ch. 8 sales returns & allowances, allowance for doubtful accounts

sales returns & allowances

customers may often return goods to a supplier. sales allowances may also be granted by a supplier if goods were damaged or defective.

• considered variable consideration (seller is uncertain as to the amt of returns/allowances that’ll be extended to the customer)

why are sales returns & allowances considered variable consideration?

because the seller is uncertain as to the amount of returns or allowances that’ll be extended to the customer

sales rev. - discounts - returns/allowances

net sales revenue (Reported on I/S)

journal entry when a return is made or an allowance is given

DR Sales Returns/Allowances

CR AR (or cash)

Sales Returns & Allowances account

• contra-sales revenue

• reduces sales revenue

• normal DR bal.

why does the sales returns/allowances journal entry also reduce the receivable (AR)?

the full invoice balance is no longer owed since merchandise has been returned

prior to preparing financial statements, it’s necessary to consider if returns are __ on inventory sold to date

expected

if returns are expected on inventory sold to date, the company would need to…

establish an allowance account for proper presentation in the financial statements

journal entry to record estimated returns

DR Sales returns (I/S)

CR Allowance for sales returns (OR refund liability) (B/S)

(increases sales returns account)

to establish estimated returns, you can use either of these 2 accounts:

allowance for sales return

refund liability

what does recording an allowance for sales revenue do to the receivable?

reduces the balance down to what the company expects to collect on its outstanding invoices, after all returns have been made

when inventory is actually returned in the following yr (this is after recording the allowance for returns), the following journal entry would be made

DR allowance for sales returns (or refund liability)

CR AR (or cash)

(this decreases the allowance and the asset, since customer returned it)

(balance sheet only entry, since the I/S was impacted on the prior yr for the estimated returns)

recording estimated returns and inventory actually being returned functions like…

BDE/ADA

why do we estimate sales returns & then record another entry when inv. is returned?

to ensure that sales revenue is not overstated for the current yr & that AR is properly stated at NRV (net realizable value)

What kind of account is sales returns?

contra sales rev.

of all adjustments to AR, this one is typically the largest

allowance for doubtful accounts (ADA)

allowance for doubtful accounts

• companies use the allowance method to estimate & recognize expected losses on receivables

• to reduce AR to their NRV

does every company use an allowance account?

no

companies use the __ model to account for expected losses (ADA)

Current Expected Credit Loss (CECL)

uncollectible AR can be handled in two ways:

direct write-off

allowance method

the CECL model is…

an allowance method

is ADA used in direct write-off method?

no

direct write-off

not allowed by GAAP if credit losses are expected (even if the chance of loss is remote)

allowance method

required by GAAP if credit losses are expected

direct write-off method journal entry (when you determine that a given customer will not pay)

DR BDE

CR AR

(this is Nawt normal.)

what are the results of using the write-off method (no allowance account)?

• AR is not valued at NRV, & is therefore more than likely overstated (since AR isn’t reduced until a specific acct. is deemed uncollectible)

• BDE is not matched with sales revenue generated from extending credit (overstates NI b/c not recording the expense)

• BDE on the I/S reflects actual losses (instead of an estimate)

with the direct write-off method, when is BDE recorded?

at the time of the write-off

allowance method

estimate of BDE hits the income statement, and a contra-asset acct (ADA) is used to reduce AR to NRV

NRV (of AR)

AR - ADA

measurement of receivables on the balance sheet; approximates the amount of cash the company expects to collect from outstanding A/R

for allowance method, you must record an adjusting journal entry based on…

year-end analysis

(BDE & ADA0

NRV represents…

the amt of cash the company expects to collect

the estimate of uncollectible accounts is based on…

the outstanding AR balance at year end (unpaid invoices!!)

BDE is either based on…

% of receivables

or

% of sales

must use % of receivables at yr end

percentage of receivables approach

the receivable balance at year-end is analyzed and the appropriate ADA balance is determined.

an adjusting entry is recorded (BDE and ADA)

journal entry for allowance method (to reflect BDE/ADA balance using % of receivables approach)

DR BDE

CR ADA

the reverse of this entry may also occur under certain circumstances

BDE is AKA…

credit losses

if you’re given expected credit losses, this is…

the target ending bal. for ADA

does GAAP prefer percentage of sales or percentage of receivables method for proper valuation of the B/S at yr end?

percentage of receivables

what does having a balance in A/R represent?

the amount of open, unpaid invoices owed to us

the estimated % of AR not collected can be determined using either…

one composite rate applied to entire AR bal. (one percentage)

aging analysis (applies diff. rates based on aging buckets)

aging analysis

• invoices are grouped into categories based on the amt of time that has passed from the due date

• an estimated uncollectible % is applied to each bucket, calculating the required ending bal. in ADA

• entry driven by this required ending bal.

why might you have a DR bal. in ADA?

you have more write-offs than planned

you need to fix a DR bal. in a contra asset (ex. ADA), b/c otherwise you’re __stating your assets

over

regardless of if you start with a DR or CR bal. in ADA, your NRV will be __ at year end

the same

(AR - ADA = NRV; since you have the same ADA)

once you have the ending ADA bal., you must…

back into your adj. journal entry:

• DR BDE

• CR ADA

this is your estimate of BDE

when an actual uncollectible balance is identified, we must..

write it off

journal entry for when a specific non-paying customer is identified (write-off)

DR ADA

CR AR

(this is a customer specific entry)

when you’re writing off a specific customer’s account, what exactly are you doing?

reducing it to 0

if a customer you previously wrote-off subsequently pays, what journal entries must be performed?

1. re-establish allowance only for the amt. being paid

   • DR AR

   • CR ADA

2. record collection

   • DR Cash

   • CR AR

(You put AR back on books to have the cash match the receivable)

if you have a write-off but already have an ending bal. in ADA, how will NRV be affected?

its the same after the write-off

are write-offs the only amounts that would be debited in ADA?

no, you can also have reduction of BDE. Which is not a write-off.

journal entry for reduction of BDE

DR ADA

CR BDE

why might you have a reduction of BDE?

at year end: as a result of aging analysis or a change in estimate

how would a reduction of BDE impact the I/S?

it would have a positive impact, because you’re reducing an expense

what might be credited in ADA?

• inc. of BDE

• collection of a prior write off

what might be debited in ADA?

• write-off

• reduction of BDE