ACCOUNTING FOR ACCOUNTS RECEIVABLE

LEARNING OUTCOMES
At the end of the session, students are able to: Differentiate between bad debts and doubtful debts; Differentiate between discount allowed and discount allowable; Make adjustment on account receivables for bad debts expense and bad debts recovered if any; and Calculate and record allowance for doubtful debts and allowance for discount allowable.
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INTRODUCTION
Most

of business sales are on credit basis. Customers are allowed to make payment at later date. Credit term exposes business to RISKS that some of the customers may never pay for the goods sold or services rendered to them.

PAYMENT STRUCTURE AND TREATMENT IN THE FIN. STMNTS

INCOME STATEMENT a Very prompt payment b Future discount allowed c Just in time payment d Reluctant to pay e Unable to pay (bankrupt or dead) f Settlement of debt after debt had been considered as bad Discount allowed Discount allowable No discount given Doubtful debt Bad debt Bad debt recovered
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BALANCE SHEET

Allowance for discount allowable

Allowance for doubtful debt

BAD DEBT EXPENSE

Certain

and proven that debtor could not settle the debt. Effect on income statement:
Uncollected

amount will be treated as bad debt expense as to reduce profit of business.

Effect
The

on balance sheet:

uncollected amount will be deducted from the account receivables as to reduce current asset of business.
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WORKED EXAMPLE
Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 9,000

Additional information as at 31/12/2010: Debts of RM500 are to be written off as bad.

ACCOUNT
Account receivables

YEAR-END BALANCES
9,000

ADJUSTMENT
- 500

BALANCE AFTER ADJUSTMENT

8,500

INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT) RM Operating Expenses Bad debts 500 BALANCE SHEET AS AT 31/12/2010 (EXTRACT) RM Current Assets RM RM RM RM

Account receivables

8,500
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BAD DEBT RECOVERED

Payments

received from debtors whose debts had been written off as bad. Effect on income statement:
A

bad debt recovered is considered as revenue; to increase profit of business.

Effect

on balance sheet:

Payments

received will increase asset of cash in the balance sheet.

WORKED EXAMPLE
Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 9,000 Bank 14,000

Additional information as at 31/12/2010: One of the debtors whose debt had previously been written off as bad sent a cheque for RM1,000 in full settlement of the amount owing.
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ACCOUNT
Bank

YEAR-END BALANCES
14,000

ADJUSTMENT
+ 1,000

BALANCE AFTER ADJUSTMENT

15,000

INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT)

RM
Other revenues Bad debts recovered

RM
1,000

RM

BALANCE SHEET AS AT 31/12/2010 (EXTRACT) RM Current Assets Account receivables Bank 9,000 15,000
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RM

RM

DOUBTFUL DEBT AND ALLOWANCE FOR DOUBTFUL DEBT

Estimation on the amount that will not be collected is known as doubtful debt. Allowance for doubtful debt (AFDD) = % x accounts receivable (after bad debt) Effect on balance sheet:

AFDD reduces accounts receivable In the first year; doubtful debt estimated will be recorded in full (worked example 1) For the next and the following year; record only the increase or decrease in the estimation (worked example 2)
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Effect on income statement:

WORKED EXAMPLE (1)

Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 8,900

Additional information as at 31/12/2010: A debtor owing RM200 was unable to settle his debt and this amount is to be written off as bad debt. The allowance for doubtful debt is 2% on the outstanding accounts receivable.
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CALCULATION
Allowance

for doubtful debt = % x outstanding accounts receivable = 2% (8,900 200) = 176

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ACCOUNT Account receivables

YEAR-END BALANCES 8,900

ADJUSTMENT - 200

BALANCE AFTER ADJUSTMENT 8,700

INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT)

RM Operating Expenses Bad debts Doubtful debt 200 176 RM RM

BALANCE SHEET AS AT 31/12/2010 (EXTRACT) RM Current Assets Account receivables (-) Allowance for doubtful debt 8,700 (176) RM RM

8,524
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WORKED EXAMPLE (2)

Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 50,000 Allowance for doubtful debts 1,000 Bad debts 1,000 Additional information as at 31/12/2010: One of the customer was declared bankrupt and unable to settle his debts. The customer still owed RM2,000. The allowance for doubtful debt is 5% on the outstanding accounts receivable.
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CALCULATION
Allowance

for doubtful debt = % x outstanding accounts receivable = 5% (50,000 2,000) = 2,400 1,000 2,400 1,400
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AFDD

Adjusted to Increase in doubtful debt

ACCOUNT

YEAR-END BALANCES

ADJUSTMENT

BALANCE AFTER ADJUSTMENT

Account receivables
Bad debts

50,000
1,000

- 2,000
+ 2,000

48,000
3,000

Allowance for doubtful debt

1,000

+ 1,400

2,400

INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT) RM Operating Expenses Bad debts Doubtful debt 3,000 1,400 BALANCE SHEET AS AT 31/12/2010 (EXTRACT) RM RM

RM
Current Assets Account receivables (-) Allowance for doubtful debt 48,000 (2,400)

RM

RM

45,600
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DISCOUNT ALLOWABLE AND ALLOWANCE FOR DISCOUNT ALLOWABLE (AFDA)

Estimation on the amount of discount that may be allowed to customers who may pay within the discount period. AFDA = % x ((accounts receivable (after bad debt) AFDD) Effect on balance sheet:

AFDA reduces accounts receivable In the first year; discount allowable estimated will be recorded in full (worked example 1) For the next and the following year; record only the increase or decrease in the estimation (worked example 2)

Effect on income statement:

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WORKED EXAMPLE (1)

Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 200,000

Additional information as at 31/12/2010: Debts of RM500 are to be written off as bad. The allowance for doubtful debt and discount allowable are 2% and 1% respectively of the outstanding accounts receivable.
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CALCULATION
Allowance

for doubtful debt = % x outstanding accounts receivable = 2% (200,000 500) = 3,990 Allowance for discount allowable = % x (outstanding accounts receivable AFDD) = 1% ((200,000 500) 3,990) = 1,955
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ACCOUNT

YEAR-END BALANCES

ADJUSTMENT

BALANCE AFTER ADJUSTMENT

Account 200,000 - 500 199,500 receivables INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT) RM Operating Expenses Bad debts Doubtful debt Discount allowable 500 3,990 1,995 RM RM

BALANCE SHEET AS AT 31/12/2010 (EXTRACT)

RM
Current Assets

RM

RM

Account receivables (-) Allowance for doubtful debt (-) Allowance for discount allowable

199,500 (3,990)
(1,995) 193,515
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WORKED EXAMPLE (2)

Trial Balance as at 31/12/2010 (extract) DR CR Account Receivables 39,600 Bad debts 1,290 Allowance for doubtful debts 900 Allowance for discount allowable 300 Additional information as at 31/12/2010: Allowance for doubtful debts to be increased to RM1200; and the allowance for discount allowable to be based on 2% of net accounts receivable.
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CALCULATION
AFDD = 1,200 AFDD Adjusted to Increase in doubtful debt

900 1,200 300

AFDA = 2% (( 39,600) 1,200) = 768 AFDA Adjusted to Increase in discount allowable

300 768 468

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ACCOUNT

YEAR-END BALANCES

ADJUSTMENT

BALANCE AFTER ADJUSTMENT

Account receivables Allowance for doubtful debt

Allowance for discount allowable

39,600 900
300

0 + 300
+ 468

39,600 1,200
768

INCOME STATEMENT FOR THE YEAR ENDED 31/12/2010 (EXTRACT) RM Operating Expenses Bad debts Doubtful debt Discount allowable 1,290 300 468 RM RM

BALANCE SHEET AS AT 31/12/2010 (EXTRACT) RM Current Assets Account receivables (-) Allowance for doubtful debt (-) Allowance for discount allowable 39,600 (1,200) (768) RM RM

37,632
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JOURNAL ENTRIES
TRANSACTION a b c d e To record bad debts written off from accounts receivable To record the recovery of bad debts To record an increase in doubtful debt estimation To record a decrease in doubtful debt estimation To record increase in allowance for discount allowable To record decrease in allowance for discount allowable To record discount allowed to debtors DR Bad debts Cash/bank Doubtful debts Allowance for doubtful debt Discount allowable Allowance for discount allowable Discount allowed CR Acc. receivable Bad debts recovered Allowance for doubtful debt Doubtful debts Allowance for discount allowable Discount allowable Acc. receivable
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