Shortcomings 1 ar not shown at net realizable value 2

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Shortcomings: 1. A/R not shown at net realizable value 2. Improper matching of revenues and expenses 3. Potential for management misrepresentation For the above reasons, the direct charge-off method is not GAAP unless the uncollectible amounts are immaterial.
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Chapter 7, p. 4 C. Allowance methods address the shortcomings of the direct charge- off method. To record sales: A/R ............... x Sales Revenue ........... x This increases net assets and increases NI. To record cash collections: Cash ............. x A/R .............................. x This has no effect on net assets and NI. Prepare an adjusting journal entry to record an estimate of Bad Debt Expense at the end of the period; this estimate includes accounts not yet identified as uncollectible: (AJE) BDE (I/S) ............... x Allowance for uncollectibles (X-A/R) ....... x This reduces both net assets and NI in the period of sale, to show A/R at NRV and to achieve proper matching of revenues and expenses. To record writeoffs of SPECIFIC ACCOUNTS IDENTIFIED AS UNCOLLECTIBLE: Allowance for uncollectibles (x-A/R) .......... x A/R .................................................................. x This has no effect on net assets (both the receivables and related contra account are reduced) and no effect on NI (no I/S accounts appear in the journal entry). Comparison of percentage of sales and percentage of receivables allowance methods: It is very important for you to understand the difference between the two methods. Both methods attempt to achieve the same objectives of matching and showing receivables at net realizable value. The percentage of sales method computes BDE as a percentage of sales and the ending balance in the allowance account is a plug. The percentage (aging) of receivables method directly computes the required balance for the allowance account and the BDE is a plug. Required: Using t-accounts for the allowance account, illustrate the differences between the percentage of sales and percentage of receivables methods.
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Chapter 7, p. 5 Example: The sales, all on account, of Thread Company in Year 1, its first year of operations, were $600,000. Cash collections totaled $500,000. On December 31, Year 1, it was estimated that 1.5% of all sales would probably be uncollectible. On that date, specific accounts in the amount of $3,000 were written off. The company's December 31, Year 2 unadjusted trial balance , after all nonadjusting and before closing entries were made, included the following: A/R ........................... $ 60,000 DR Allowance for uncoll. 4,000 DR Bad debt expense .... ---------- Sales, ....................... 700,000 CR In Year 2, Thread used the aging method for estimating uncollectibles. It estimated that the $60,000 December 31, Year 2 A/R balance contained $12,000 of probable uncollectibles. Required: Prepare all journal entries related to sales and receivables for both years. Year 1: A/R 600,000 Sales 600,000 Cash 500,000 A/R 500,000 12/31 Bad Debt Expense 9,000 AFDA 9,000 AFDA 3,000 A/R 3,000 Year 2: A/R 700,000 Sales 700,000 Cash 640,000 A/R 640,000 12/31 Bad Debt Exp. 16,000 AFDA 16,000
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Chapter 7, p. 6 D. Disposition of A/R: Assignment and factoring To shorten the cash-to-cash operating cycle (see diagram), a company may transfer the receivables to another company or third party for cash: Cash => purchase => sell goods => collect cash goods on account Firms may assign
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