Handout 06 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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I NTRODUCTION TO F INANCIAL A CCOUNTING 33:010:272 S ECTIONS 08 09 |FALL 2011 P ROFESSOR J ULIAN Y EO Copyright © 2011 1 You may only share these materials with current term students. Class Notes 6: Assets - Accounts Receivable When we look at components of current assets, the ‘appropriate’ amount reported for each class of asset is not always straightforward. In this document, we begin by looking at issues reported to the amount reported in Accounts Receivable. Specifically, we address the following issues: 1. How to account for Accounts Receivable? o The direct write-off method o The allowance method 2. Comparing the balance sheet and income statement approaches 3. How do we account for Bad Debt in the Cash Flow Statement? 4. More Analysis of Accounts Receivable Learning Objectives Upon completion of this topic, you should be able to: Identify problems associated with the Direct Write-off Method and appreciate why Direct Write-off Method is a non-GAAP method Able to report Accounts Receivable under the Allowance Method (GAAP) o Income Statement Approach - % Sales o Balance Sheet Approach - % ending Accounts Receivable Aging Schedule Specific Analysis of individual accounts Able to make Journal Entries under the Allowance Method Understand how Bad Debts affect Statement of Cash Flows 1. How to account for Accounts Receivable? A firm that sells on credit should be aware that some of its customers would be unable or unwilling to pay their accounts. To reflect these potential bad debts , the company must adjust the balances of accounts receivable and sales revenue (or expenses) in order to report them at their expected value, i.e., the amount to be collected in the normal course of business.
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Copyright © 2011 2 You may only share these materials with current term students. There are two methods for recognizing the bad debt expense: the direct write-off method and the allowance method. 1.1 The direct write-off method The direct write-off method is very simple. When specific accounts are identified as uncollectible, the bad debt expense is increased (debited) and A/R is reduced (credited) for the amount identified as uncollectible. When collection is made on a receivable that was previously written-off, cash is increased (debited) and the bad debt expense is reduced (credited). The direct write-off method is a non-GAAP method It results in poor matching of expenses with revenues. Problems with the direct write-off method include: It doesn’t recognizes estimated bad debt expense in the period of sales It doesn’t recognizes a portion of accounts receivable is uncollectible When bad debt is written off in the subsequent period, the direct approach affects subsequent periods’ net income or net accounts receivable Yet, for calculating income taxes, companies must use the direct write-off method. (Why?)
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Handout 06 - INTRODUCTION TO FINANCIAL ACCOUNTING...

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