current-assets-part-ii

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Unformatted text preview: e. the actual write off in a subsequent period will generally you will soon see, subsequent period will generally not impact income. Download free ebooks at bookboon.com 11 Alternative Approaches for Uncollectibles Current Assets: Part II 3. Alternative Approaches for Uncollectibles Having established that an allowance method for ITO COMPANY Balance Sheet uncollectibles is preferable (indeed, required in December 31, 20X3 many cases), it is time to focus on the details. Let’s Assets begin with a consideration of the balance sheet. ... Suppose that Ito Company has total accounts $425,000 A ccounts receivable (25,500) receivable of $425,000 at the end of the year, and Less: Allowance for uncollectibles ... is in the process or preparing a balance sheet. Obviously, the $425,000 would be reported as a current asset. But, what if it is estimated that $25,500 of this amount may ultimately prove to be uncollectible? Thus, a more correct balance sheet presentation would appear as shown at right. $399,500 The total receivables are reported, along with an allowance account (which is a contra asset account) that reduces the receivables to the amount expected to be collected. This anticipated amount to be collected is often termed the “net realizable value.” 3.1 Determining the Allowance Account In the preceding illustration, the $25,500 was simply given as part of the fact situation. But, how would such an amount actually be determined? If Ito Company’s management knew which accounts were likely to not be collectible, they would have avoided selling to those customers in the first place. Instead, the $25,500 simply relates to the balance as a whole. It is likely based on past experience, but it is only an estimate. It could have been determined by one of the following techniques: AS A PERCENTAGE OF TOTAL RECEIVABLES: Some companies anticipate that a certain percentage of outstanding receivables will prove uncollectible. In Ito’s case maybe 6% ($425,000 X 6% = $25,500). VIA AN AGING ANALYSIS: Other companies employ more sophisticated aging of accounts receivable analysis. They will stratify the receivables according to how long they have been outstanding (i.e., perform an aging), and apply alternative percentages to the different strata. Obviously, the older the account, the more likely it is to represent a bad account. Ito’s aging may have appeared as follows: Download free ebooks at bookboon.com 12 Alternative Approaches for Uncollectibles Current Assets: Part II Both the percentage of total receivables and the aging are termed “balance sheet approaches.” In both cases, the allowance account is determined by an analysis of the outstanding accounts receivable on the balance sheet. Once the estimated amount for the allowance account is determined, a journal entry will be needed to bring the ledger into agreement. Assume that Ito’s ledger revealed an Allowance for Uncollectible Accounts credit balance of $10,000 (prior to performing the above analysis). As a re...
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