Accounts Receivable and Estimating Doubtful Accounts

INSTRUCTION: Rewrite these notes on “Accounts Receivable & Estimating Doubtful Accounts” in your notebook.
Follow the same formatting. An absolute of 5% will be added to your exam if accomplished.
Accounts Receivable & Estimating Doubtful Accounts
Notes

Accounting standard background

IAS32: Financial Instruments Presentation defines that a financial asset is any asset that is 1cash, an 2equity instrument of
another entity, or a 3contractual right to receive cash or another financial asset from another entity or to exchange financial
assets or liabilities with another entity under the conditions that are potentially favorable to the entity.

Receivables which is a balance due to an entity but not yet paid resulting from a business transaction is a financial asset.

In accordance to IAS1: Presentation of Financial Statements, receivables which are realizable within 12 months from the
reporting period or within the normal operating cycle, whichever is longer should be presented under the line item called
“trade and other receivables.” – be it a trade or a nontrade receivable. A trade receivable results from the sale of
goods/services in the normal course of business operations. Apart from, any other receivables should be reported as
nontrade.

Initial measurement
IFRS9: Financial Instruments mandates that trade receivables should be initially measured at their transaction price.
Transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring the
promised goods or services to a customer, excluding amounts collected on behalf of third parties. In other words,
transaction price is also the face amount of an account receivable, i.e., the amount stated to be the value of an account.

Since all accounts in the statement of financial position should be reflected at their carrying amounts (ending balances),
below is a comprehensive accounting technique to compute for the carrying amount of accounts receivable:
Accounts receivable, beg xx
Add: Credit sales xx - Sales on account granted to credit customers.
Less: Cash collections, gross of discount - Offsetting cash collections with discounts do not reflect the
(xx) total amount deducted to AR.
- The amount of which collectibility is not assured according
Accounts written off (xx) to the management’s discretion.
Sales returns on account (xx) - Sales returns directly decreases the credit sales.
Accounts receivable, end xx

Subsequent measurement
Trade receivables are subsequently measured at amortized cost (net realizable value). Measuring trade receivables at
their net realizable value conforms the conservatism principle: i.e. deducting all the related allowances to reflect the
estimated amount that the entity expects to collect. Allowances are the total estimated amount that the management is
expecting to incur. Below is the computation of NRV of an accounts receivable:
Accounts receivable, end xx
Less: Allowance for doubtful accounts xx - Total estimated amount of uncollectible accounts.
Allowance for sales returns (xx) - Total estimated amount of sales returns expected from the
customers.
Allowance for sales discounts (xx) - Total estimated sales discounts to grant to the customers.
Allowance for freight charges (xx) - Total estimated amount of freight to be reimbursed to the
customers.
Net realizable value – AR xx
Estimating doubtful accounts
Allowance for doubtful accounts is the total estimated amount of uncollectible accounts expected by the entity.
Determining this allowance follows this accounting formula:
Allowance for doubtful accounts, beg xx
Add: Doubtful accounts expense xx - Determined by percentage of credit sales.
Recovery of accounts previously written
(xx)
off
Less: Accounts written-off (xx)
Computed using either percentage of accounts
Allowance for doubtful accounts, end xx - receivable or aging of accounts receivable

1. Accounts written-off. To write-off accounts is to directly derecognize a part of a receivable. To record written-off
accounts involves:
Allowance for doubtful accounts xx
Accounts receivable xx
Observe that both accounts receivable account and the allowance for doubtful accounts are decreased. That’s why in
computing AR, end and AFDA, end, accounts written-off are deducted.

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Accounts Receivable and Estimating Doubtful Accounts
2. Recovery of previously written-off accounts. There are instances that those previously determined to be worthless
accounts can still be recovered. To record this scenario, the journal entry is:
Accounts receivable xx
Allowance for doubtful accounts xx
This is to reverse the writing off of accounts.
Cash xx
Accounts receivable xx
This is to record the cash collected from previously written-off accounts. Observe that accounts receivable account is
increased and decreased by the same amount. That is why recovery of previously written-off accounts affects
(increases) only the allowance for doubtful accounts.

3. Doubtful accounts expense. This the amount of which the management considered to be doubtful of collection. This
is only the addition to the total allowance of doubtful accounts due to new receivables. To record doubtful accounts
expense, the journal entry is:
Doubtful accounts expense xx
Allowance for doubtful accounts xx
Doubtful accounts expense is also called bad debts.

Three methods in estimating doubtful accounts

Estimating doubtful accounts can be determined through 1percentage of credit sales, 2percentage of accounts receivable,
and through 3aging of accounts receivable.
1. Percentage of credit sales. A certain percentage decided by the management multiplied by the amount of credit
sales will yield to doubtful accounts expense. Since this method adheres to the matching principle, the amount
computed is considered as an expense rather than an allowance for doubtful accounts.
DAE=da % × Credit sales
2. Percentage of accounts receivable. A certain percentage decided by the management multiplied by the ending
balance of accounts receivable will yield to allowance for doubtful accounts, ending balance.
AFDA , end=da % × Accounts receivable ,end
3. Aging of accounts receivable. Several percentages are applied to each receivable classified by their age. The total
computed amount will result to allowance for doubtful accounts, ending balance. This is, among the three methods,
the most relevant and reliable approach.

***In cases wherein there is a change in the method of identifying doubtful accounts, e.g. percentage of credit
sales to aging of accounts receivable, the journal entries below are recorded in applying the said adjustment:
Doubtful accounts expense xx
Allowance for doubtful accounts xx
This is to adjust AFDA when the new method results to higher allowance than previously applied.

Allowance for doubtful accounts xx

Doubtful accounts expense xx
This is to adjust AFDA when the new method results to lower allowance than previously applied.

Establishing AFDA without pre-existing policy

In cases wherein the company does not have the current policy to establish an AFDA account, the best way to estimate
doubtful accounts percentage is by following the accounting formula below:

Credit losses−Recovery of accounts

da %=
Credit sales
1
Credit losses are the cumulative amount of accounts written-off during a required span of years.
2
Recovery of accounts are the cumulative cash collection from previously written-off accounts during a period of n years.
3
Credit sales are reflected also at cumulative amount.

Nothing follows.
PRACTICE QUESTIONS

PQ1:
BOVS Co. received a balance of 8,200,000 in the accounts receivable control account at year-end. An analysis
of the accounts receivable showed the following:

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Accounts Receivable and Estimating Doubtful Accounts
Accounts known to be worthless 100,000
Advance payments to creditors on purchase orders 400,000
Advances to affiliated entities 1,000,000
Customers’ account reporting credit balances from sales returns (600,000)
Interest receivable on bonds 400,000
Trade accounts receivable – unassigned 2,000,000
Subscription receivable due in 30 days 2,200,000
Trade accounts receivable – assigned (Finance Co. equity in
assigned accounts is 500,000) 1,500,000
Trade installment receivable due 1-18 months, including unearned
finance charge of 50,000 850,000
Trade accounts receivable from officers due currently 150,000
Trade accounts on which postdated checks are held and no
entries were made on receipt of checks 200,000
Total 8,200,000

Q: What amount should be reported as trade accounts receivable at year-end?

A: 4,650,000

Credit balance in customers’ account represents either overpayment of the account due or advance deposits
from customers for future sales which results a negative balance in the accounts receivable account.
Nevertheless, customers’ credit balance should not be offset against accounts receivable and should be
separately reported under the current liabilities section in the statement of financial position of an entity.
Advances to affiliated parties are considered as noncurrent investment which can be recovered in an indefinite time. Affiliates are those
entities by which a reporting entity has either nominal investment, significant influence or control.

Generally, subscription receivable is a contra-equity account to subscribed shares. However, Philippine Interpretations Committee
(PIC) suggests that if such receivable is realizable within 12 months notwithstanding; then, it should be reported as nontrade current
receivable.

PQ2:
At year-end, Penny’s Resto reported that the current receivables consisted of the following:
Trade accounts receivable 930,000
Allowance for uncollectible accounts (20,000)
Claims against shipper for goods lost in transit in November
30,000
Selling price of unsold goods sent by Penny’s Resto on
consignment at 130% of cost and not included in the company’s
ending inventory 260,000
Security deposit on lease of warehouse used for storing some
inventories 300,000
Total 1,500,000

Q: What total amount should be reported as trade and other receivables under current assets at year-end?
A: 940,000

Claims against shipper is a nontrade receivable which is immediately demandable. It constitutes damages on the part of the reporting
entity.
Goods out on consignment do not constitute as sale until it is sold. These must be included in the inventory account of the reporting
entity.
Security deposit paid to lessor is a noncurrent asset. It is receivable only at the time when the contract of lease will come to its
expiration.

PQ3-5:
Von Doom Co. provided the following data for the current year in relation to accounts receivable:
Debits
January 1 AR balance after deducting credit balance
530,000
of 30,000
Charge sales 5,250,000
Charge for goods out on consignment 50,000
Shareholders’ subscription 1,000,000
Accounts written off but recovered 10,000
Cash paid to customer for January 1 credit balance 25,000
Goods shipped to cover January 1 credit balance 5,000

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Accounts Receivable and Estimating Doubtful Accounts
Deposits on long term contract 500,000
Claims against the common carrier 400,000
Advances to supplier 300,000

Credits
Collections from customers, including overpayment
5,200,000
of 50,000
Writeoff 35,000
Merchandise returns 25,000
Allowances to customers for shipping damages 15,000
Collection on carrier claims 50,000
Collection subscription 200,000

Q: What is the balance of accounts receivable on December 31?

A: 595,000

Q: What total amount of trade and other receivables should be reported under current assets?
A: 1,245,000

Q: What total amount of other receivables should be reported under noncurrent assets?
A: 1,300,000

PQ6:
Nepol® Co. provided the following data relating to accounts receivable for the current year:
Accounts receivable, January 1 650,000
Credit sales 2,700,000
Sales returns 75,000
Accounts written off 40,000
Collections from customers 2,150,000
Estimated future sales returns at December 31 50,000
Estimated uncollectible accounts at 12/31 per aging 110,000

Q: What is the amortized cost of accounts receivable on December 31?

A: 925,000

PQ7:
Roved N’ Sewn Inc. provided the following data for the current year:
Sales on account 3,600,000
Notes receivable to settle accounts 400,000
Provision for doubtful accounts 90,000 Q: What is the net
Accounts receivable written off 25,000 realizable value of
Purchases on account 3,900,000 accounts receivable at
Payments to creditors 3,200,000 year-end?
Discounts allowed by creditors 260,000 A: 605,000
Merchandise returned by customer 15,000
Collections received to settle accounts 2,450,000 PQ8-9:
Notes given to creditors in settlement of accounts 250,000 Siete Moll provided the
Merchandise returned to suppliers 70,000 following transactions
Payment on notes payable 100,000 affecting accounts
Discounts taken by customers 40,000 receivable during the
Collections received in settlement of notes 180,000 current year:
Sales – cash and credit 5,900,000
Cash received from credit customers, all of whom took advantage
of the discount feature of the credit terms 4/10, n/30 3,024,000
Cash received from cash customers 2,100,000
Accounts receivable written off as worthless 50,000
Credit memorandum issued to credit customers for sales returns
and allowances 250,000
Cash refunds given to cash customers for sales returns and
allowances 20,000
Recoveries on accounts receivable written off as uncollectible in
prior periods not included in cash received from customers stated
above 80,000

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Accounts Receivable and Estimating Doubtful Accounts

Balances on January 1
Accounts receivable 950,000
Allowance for doubtful accounts 100,000

The entity provided for uncollectible account losses by crediting allowance for doubtful accounts in the amount
of 70,000 for the current year.

Q: What is the balance of accounts receivable on December 31?

A: 1,300,000

Q: What is the balance of allowance for doubtful accounts on December 31?

A: 200,000

PQ10:
Orr Co. prepared an aging of accounts receivable on December 31 and determined that the net realizable
value of the accounts receivable was 2,500,000.
Allowance for doubtful accounts on January 1 280,000
Accounts written-off as uncollectible 230,000
Accounts receivable on December 31 2,700,000
Uncollectible accounts recovery 50,000

Q: What amount should be recognized as doubtful accounts expense for the current year?
A: 100,000

PQ11:
Seiko Co. reported the following balance after adjustment at year-end:
2019 2018
Accounts receivable 5,250,000 4,800,000
Net realizable value 5,100,000 4,725,000

During 2019, the entity wrote off accounts totaling 160,000 and collected 40,000 on the accounts written off in
previous year.

Q: What amount should be recognized as doubtful accounts expense for the year ended December 31, 2019?
A: 195,000

PQ12:
Mill Co.’s allowance for doubtful accounts was 1,000,000 at the end of 2019 and 900,000 at the end of 2018.
For the year ended December 31, 2019, the entity reported doubtful accounts expense of 160,000 in the
income statement.

Q: What amount was debited to the appropriate account to write-off uncollectible accounts in 2019?
A: 60,000

PQ13:
At the end of first year operations, WonderBro Co. had a net realizable value of accounts receivable of
5,000,000.
During the year, the entity recorded charges to bad debt expense of 800,000 and wrote-off as uncollectible
accounts receivable of 200,000.

Q: What is the year-end accounts receivable balance before allowance for doubtful accounts?
A: 5,600,000

PQ14-15:
At the beginning of current year, Jamin Co. had a credit balance of 260,000 in the allowance for uncollectible
accounts. Based on past experience, 2% of credit sales would be uncollectible.
During the current year, the entity wrote off 325,000 of uncollectible accounts. Credit sales for the year totaled
9,000,000.

Q: What is the uncollectible accounts expense for the year?

A: 180,000

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Accounts Receivable and Estimating Doubtful Accounts
Q: What amount should be reported as allowance for uncollectible accounts at year-end?
A: 115,000

PQ16:
Effective with the current year, Hall Co. adopted a new accounting method for estimating the allowance for
doubtful accounts at the amount indicated by the year-end aging of accounts receivable.
Allowance for doubtful accounts on January 1 250,000
Provision for doubtful accounts during the current year at 2% of
credit sales of 10,000,000 200,000
Accounts written-off 205,000
Estimated uncollectible accounts per aging on December 31 220,000

Q: After year-end adjustment, what is the doubtful accounts expense for the current year?
A: 175,000

The adjusting journal entry:

Allowance for doubtful accounts 25,000
Doubtful accounts expense 25,000

PQ17-21:
From inception of operations, Axis Co. carried no allowance for doubtful accounts. Uncollectible accounts were
expensed as written off and recoveries were credited to income as collected.
During 2019, management recognized that the accounting policy with respect to doubtful accounts was not
correct and determined that an allowance for doubtful accounts was necessary.
A policy was established to maintain an allowance for doubtful accounts based on historical bade debt
percentage applied to year-end receivable.
The historical bad debt loss percentage is to be recomputed each year based on all available past years
up to a maximum of five years.
Year Credit sales Write-offs Recoveries
2015 1,500,000 15,000 0
2016 2,250,000 38,000 2,700
2017 2,950,000 52,000 2,500
2018 3,300,000 65,000 4,800
2019 4,000,000 83,000 5,000

The entity reported accounts receivable of 1,250,000 on December 31, 2018 and 2,000,000 on December 31,
2019.

Q: What is the bad debt rate in 2018?

A: 1.6%

Q: What is the bad debt rate in 2019?

A: 1.7%

Q: What is the allowance for doubtful accounts on December 31, 2018?

A: 20,000

Q: What is the allowance for doubtful accounts on December 31, 2019?

A: 34,000

Q: What is the doubtful accounts expense for 2019?

A: 92,000

PQ22-25:
From inception of operations, Murr Co. provided for uncollectible accounts expense under the allowance
method.
Provisions were made monthly at 2% credit sales, bade debts written off were charged to the allowance
account and recoveries of bad debts previously written off were credited to the allowance account.
No year-end adjustments to the allowance account were made.
The allowance for doubtful accounts was 120,000 on January 1, 2019.

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Accounts Receivable and Estimating Doubtful Accounts
During the current year, credit sales totaled 9,000,000, interim provisions for doubtful accounts were made at
2% credit sales, 90,000 of bad debts were written off and recoveries of accounts previously written off
amounted to 15,000.

The entity prepared an aging of accounts receivable for the first time on December 31, 2019.
Classification Balance Uncollectible %
November – December 2,000,000 2%
July – October 600,000 10%
January – June 400,000 25%
Prior January 1, 2019 200,000 75%
3,200,000

Based on the review of collectability of the accounts balances in the “prior January 1, 2019” aging category,
additional accounts amounting 60,000 are to be written off on December 31, 2019.
Effective with the year ended December 31, 2019, the entity adopted a new accounting method for estimating
the allowance for doubtful accounts at the amount indicated by the year-end aging analysis of accounts
receivable.

Q: What is the required allowance for doubtful accounts on December 31, 2019?
A: 305,000

Q: What amount was recorded as doubtful accounts expense for 2019?

A: 180,000

Q: What amount should be reported as doubtful accounts expense in the income statement for 2019?
A: 320,000

Q: What is the year-end adjustment to the allowance for doubtful accounts on December 31, 2019?
A: 140,000

The adjusting journal entry:

Doubtful accounts expense 140,000
Allowance for doubtful accounts 140,000

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Nothing follows.