ACT3391Fall2009handoutCH7&8

ACT3391Fall2009handoutCH7&8 - *Notes related to...

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*Notes related to Chapter 7 GAAP requires that Accounts Receivable (AR) be reflected on the balance sheet at Net Realizable Value (NRV). NRV reflects the amount of AR that you expect to collect. Gross AR minus allowance(s) = NRV. Generally , the most significant allowance account is the one for doubtful accounts. Methods for recording uncollectible ARs – p. 327 of text. Direct write-off method is generally NOT used. The allowance method has two approaches that can be used to calculate bad debt expense. One approach is based on a % of sales while the other is based on a % of receivables. EXAMPLE PROBLEM – solving for bad debt expense with % of sales used DURING the year and % of receivables used as of year-end. For the year ended 12-31-07, Wingen Co. estimated its allowance for doubtful accounts by examining an aging of its year-end accounts receivable . (Aging is an allowance method that is based on a % of receivables.) Certain information relating to the 2007 operations of Wingen Co. follows: Allowance for doubtful accounts @ 12-31-06 $ 25,000 Provision made to the allowance for doubtful accounts during 2007 for uncollectible accounts - based on a % of sales $105,000 Bad debts written off during 2007 $ 90,000 Subsequent collection during 2007 of accounts previously written off $ 15,000 Estimated uncollectible accounts per the year-end aging analysis $ 28,000 After making the required year-end adjusting journal entry, what will be Wingen's total bad debt expense for 2007? ( Note that you are required to determine the total bad debt expense for the entire year of 2007 .) SOLUTION : If you use an allowance method based on a % of receivables, after making the proper adjusting journal entry, the balance in your allowance for doubtful accounts should be the same as the amount identified by your aging analysis. Allowance for doubtful accounts, beginning balance 25,000 Increase in allowance during the year ( increase in bad debt expense ) 105,000 Write-off of bad debts (reduces the balance in the allowance) (90,000) Subsequent collections of ARs previously written off (increases the balance in the allowance) 15,000 Balance before adjustment 55,000 Adjustment needed ( reduction in bad debt expense ) (27,000) Required ending balance in the allowance for doubtful accounts 28,000 Bad debts expense = $105,000 – 27,000 = $78,000 1
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EXAMPLE PROBLEM – solving for cash collections Assume that a firm reported the following information: AR, 01-01-08 $ 4,500,650 AR, 12-31-08 $ 4,250,375 Write-offs of ARs during 2008 $ 202,000 Sales during 2008 $145,000,000 Also, assume that 85% of the firm’s sales are made on a credit basis. How much cash did the firm collect from sales during 2008? SOLUTION : Think of the events/transactions that cause the balance in the AR to change: Credit sales cause the AR balance to increase Subsequent collections of ARs cause the AR balance to increase Write-offs of ARs cause the AR balance to decrease Collections of ARs cause the AR balance to decrease AR balance at beginning of period 4,500,650 Plus credit sales = $145,000,000 x .85 123,250,000 Plus subsequent collections of ARs previously written-off (none mentioned) 0 Minus write-offs of ARs 202,000 Minus collections of ARs ????
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