L1 ESTIMATION OF DOUBTFUL ACCOUNTS & NOTES RECEIVABLE

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 

THREE METHODS OF ESTIMATING DOUBTFUL ACCOUNTS 

AGING OF ACCOUNTS RECEIVABLE 

involves an analysis where the accounts are classified into not due or past due categories such as: not due, 1 to 30 days past due, 31 to 60 days past due, 61 to 90 days past due, 91 to 120 days past due, 121 to 180 days past due, 181 to 365 days past due, and more than 1 year past due. 

The allowance is determined by multiplying the total of each classification by the rate or percent of loss experienced by the entity for each category. 

PERCENT OF ACCOUNTS RECEIVABLE 

A certain rate is multiplied by the open accounts at the end of the period to get the required allowance balance. The rate used is usually determined from past experience of the entity. 

PERCENT OF SALES METHOD 

The amount of sales for the year is multiplied by a certain rate to get the doubtful accounts expense. The rate may be applied on credit sales or total sales. 

credit balance

DEBIT BALANCE IN ALLOWANCE FOR DOUBTFUL ACCOUNTS 

The allowance for doubtful accounts normally has a . However, 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 accounts written off during the year.

Notes receivable

are claims supported by formal promises to pay, usually in the form of notes. 

promissory note

is an unconditional written promise: 

• Made by one person (the maker) to another person (the payee) 

• Signed by the maker 

• Engaging to pay on demand or at a fixed future time 

• A definite sum of money 

Key Points: 

• The note may be payable on demand or at a definite future date 

• The term "notes receivable" represents only claims from sale of merchandise or service in the ordinary course of business 

• Notes from officers, employees, shareholders, and affiliates must be separately designated 

DISHONORED NOTES 

When a promissory note matures and is not paid, it is said to be

accounts receivable 

Treatment: 

• Dishonored notes receivable should be removed from the notes receivable account 

• Transferred to

• The amount debited to accounts receivable includes: 

• Face amount 

• Interest 

Reason: The overdue note has lost part of its status as a negotiable instrument and represents only an ordinary claim against the maker.

• present value

INITIAL MEASUREMENT OF NOTES RECEIVABLE 

• Notes receivable shall be measured initially at

• Present value = sum of all future cash flow discounted using the prevailing market rate of interest for similar notes 

• The prevailing market rate is the effective interest rate 

face amount 

Short-Term Notes Receivable 

• Measured at

• Cash flows are NOT discounted because the effect of discounting is usually not material

1. face amount 

2. present value 

Long-Term Notes Receivable 

The initial measurement depends on whether the notes are interest-bearing or noninterest-bearing: 

1. Interest-Bearing Long-Term Notes 

• Measured at which is actually the present value upon issuance 

2. Noninterest-Bearing Long-Term Notes 

• Measured at = discounted value of future cash flows using the effective interest rate 

Remember: noninterest-bearing" is a misnomer because all notes implicitly contain interest. It's simply a case of interest being included in the face amount rather than stated as a separate rate. 

SUBSEQUENT MEASUREMENT 

Subsequent to initial recognition, long-term notes receivable shall be measured at amortized cost using the effective interest method. 

amortized cost

SUBSEQUENT MEASUREMENT 

Subsequent to initial recognition, long-term notes receivable shall be measured at using the effective interest method.