Accounting for Advanced Accruals
Explanations to the transactions follow below.
Event No. 1. When we recognized bed debts expense (Event No. 3 in 20X7) we actually did not write-off the receivable, and recorded an allowance for a future write-off. Only when we know for sure that an amount ($150) is uncollectible (for example, a customer refuses or can't pay), do we decrease Accounts Receivable and Allowance for Bed Debts. By doing this, we write-off the amount from receivables and from the allowance account. This is an asset exchange transaction:
Illustration 6-7: Effect of receivables write-off in the horizontal model
| Event No. |
Assets |
= |
Liab. |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|||
| Accts Rec. |
- |
Allow. |
||||||||||||
| 1 |
(150) |
- |
(150) |
= |
n/a |
+ |
n/a |
n/a |
- |
n/a |
= |
n/a |
n/a |
|
The write-off does not change net realizable value of receivables on the balance sheet. Look at the presentation below and you will see that the net realizable value (respectively, total assets) remain unchanged before and after the write-off transaction:
Illustration 6-8: Impact of receivables write-off on their net realizable value
|
|
Before Write-off |
After Write-off |
| Accounts Receivable |
$1,200 |
$1,050 |
| Less: Allowance for Bad Accounts |
(200) |
(50) |
| Net Realizable Value |
$1,000 |
$1,000 |
Event No. 2. Proving services on account acts to increase Accounts Receivable and Training Revenue. This is an asset source transaction:
Illustration 6-9: Effect of revenue recognition in the horizontal model
| Event No. |
Assets |
= |
Liabilities |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|
| 2 |
2,000 |
= |
n/a |
+ |
2,000 |
2,000 |
- |
n/a |
= |
2,000 |
n/a |
|
Event No. 3. Sometimes a favorable to a company situation takes place. A customer, whose debt was written-off, is able to pay the amount owed. In this case the company should re-establish the receivable amount and then record the cash collection. In our example, $30 that has already been written-off is re-established in the records. The journal entry to do that is a reversal of the entry made at the write-off point. So, Accounts Receivable and Allowance for Bed Accounts increase:
Illustration 6-10: Effect of receivables write-off reversal in the horizontal model
| Event No. |
Assets |
= |
Liab. |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|||
| Accts Rec. |
- |
Allow. |
||||||||||||
| 3a |
30 |
- |
30 |
= |
n/a |
+ |
n/a |
n/a |
- |
n/a |
= |
n/a |
n/a |
|
Then the collection of cash from receivables is recorded:
Illustration 6-11: Effect of cash collection in the horizontal model
| Event No. |
Assets |
= |
Liab. |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|||
| Cash |
+ |
Accts Rec. |
||||||||||||
| 3b |
30 |
+ |
(30) |
= |
n/a |
+ |
n/a |
n/a |
- |
n/a |
= |
n/a |
30 |
OA |
4) As we mentioned before, the company owner (management) estimates what receivables amount is expected to be uncollectible. Let us assume that for this year, based on historical data and current period situation, the uncollectible percentage is set to 8% of gross receivables. As the ending balance of Accounts Receivable is $1,050, the allowance for doubtful accounts should have a balance of $84 (i.e., $1,050 x 8%). However, the balance is in fact only $80 ($200 of beginning balance - $150 written-off + $30 recovery of bad debt). Accordingly, it is necessary to adjust the allowance for doubtful accounts by $4 to arrive at the desired $84 ending balance. We recognize that additional amount of bad debt expense by posting the period-end adjusting entry. This entry acts to increase both Allowance and Bad Debts Expense:
Illustration 6-12: Effect of adjusting allowance for bad debt in the horizontal model
| Event No. |
Assets |
= |
Liabilities |
+ |
Equity |
Rev. |
- |
Exp. |
= |
Net Inc. |
Cash Flow |
|
| 4 |
(4) |
= |
n/a |
+ |
(4) |
n/a |
- |
(4) |
= |
(4) |
n/a |
|
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