On campuses across the country it distributed one

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with no credit-approval process. On campuses across the country it distributed one million computers with a selling price of $800 each. This increased Quick Buck’s revenues and receivables by $800 million. The promotion was a huge success! The 2010 balance sheet and income statement looked great. Unfortunately, during 2011, nearly 40% of the customers defaulted on their loans.This made the 2011 in- come statement and balance sheet look terrible. Illustration 9-1 shows the effect of these events on the financial statements if the direct write-off method is used. 400 Chapter 9 Accounting for Receivables Distinquish between the methods and bases companies use to value accounts receivable. S T U D Y O B J E C T I V E 3 Cash Flows no effect A OE L H11005 H11001 H11002 200 Exp H11002 200 Year 2010 Year 2011 Net income Net income Huge sales promotion. Sales increase dramatically. Accounts receivable increases dramatically. Customers default on loans. Bad debts expense increases dramatically. Accounts receivable plummets. Illustration 9-1 Effects of direct write-off method PDF Watermark Remover DEMO : Purchase from to remove the watermark
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Accounts Receivable 401 Under the direct write-off method, companies often record bad debts expense in a period different from the period in which they record the revenue.The method does not attempt to match bad debts expense to sales revenues in the income state- ment. Nor does the direct write-off method show accounts receivable in the bal- ance sheet at the amount the company actually expects to receive. Consequently, unless bad debts losses are insignificant, the direct write-off method is not accept- able for financial reporting purposes. ALLOWANCE METHOD FOR UNCOLLECTIBLE ACCOUNTS The allowance method of accounting for bad debts involves estimating uncol- lectible accounts at the end of each period.This provides better matching on the in- come statement. It also ensures that companies state receivables on the balance sheet at their cash (net) realizable value. Cash (net) realizable value is the net amount the company expects to receive in cash. It excludes amounts that the com- pany estimates it will not collect. Thus, this method reduces receivables in the bal- ance sheet by the amount of estimated uncollectible receivables. GAAP requires the allowance method for financial reporting purposes when bad debts are material in amount.This method has three essential features: 1. Companies estimate uncollectible accounts receivable. They match this esti- mated expense against revenues in the same accounting period in which they record the revenues. 2. Companies debit estimated uncollectibles to Bad Debts Expense and credit them to Allowance for Doubtful Accounts (a contra-asset account) through an adjusting entry at the end of each period. 3. When companies write off a specific account, they debit actual uncollectibles to Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.
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