The percentage of receivables basis will normally

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$500) to arrive at a credit balance of $2,228. The percentage- of-receivables basis will normally result in the better approximation of cash realizable value. Cash Flows no effect A OE L H11005 H11001 H11002 1,700 Exp H11002 1,700 PDF Watermark Remover DEMO : Purchase from to remove the watermark
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406 Chapter 9 Accounting for Receivables When Investors Ignore Warning Signs Recently Nortel Networks announced that half of its previous year’s earnings were ”fake.” Should investors have seen this coming? Well, there were issues in its annual report that should at least have caused investors to ask questions. The company had cut its al- lowance for doubtful accounts on all receivables from $1,253 million to $544 million, even though its total balance of receivables remained relatively unchanged. This reduction in bad debts expense was responsible for a very large part of the com- pany’s earnings that year. At the time it was unclear whether Nortel might have set the reserves too high originally and needed to reduce them, or whether it slashed the allowance to artificially boost earnings. But one thing is certain—when a company makes an accounting change of this magnitude, investors need to ask questions. Source: Jonathan Weil, “Outside Audit: At Nortel, Warning Signs Existed Months Ago,” Wall Street Journal, May 18, 2004, p. C3. When would it be appropriate for a company to lower its allowance for doubtful ac- counts as a percentage of its receivables? I N V E S T O R I N S I G H T DO IT! UNCOLLECTIBLE ACCOUNTS RECEIVABLE action plan a20 Report receivables at their cash (net) realizable value. a20 Estimate the amount the company does not expect to collect. a20 Consider the existing balance in the allowance account when using the percentage-of-receivables basis. Brule Co. has been in business five years.The ledger at the end of the current year shows: Accounts Receivable $30,000 Dr. Sales $180,000 Cr. Allowance for Doubtful Accounts $2,000 Dr. Bad debts are estimated to be 10% of receivables. Prepare the entry to adjust the Allowance for Doubtful Accounts. Solution The following entry should be made to bring the balance in the Allowance for Doubtful Accounts up to a balance of $3,000 (0.1 H11003 $30,000): Bad Debts Expense [(0.1 H11003 $30,000) H11001 $2,000] 5,000 Allowance for Doubtful Accounts 5,000 (To record estimate of uncollectible accounts) Disposing of Accounts Receivable In the normal course of events, companies collect accounts receivable in cash and remove the receivables from the books. However, as credit sales and receivables have grown in significance, the “normal course of events” has changed. Companies now frequently sell their receivables to another company for cash, thereby shortening the cash-to-cash operating cycle. Describe the entries to record the disposition of accounts receivable. S T U D Y O B J E C T I V E 4 Related exercise material: BE9-3, BE9-4, BE9-5, BE9-6, BE9-7, E9-3, E9-4, E9-5, E9-6, and DO IT!
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