring the quality and liquidity of measuring the quality and liquidity of accounts receivables. It indicates how often accounts receivables. It indicates how often receivables are collected during a period of receivables are collected during a period of timetime

Accounts receivables TurnoverAccounts receivables Turnover= = Net Credit SalesNet Credit Sales

Average accounts receivablesAverage accounts receivables