Chapter 2: Bank Reconciliation

Three kinds of bank deposits:

1) Demand deposit
= this is the current account or checking account or commercial deposit where
deposits are covered by deposit slips and where funds are withdrawals on demand
by drawing checks against the bank.
= non-interest bearing

2) Saving deposit
= the depositor is given a passbook upon the initial deposit.
= passbook is required when making deposits and withdrawals. Withdrawals are
made anytime but the bank sometimes may require notice of withdrawal.
= interest bearing.

3) Time deposit
= this is similar to saving deposit in the sense that it is interest bearing.
= it is evidenced; however, by a formal agreement embodied in an instrument
called certificate of deposit.
= may be predetermined or withdrawn on demand on or after a certain period of
time agreed upon.

What is bank reconciliation?

Bank reconciliation is a statement which brings into agreement the cash balance
per book and cash balance per bank.
= it is usually prepared monthly because the bank provides the depositor with the
bank statement at the end of every month.
Bank statement
= is a monthly report of the bank to the depositor showing the cash balance per
bank at the beginning, the deposits acknowledged, the checks paid, other charges and
credits and the daily cash balance per bank during the month.
= is an exact copy of the depositor’s ledger in the records of the bank.
= when it is received, attached thereto are the depositor’s canceled checks and any
debit or credit memoranda that have affected the depositor’s account.
Canceled checks
= are the checks issued by the depositor and paid by the bank during the month.
= they are called cancelled checks because they are literally canceled by stamping
or punching to show that they have been paid.
Reconciling items
At the end of every month, comparison between the cash records of the depositor
and the bank statement received from the bank will yield the following reconciling items:
1) Book reconciling items:
a. Credit memos b. Debit memos c. Errors
2) Bank reconciling items:
a. Deposit in transit b. Outstanding checks c. Errors
Credit memos
= refer to items not representing deposits credited by the bank to the account of the
depositor but not yet recorded by the depositor as cash receipts.
= have the effect of increasing the cash balance.
= typical examples of credit memos are:
a) Notes receivable collected by the bank in favor of the depositor and credited to the
account of the depositor.
b) Proceeds of bank loan credited to the account of the depositor.
c) Matured time deposits transferred by the bank to the current account of the depositor.

Debit memos
= refer to items not representing checks paid by bank which are charged or debited
by the bank to the account of the depositor nut not yet recorded by the depositor as cash
disbursements.
= have the effect of decreasing the cash balance. Typical examples of debit
memos are:
a) NSF or no sufficient fund checks
= these are checks deposited but returned by the bank because of
insufficiency of fund.
= other name of NSF is DAIF or “Drawn against insufficient fund”.

b) Technically defective checks

= these are checks deposited but returned by the bank because of technical defects
such as absence of signature or countersignature, erasures not countersigned,
mutilated checks, conflict between amount in words and amount in figures.

c) Bank service charges

= these include bank charges for interest, collection, checkbook and
penalty.

d) Reduction of loan
= this pertains to amount deducted from the current account of the depositor
in payment for loan which the depositor owes to the bank and which has already
matured.

Deposit in transit
= are collections already recorded by the depositor as cash receipts but not yet
reflected on the bank statement.
Deposit in transit include:
a) Collections already forwarded to the bank for deposit but too late to appear in
the bank statement.
b) Undeposited collections or those still in the hands of the depositor. In effect,
these are cash on hand awaiting delivery to the bank for deposit.
Outstanding checks
= are checks already recorded by the depositor as cash disbursements but not yet
reflected on the bank statement. Outstanding checks include:
a) Checks drawn and already given to payees but not yet presented for payment.
b) Certified checks – is one where the bank has stamped on its face the word
“accepted” or “certified” indicating sufficiency of fund. When the bank certifies a check,
the account of the depositor is immediately debited or charged to insure the eventual
payment of the check. Certified checks should be deducted from the total outstanding
checks (if included therein) because they are no longer outstanding for bank
reconciliation purposes.
Forms of Bank Reconciliation
The following formats may be used in reconciling the book balance and the bank
balance:
a) Adjusted balance method – under this method, the book balance and the bank
balance are brought to a correct cash balance that must appear on the balance
sheet.
b) Book to bank method – under this method, the book balance is reconciled with
the bank balance or the book balance is adjusted to equal the bank balance.
c) Bank to book method – under this method, the bank balance is reconciled
with the is reconciled with the book balance or the bank balance is adjusted to equal the
book balance.
Adjusted Balance Method
Book Balance xx
Add: Credit memos xx
Less Debit memos (xx)
Adjusted Book Balance xx

Bank Balance xx The reconciling items of the

book Add: Deposits in Transit xx are simply termed as credit
Less Outstanding Checks (xx) memos and debit memos. In
actual Adjusted Bank Balance xx formal reconciliation, details will
have to be shown.
Moreover, errors are excluded because no definite rule can be made whether these
are to be added or deducted.
Errors will have to be analyzed for proper treatment. But errors are reconciling
items of the party which committed them. It will observe that under the adjusted balance
method, the credit memos are always added to the book balance and the debit memos are
always deducted from the book balance.
The above procedures can be explained as follows:
The adjusted balance method means that the book balance and the bank balance
are adjusted to equal the correct cash balance.
Credit memos already increased the bank balance but have no effect on the book
balance because the credit memos are not yet recorded by the depositor.
 Consequently, the book balance is understated in relation to the correct cash
balance. Hence, credit memos are added to the book balance.
Debit memos already decreased the bank balance but have no effect on the book
balance because the debit memos are not yet recorded by the depositor.
Consequently, the book balance is understated in relation to the correct cash
balance. Hence, credit memos are added to the book balance.
Debit memos already decreased the bank balance but have no effect on the book
balance because debit memos are not yet recorded by the depositor.
Consequently, the book balance is overstated in relation to the correct cash
balance. Hence, debit memos are deducted from the book balance.
Deposit in transit already increased the book balance but have no effect on the
bank balance because the deposits are not yet recorded by the bank.
Consequently, the bank balance is understated in relation to the correct cash
balance. Hence, deposits in transit are added to the bank balance.
Outstanding checks already decreased the book balance but have no effect on the
bank balance because the checks are not yet paid by the bank.
Consequently, the bank balance is overstated in relation to the correct cash
balance. Hence, outstanding checks are deducted from the bank balance.
Book to Bank Method
Book Balance xx
Add: Credit Memos xx
Outstanding xx
Checks
Total xx

Less: Deposits in Transit (xx)

Debit Memos (xx)
Bank Balance xx

When the reconciliation starts with the book balance and ends with the bank
balance, the usual book reconciling items are treated in the same manner they are treated
in the “adjusted balance method”, that is, credit memos are added, and debit memos are
deducted.
However, with respect to the bank reconciling items treatment is simply
“reversed”. Thus, since the deposit in transit is added to the bank balance, it is now
deducted from the book balance, and since the outstanding check is deducted from the
bank balance, it is now added to the book balance.
The explanation for the “reversal rule” on the treatment of the bank
reconciling items may be stated as follows: The book to bank method means that the
book balance is adjusted to equal the bank balance. Deposit in transit already increase the
book balance but have no effect on the bank balance because the deposits are not yet
recorded by the bank. Consequently, the book balance is overstated in relation to the bank
balance. Hence, deposits in transit are deducted from the book balance following the
book to bank method.
On the other hand, outstanding checks already decreased the book balance but
have no effect on the bank balance because the checks are not yet paid by the bank.
Consequently, the book balance is understated In relation to the bank balance. Hence,
outstanding checks are added to the book balance, following the book to bank method.

Bank to Book Method

Bank Balance xx
Add: Deposits in Transit xx
Debit Memos xx
Total xx

Less: Credit Memos (xx)

Outstanding (xx)
Checks
Bank Balance xx
When the reconciliation starts
with the bank balance and ends with the book balance, the usual bank reconciling items
are treated in the same manner they are treated in the “adjusted balance method”, that is,
deposit in transit is added and outstanding check is deducted.
However, with respect to the book reconciling items, the treatment is simply
“reversed”. Thus, since the credit memos are added to the book balance, they are now
deducted from the bank balance, and since the debit memos are deducted from the book
balance, they are now added to the bank balance.
The explanation for the “reversal rule” on the treatment of the book reconciling
items may be stated as follows:
The bank to book method means that the bank balance is adjusted to equal the
book balance. Debit memos already decreased the bank balance but have no effect on the
book balance because they are not yet recorded by the depositor.
Consequently, the bank balance is understated in relation to the book balance,
Hence, debit memos are added to the bank balance.
On the other hand, credit memos already increased the bank balance but have no
effect on the book balance because they are not yet recorded by the depositor.
Consequently, the bank balance is overstated in relation to the book balance.
Hence, credit memos are deducted from the bank balance.
General procedures in preparing the reconciliation.
a) Determine the balance per book and the balance per bank
b) Trace the cash receipts to the bank statement to ascertain whether there are
deposits not yet acknowledged by the bank.
c) Trace the checks issued to the bank statement to ascertain whether there are
checks not yet presented for payment.
d) The bank statement should be examined to determine whether there are bank
credits or bank debits not yet recorded by the depositor.
e) Watch out for errors. Errors are reconciling items of the party which committed
them.
Preparation of adjusting entries.
 Only the book reconciling items require adjusting entries on the book of
depositor. This is but understandable. The adjustments are necessary to bring the cash in
bank balance to its correct balance for statement presentation purposes.
Chapter 3: Proof of Cash
Two-date bank reconciliation
= the bank reconciliation is so-called “two-date: because it literally involves two
dates.
The procedures followed for a one-date reconciliation are the same for a two-date
bank reconciliation.
A two-date bank reconciliation becomes complicated only when certain facts or
data are omitted, hence the necessity for computing them.
But if all the facts are available, then reconciliation statements will simply be
prepared as of the two dates prepared. Among others, the omitted information may be any
one or a combination of the following:
a) Book balance – beginning and ending
b) Bank balance – beginning and ending
c) Deposit in transit – beginning and ending
d) Outstanding checks – beginning and ending
If the ending balance are not given, the following formulas may help. If beginning
balances are omitted, the formulas should simply be reversed or just work back.
Computation of Book Balance
Balance per book- beg. of month xx
Add: Book Debits during the month xx
Total xx
Less: Book Credits during the month (xx)
Balance per book end of the month xx

Book debits= refer to cash receipts or all items debited to the cash in bank account.
Book credits= refer to cash disbursements or all items credited to the cash in bank
account.
In a T-account form, the cash in bank may appear as follows:
Cash In Bank
Balance – beginning xx Book credits xx
Book debits xx Balance – ending x

Balance per Bank- beg. of month xx

 Add: Bank Credits during the month xx
Total xx
Less: Bank Debits during the month (xx)
Balance per bank end of the month xx

Bank credits= refer to all items credited to the amount of the depositor which
include deposits acknowledged by bank and credit memos.
In the absence of any statement to the contrary, bank credits are assumed to
be deposits acknowledged by bank.
Bank debits= refer to all items debited to the account of the depositor which
includes checks paid by the bank and debit memos.
In the absence of any statement to the contrary, bank debits are assumed to be
checks paid by bank.
In a T-account form, the depositor’s account, Company X, will appear as follows:
Company X
Balance – beginning xx Book credits xx
Book debits xx Balance – ending x

Computation of deposit in transit

Deposit in Transit – beg. month xx
Add: Cash Receipts deposited during the month xx
Total deposited to be acknowledged by the bank xx
Less: Deposits acknowledged by the bank during the month (xx)
Deposit in Transit xx

In other words, procedure wise, all items debited to the cash in bank account
which do not represent deposits should be deducted from the book debits total to arrive at
the cash receipts deposited.
In the absence of any statement to the contrary, book debits are assumed to be
cash receipts deposited.
In other words, all items credited to the depositor’s account which do not
represent deposits should be deducted from the bank credits to determine the
deposits acknowledge by bank.
Moreover, bank credits are assumed to be deposits acknowledged by bank in
the absence of any statement to the contrary.

Computation of Outstanding Checks

 Outstanding Checks – beg. month xx
Add: Checks Drawn deposited during the month xx
Total checks to be paid by the bank xx
Less: Checks paid by the bank during the month (xx)
Outstanding Checks xx

All items not representing checks credited to the cash in bank account should
be deducted from the book credits total to arrive at the checks drawn by the
depositor.
But as a rule, all book credits in the absence of any statement to the contrary
are assumed to be checks issued.
All items debited to the account of the depositor not representing checks paid
should be deducted from the bank debits total to arrive at the checks paid by bank.
But as a rule, all bank debits in the absence of any statement to the contrary
are assumed to be checks paid by bank.

Comments on the book items:

a. Credit memos of the previous month do not affect the bank receipts for the current
but increased the book receipts for the current month because the credit memos for
the previous month are recorded only by the depositor during the current month.

Consequently, the book receipts for the current month are overstated in
relation to the correct receipts for the current month. Hence, credit memos of the
previous month are deducted from the book receipts for the current month.

b. Credit memos of the current month already increased the bank receipts for the
current month but have no effect on the book receipts for the current month
because the credit memos of the current month are not yet recorded by the
depositor during the current month.
Consequently, the book receipts for the current month are understated in
relation to the correct receipts for the current month. Hence, credit memos of the
current month are added to the book receipts for the current month.
c. Debit memos of the previous month do not affect the bank disbursements for the
current month but increased the book disbursements for the current month because
the debit memos of the previous month are recorded only by the depositor during
the current month.
Consequently, the book disbursements for the current month are overstated
in relation to the correct disbursements for the current month. Hence, debit memos
of the previous month are deducted from the book disbursements for the current
month.
d. Debit memos of the current month already increased bank disbursements for the
current month but have no effect on the book disbursements for the current month
because the debit memos of the current month are not yet recorded by the
depositor.
 Consequently, the book disbursements for the current month are
understated in relation to the correct disbursements for the current month. Hence,
debit memos of the current month are added to the book disbursements for the
current month.

Comments on the bank items:

a. Deposits in transit of previous month do not affect book receipts for the
current month but increased bank receipts for the current month because the
deposits are recorded only by the bank during the current month.
Consequently, bank receipts for the current month are overstated in
relation to the correct receipts for the current month. Hence, deposits in transit of
the previous month are deducted from the bank receipts for the current month.
Thus, January deposit in transit of P40,000 is deducted from the February bank
receipts.
b. Deposit in transit of the current month already increased book receipts but have no
effect on the bank receipts for the current month because the deposits are not yet
recorded by the bank during the current month.
Consequently, the bank receipts for the current month are understated in
relation to the correct receipts for the current month. Hence, deposits in transit of
the current month are added to the bank receipts of the current month.
c. Outstanding checks of the previous month do not affect the book disbursements
but increased bank disbursements for the current month because the outstanding
checks of the previous month are paid only by the bank during the current month.
Consequently, the bank disbursements for the current month are overstated
in relation to the correct disbursements for the current month. Hence, outstanding
checks of the previous month are deducted from the bank disbursements for the
current month.
e) Outstanding checks of the current month increased the book disbursements for the
current month but have no effect on the bank disbursements for the current month
because the checks are not yet paid by the bank during the current month.
Consequently, the bank disbursements for the current month are
understated in relation to the correct disbursements for the current month. Hence,
outstanding checks of the current month are added to the bank disbursements for
the current month.

Book to bank method

a) The book reconciling items – note collected, NSF check and service charge – are
treated in the same manner following the adjusted balance method.
b) The bank reconciling items – deposited in transit and outstanding check – are treated
in the “reverse”.
c) The book to bank proof of cash means that the book receipts and disbursements are
adjusted to equal the bank receipts and disbursements.
d) Deposit in transit of previous month do not affect the book receipts for the current
month but increased the bank receipts for the current month.
 Consequently, the book receipts for the current month are understated in relation
to the bank receipts for the current month. Hence, deposits in transit of the previous
month are added to the book receipts for the current month
e) Deposits in transit of the current month increased the book receipts for the current
month but have no effect on the bank receipts for the current month. Consequently, the
book receipts for the current month are overstated in relation to the bank receipts for the
current month. Hence, deposits in transit of the current month are deducted from the book
receipts for the current month.
f) Outstanding checks of the previous month do not affect the book disbursements for the
current month but increased the bank disbursements for the current month.
Consequently, the book disbursements for the current month are understated in
relation to the bank disbursements for the current month. Hence, outstanding checks of
the previous month are added to the book disbursements for the current month.
f) Outstanding checks of the current month increased the book disbursements for the
current month but have no effect yet on the bank disbursements for the current
month.
Consequently, the book disbursements for the current month are overstated in
relation to the bank disbursements for the current month. Hence, outstanding checks of
the current month are deducted from the book disbursements for the current month.

Bank to Book Method

a) The bank reconciling items – deposit in transit and outstanding check – are treated in
the same manner following the adjusted balance method.
b) The book reconciling items – note collected, NSF and service charge – are treated in
the “reverse”.
c) The bank to book proof of cash means that the bank receipts and disbursements for the
current month are adjusted to equal the book receipts and disbursements for the current
month.
d) Credit memos of previous month do not affect the bank receipts for the current month
but increased the book receipts for the current month.
Consequently, the bank receipts for the current month are understated in relation to
the book receipts for the current month. Hence, the credit memos of the previous month
are added to the bank receipts for the current month.
e) Credit memos of the current month increased the bank receipts for the current month
but have no effect yet on the book receipts for the current month.
Consequently, the bank receipts of the current month are overstated in relation to
the book receipts of the current month. Hence, the credit memos of the current month are
deducted from the bank receipts for the current month.
g) Debit memos of previous month do not affect the bank disbursements for the current
month but increased the book disbursements for the current month.
Consequently, the bank disbursement for the current month are understated in the
relation to the book disbursements for the current month. Hence, the debit memos of
previous month are added to the bank disbursements for the current month.
f) Debit memos of current month increased the bank disbursements for the current month
but have no effect yet on the book disbursements for the current month.
 Consequently, the bank disbursements for the current month are overstated in
relation to the book disbursements for the current month. Hence, the debit memos of
current month are deducted from the bank disbursements for the current month.
Chapter 4: Accounts Receivable
Examples of Nontrade receivables
1) Advances to or receivables from shareholders, directors, officers or employees
= If advances are collectible within one year, it is classified as current assets,
otherwise, noncurrent asset.
2) Advances to affiliates are usually treated as long-term investments.
3) Advances to suppliers for the acquisition of merchandise are current assets.
4) Subscription receivable are current assets if collectible within one year. Otherwise,
they are shown preferably as a deduction from subscribed share capital.
Customer’s credit balance
= are credited balances in accounts receivable resulting from overpayments,
returns and allowances, and advance payments from customers.
= classified as current liabilities and are not offset against the debit balances in
other customers’ accounts, EXCEPT when the same is not material in which case only
the net accounts receivable may be presented.
PFRS 9, paragraph 5.1.1, provides that a financial asset shall be recognized
initially at fair value plus transaction costs that are directly attributable to the acquisition.
Fair value of financial asset is usually the transaction price, meaning, the fair value
of the consideration given.
For short term receivables, fair value = face value or original invoice amount.
Cash flows relating to short-term receivables are not discounted because the effect
of discounting is usually immaterial. Therefore, accounts receivable shall be measured
initially at face value. For long-term receivables that are interest bearing, the fair value is
equal to face value.
But, the long term receivables that are not interest bearing, the fair value is equal
to present value of all future cash flows discounted using the prevailing market rate of
interest for similar receivables.
Therefore, long-term interest-bearing notes receivable shall be measured initially
at face value and long-term noninterest-bearing notes receivable shall be measured at
present value.
Accounts receivable
= are open accounts arising from sale of merchandise or services in the ordinary
course of business.
= measured initially at face value or original invoice amount.
= subsequently, the accounts receivable shall be measured at net realizable value
= based on established basic principle that “assets shall not be carried at above
their recoverable amount.”, meaning to say, the initial amount recognized for accounts
receivable shall be reduced by adjustments which in the ordinary course of business will
reduce the amount recoverable from the customer. Net realizable value
 = the amount of cash expected to be collected or the estimated recoverable
amount.
The following deductions are made in estimating the net realizable value of trade
accounts receivable:
a) Allowance for freight charge
b) Allowance for sales return
c) Allowance for sales discount
d) Allowance for doubtful accounts.

Terms related to freight charge FOB Destination

= the ownership of the goods purchased are transferred to the buyer upon receipt.
= the seller is responsible for related freight charges up to the point of destination.
FOB Shipping point = the ownership of goods purchased are transferred to the buyer
upon in transit or shipment.
= the buyer is responsible for related freight charges from the point in transit upon
the point of destination.
FOB means Free On Board.
Freight Collect
= freight charges on the goods shipped is not yet paid.
= the buyer is the one who paid the related freight charge.
Freight Prepaid
= freight charges on the goods shipped is already paid by the buyer.
Accounting for Freight Charge
There are instances that the goods are sold “FOB Destination” but shipped “freight
collect” with the situation that the buyer will pay for the freight charge and deduct the
same when remittance is made by him. On the part of seller, the freight charge is
recorded by debiting freight out and crediting allowance for freight charge.

Accounting for sales returns

The measurement of accounts receivable shall also recognize the probability that
some customers will return goods that are unsatisfactory, defective or will make other
claims requiring reductions in the amount due as in the case of shipment shortage and
defects.

Sales discount Cash discount

= is a reduction from an invoice price by reason of prompt payment.
= aka sales discount on the part of seller while purchase discount on the part of
buyer.
= can be expressed as 6/10, n/30 which means that the buyer will grant 6%
discount when the payment is made within 10 days. The n/30 pertains to the credit period
given by the seller to the buyer which means the buyer should pay within 30 days,

Methods of recording credit sales

1) Gross method = the accounts receivable and sales are recorded at gross
amount of the invoice. = Most common and widely used by the entity because
it is simple to apply
2) Net method = the accounts receivable and sales are recorded at net amount of
the invoice (invoice price minus the cash discount).
Allowance for sales discount
 If customers are granted cash discounts for prompt payment, then, conceptually
estimates of cash discounts on open accounts at the end of the period based on past
experience shall be made.
For example, of the accounts receivable of Php900,000.00 at the end of reporting
period, it is reliably estimated that discounts to be taken will amount to Php50,000.00.
The adjustment to record the expected sales discount is:

Sales discount 50,000

Allowance for sales discount 50,000
The adjustment may be reversed at the beginning of the next period in order that
discounts can then be charged normally to sales discount account.
Accounting for bad debts
Business entities that sell on credit assumes the risk that some customers will not
pay their accounts. When an account becomes uncollectible, the entity has sustained a
bad debt loss.
This loss is simply one of the costs of doing the business on credit. Two method
for accounting in bad debt loss:
1) Allowance method
2) Direct writeoff method
Allowance method
= requires recognition of a bad debt loss if the accounts are doubtful of collection.
The entry to recognize the doubtful accounts is:
Doubtful accounts xx
Allowance for doubtful accounts xx
The allowance for doubtful accounts is deduction from accounts receivable.
If the doubtful accounts are subsequently found to be worthless or uncollectible,
the accounts are written off as follows:
Allowance for doubtful accounts xx
Accounts receivable xx
GAAP require the use of the allowance method because it conforms with the
matching principle. Moreover, accounts receivables would be properly measured at net
realizable value.
Direct Writeoff Method
= requires recognition of bad debt loss only when the accounts proved to be
worthless or uncollectible.
= worthless accounts are recorded by debiting bad debt loss and crediting accounts
receivable. No entry is necessary if the accounts are only doubtful of collection.
= often used by small businesses because of it is simple to apply.
= BIR (Bureau of Internal Revenue) recognizes only this method for income tax
purposes
 = it violates the matching principle because the bad debt loss is often recognized
in later accounting period than the period in which the sales revenue was recognize.

Chapter 5: Estimation of Doubtful Accounts

Method of estimating doubtful accounts
= are recognized when the loss is probable, and the amount can be estimated
reliably.
= this approach is in line with the recognition of “provision” which is both
“probable and measurable” in accordance with PAS 37.
Three methods of estimating doubtful accounts
1) Aging of accounts receivable (statement of financial position approach).
2) Percent of accounts receivable (statement of financial position approach).
3) Percent of sales (income statement approach).
Aging of Accounts Receivable
= involves an analysis of the accounts where they are classified as not due or past due.
Past due = refers to the period beyond maximum credit term.
= accounts are further classified in terms of the length of the period they are
past due.
1.Aging the Accounts Receivable or Statement of Financial Position Approach The
accounts are classified into NOT DUE or PAST DUE.
a. Not due
b. 1 to 30 days past due
c. 31 to 60 days past due
d. 61 to 90 days past due
e. 91 to 120 days past due
f. 121 to 180 days past due
g. 181 to 365 days past due
h. More than 1 year past due
• Total Amount multiply by the rate or percentage = Allowance.
• More accurate and scientific computation of the allowance for doubtful accounts.
• Advantage of presenting fairly the accounts receivable in the statement of financial
position at net realizable value.
When is an account past due?
• The credit term will determine whether an account is past due.
• Example, if the credit terms were 2/10, n/30, and the account is 45 days old, it is
considered as 15 days past due.
• Therefore, the phrase “past due” refers to the period beyond the maximum credit
term.
Percent of Accounts Receivable or also Statement of Financial Position Approach
• A certain rate is multiplied by the open accounts at the end of the period in order
to get the required allowance balance
. • The rate used is usually determined from past experience of the entity
. • This procedure has the advantage of presenting the accounts receivable at
estimated net realizable value. The approach is also simple to apply.
• The approach violates the principle of matching bad debts loss against the sales
revenue.
• The loss experience rate may be difficult to obtain and may not be reliable.
Percent of Sales or Income Statement Approach
Sales x Rate
= Doubtful Account Expense
• Can be applied to credit sales of total sales Rate %
• Dividing the Bad Debts Losses in prior years by the CHARGE Sales of the prior year
• The rate is multiplied by the current year’s CHARGE sales to arrive at doubtful
accounts Rate %
• Dividing the Bad Debts Losses in prior years by the TOTAL Sales of the prior year
• The rate is multiplied by the current year’s TOTAL sales to arrive at doubtful accounts
• Has the advantage of eliminating the extra work of making a record of cash and credit
sales
However, this approach may prove unsatisfactory when there is considerable
fluctuation in the proportion of cash and credit sales periodically.
Argument for Percent of sales method
• Proper matching of cost against revenue is achieved.
• This is so because the bad debt loss is directly related to sales and reported in the
year of sale.
• Thus, the method is an income statement approach because it favors the income
statement.
Argument against Percent of sales method
• The accounts receivable may not be shown at estimated realizable value.
• Thus, it becomes necessary that from time to time the accounts should be “aged”
to ascertain the probable loss.
• As a consequence, the rate applied on sales should be revised accordingly.
Correction in allowance for doubtful accounts
• The correction is to be reported in the income statement either as an addition to
or subtraction from doubtful account expense.
• Change in estimate are treated currently and prospectively, if necessary.
An inadequate allowance is adjusted as follows:
Doubtful accounts xxx
 Allowance for Doubtful Accounts xxx
An excessive allowance is recorded as follows:
Allowance for Doubtful Accounts xxx
Doubtful Accounts xxx
Debit balance in allowance
• In certain instances, it may have a debit balance because it may be the policy of
the entity to adjust the allowance at the end of the period and record the accounts written
off during the year
. • For example, on January 1, the Allowance account before adjustment has a
credit balance of P30,000 and during the year an account of P50,000 is written off and
recorded as follows:
Allowance for doubtful accounts 50,000
Accounts Receivable 50,000
Thus, on Dec. 31, the allowance account has a debit balance of P20,000 before
adjustments.
The charge to the allowance account simply predates the recording of doubtful account.
To continue the Example:
If on December 31, the required allowance is 40,000, the adjustment should be:
Doubtful accounts 60,000
Allowance for Doubtful accounts 60,000
Note that after the adjustment for the doubtful accounts, the allowance account has
credit of P40,000, which is the required allowance.
Required Allowance 40,000
Add: Debit balance in allow. 20,000
Doubtful Account Expense 60,000

Notes by: Jenn Gabrielle D. Sayong