Video Transcript: Accounts Receivable

Hello and welcome back now we're going to talk about accounts receivable  under the accrual basis, a merchandising company that extends credit records  revenue when it makes a sale, because at this time, it has earned and realized  the revenue. The company has earned the revenue because it has completed  the seller's part of this sales contract by delivering the goods. The company has  realized the revenue because it has received the customer's promise to pay in  exchange for the goods. This promise to pay by the customer is an accounts  receivable to the seller. Accounts receivable are amounts that customers owe a  company for goods sold and services rendered on the account. Frequently,  these receivables, resulting from credit sales of goods and services are called  trade receivables, when a company sells goods on account, customers do not  sign formal, written promises to pay, but they agree to abide by the company's  customary credit terms. However, customers may sign a sales invoice to  acknowledge the purchase of goods payment terms for sales on account  typically run from 30 to 60 days. Companies usually do not charge interest on  amounts owed, except on some past due amounts, because customers do not  always keep their promises to pay. Companies must provide for these  uncollectible accounts in their records. Companies use two methods for  handling uncollectible accounts, the allowance method provides in advance for  uncollectible accounts, or the direct write off method recognizes bad accounts  as an expense at the point when judged to be uncollectible and is in and is the  required method for federal income tax purposes. However, since the allowance  method represents the accrual basis of accounting and is the accepted method  to record uncollectible accounts for financial accounting purposes, we only  discuss and illustrate the allowance Allowance Method in this text. Even though  companies carefully screen credit customers, they cannot eliminate all  uncollectible accounts. Companies expect some of their accounts to become  uncollectible, but they do not know which ones. The matching principle requires  deducting expenses incurred in producing revenues from those revenues during the accounting period. The allowance method of recording uncollectible  accounts. Adheres to this principle by recognizing the uncollectible accounts  expense in advance of identifying specific accounts as being uncollectible, the  required entry has some similarity to the depreciation entry in chapter three,  because it debits and expense and credits and allowance, which is your contra  asset account, the opposite. The purpose of the entry is to make the income  statement fairly present the proper expense and the balance sheet fairly  represent the asset. Uncollectible accounts, expense, also called the Doubtful  Accounts expense, or bad debt expense is an operating expense that the  business incurs when it sells on credit. We classify uncollectible accounts  expense as a selling expense because it results from the credit sales. Other  accountants might classify it as an administrative expense because the credit  department has an important role in setting credit terms. To adhere to the 

matching principle, companies must match the uncollectible account expense  against the revenues it generates. Thus an uncollectible account arising from a  sale made in 2010 is a 2010 expense, even though this treatment requires the  use of estimates. Estimates are necessary because the company sometimes  cannot determine until 2008 or later, which 2010 customer accounts will become uncollectible. Recording the uncollectible accounts adjustment. A company that  estimates uncollectible accounts makes an adjusting entry at the end of each  accounting period it debits uncollectibles accounts expense, thus recording the  operating expense in the proper period the credit is to an account called  allowance for uncollectible accounts as a contra account to the accounts  receivable account, the allowance for uncollectible accounts reduces accounts  receivable to the net realized value. Net realized value is the amount the  company expects to collect from accounts receivable when the firm makes the  uncollectible accounts adjusting entry, it does not know which specific accounts  will become uncollectible. Thus, the company cannot enter credits in either the  accounts receivable control account or the customers accounts receivable,  subsidiary ledger accounts, if only one or the other were credited the accounts  receivable control account balance would not agree with the total of the  balances in the accounts receivable subsidiary ledger without crediting the  accounts receivable control account, the allowance account lets the company  show that some of its accounts receivable are probably uncollectible. To  illustrate the adjusting entry for uncollectible accounts, assume a company has  $100,000 of accounts receivable and estimates its uncollectible accounts  expense for a given year at $4,000 the adjusting entry required at year end, you  simply debit the uncollectible account expense for $4,000 and credit the  allowance for uncollectible accounts. So what you originally have done, you  have your accounts receivable account for $100,000 and you're saying that  4000 of that is not going to be collected. So through the month, you have  chosen $4,000 as that uncollectible amount and posted it to your allowance for  uncollectible accounts. But you have to close that because it's a contra account.  Therefore you're closing it into the expense and that's where the adjusting entry  comes in. The debit to uncollectible accounts. Expense brings about a matching  of expenses and revenues on the income statement. Uncollectible accounts,  expense is matched against the revenues of the accounting period. The credit to allowance for uncollectible accounts reduces the accounts receivable to their net realized value on the balance sheet. When the books are closed, the firm closes uncollectible accounts, expense to income summary, it reports the allowance on  the balance sheet as a deduction from accounts receivable as follows, okay, so  you have under current assets, is where accounts receivable falls under. For the $100,000 is the amount of your accounts receivable, less the allowance for  uncollectible accounts. For a net of $96,000 estimating uncollectible accounts  use two basic methods. The first method is percentage of sales method, and it 

focuses on the income statement and the relationship of uncollectible accounts  to sales. The second method, percentage of receivables method, focuses on the balance sheet and the relationship of the allowance for uncollectible accounts to accounts receivable, percentage of sales. Method estimates uncollectible  accounts from the credit sales of a given period in theory, the method is based  on a percentage of prior years actual uncollected accounts to prior years credit  sales, when cash sales are small or make up a fairly consistent percentage of  total sales, firms base the calculation on total net sales, since at least one of  these conditions is usually met, companies commonly use total net sales rather  than credit sales the formula to determine the amount of the entry is as follows,  amount of journal entry, amount of journal entry for uncollectible accounts,  minus the net sales times percentage estimate as uncollectible. To illustrate this, assume that the Rankin company's uncollectible counts 2008 sales were 1.1%  of total net sales. A similar calculation for 2009 showed an uncollectible account  percentage of point 9% the average for the two years is 1% Rankin does not  expect 2010 to differ from the previous two years. Total Net sales for 2010 were  $500,000 receivables at year end were $100,000 and the allowance for  uncollectible accounts had a zero balance. Rankin would make the following  adjusting entry the uncle on December 1, they would debit uncollectible account  expense for 5000 and the allowance for uncollectible accounts, they would  credit for 5000 and this entry is made to record the estimated uncollectible  accounts. And this is what your your T accounts, your accounts would look like  for the uncollectible account expense. You are zeroing the balance before  adjustment was zero, and December 31 you have adjustment of $5,000 for the  allowance for uncollectible accounts, and is expensed out as an adjustment for  5000 under the expense account. Rankin reports uncollectible accounts  expense on the income statement. It reports the accounts receivable, less the  allowance among current assets in the balance sheet, as follows. So again, you  have your accounts receivable for 1000 100,000 less the allowance for  uncollectible accounts of 5000 and a net realized value of your accounts  receivable is the $95,000 on the income statement. Rankin would match the  uncollectible accounts expense against the sales revenues in the period. We  would classify this expense as a selling expense, and since it is a normal  consequence of selling on credit, the allowance for uncollectible accounts  usually has either a debit or credit balance before the year end adjustment  under the percentage of sales method, the company ignores any existing  balance in the allowance when calculating the amount of year end adjustment,  except that the allowance account must have a credit balance after adjustment.  For example, assume Rankin's allowance account had $300 credit before  adjustment, the adjusting entry would still be for $5,000 however, the balance  sheet would show $100,000 account receivable less a $5,300 allowance for  uncollectible accounts, resulting in net receivables of 94, seven on the income 

statement. Uncollectible account expense would still be the 1% of total net  sales, which is $5,000