Recording-2025-11-10T18:01:51.612Z

Preparation for Exam

• Calculator Reminder: Bring a calculator to the exam on Wednesday.

• Last Drop Date: Mark the calendar for this Friday as the last drop date.

Chapter 7 Review: Accounts Receivable

• Accounts Receivable Definition: Accounts receivable arises when a customer promises to pay in the future for goods or services received, termed as credit sales.

• Creditor Relations: Accounts receivable highlights the sales transaction between a company and its customer.

• Matching Principle: Under accrual accounting, expenses related to credit sales must be recorded in the same period as the credit sales occur.

Bad Debt Expense

• Definition: Bad debt expense is the estimated uncollectible accounts related to credit sales. It is important because it reflects the credit risk associated with customers unable to pay.

• Difference Between Credit and Cash Sales: Credit sales concern future payments and potential defaults, while cash sales assure immediate cash flow.

• Recognition: Recorded in the same period as the revenue of credit sales.

Methods for Estimating Bad Debt Expense

1. Direct Write-Off Method

• Description: Not in accordance with GAAP as it does not meet the matching principle requirements. Revenue and accounts receivable are recorded during the sales period, but bad debt expense is recorded only when default occurs.

• Recording: Upon default, the bad debt expense is recorded with a write-off of accounts receivable - no allowance account involved.

2. Allowance Method (GAAP Compliant)

• Description: Involves estimating bad debt expense during the period that sales occur, utilizing an allowance account.

• Three Variations:

  1. Percentage of Credit Sales Method

  • Apply a set percentage to credit sales. For example, using a given percentage of 2% on net credit sales of $20,000 results in a bad debt expense of:
    $ext{Bad Debt Expense} = 20,000 imes 0.02 = 400$

  • The allowance account would then have a balance adjusted accordingly.

  1. Percentage of Accounts Receivable Method

  • Estimate the uncollectible accounts based on accounts receivable balance (e.g., estimating 4% on $30,000 results in an allowance target balance of 1,200).

  • This target balance is very distinct from the journal entry posting amount.

    • Calculation: If prior balance is 1,000, an increase of 200 (1,200 - 1,000) is recorded as bad debt expense.

  1. Aging of Accounts Receivable

  • Classifies accounts based on how overdue they are, applying higher risk to older debts.

  • Example: A final estimated amount of 1,500 could be recorded from this method.

Net Realizable Value

• Definition: Represents the estimated collectible amount of accounts receivable, which equals total accounts receivable minus the allowance for doubtful accounts.

• Post Write-Off Phase: The net realizable value remains unchanged after an accounts receivable