ACCY112 Spring 2013-Week 4

3.

Questions: DQ18.3; DQ18.5; EQ18.2; EQ18.8; EQ18.13; PQ18.5 Determining the amount of the allowance for doubtful debts by simply using a percentage of net sales is the obvious way to do it the alternatives are complicated and onerous. Discuss. The percentage of credit sales approach to measurement, if based on past experience and a consideration of current economic conditions, is simple to apply and probably less costly than the ageing of accounts receivable technique. It could be argued as well that the percentage of sales approach gives a better association of the expense against income/revenue. However, the ageing of accounts receivable technique is likely to provide a better measure of the collectible amount of receivables as shown on the entitys balance sheet at the end of the accounting period. As it focuses on the source of bad debts, outstanding accounts receivable and takes into account the established relationship between length that an account is outstanding and the increased likelihood that it will not be collected. It is also more consistent with the conceptual framework, focusing on valuation of assets.

5.

The two main ways of determining the allowance for doubtful debts are sometimes referred to as the balance sheet and the income statement approach. To which method does each term refer, why and which would be more appropriate under the IASBs Conceptual Framework? The ageing of accounts receivable method is based on the accounts receivable in the statement of financial position (balance sheet) at the end of the period. Being based on the actual accounts receivable outstanding at that point in time the figure calculated determines the figure that should be presented in the balance sheet as the allowance for doubtful debts, and the expense flows from the required adjustment. It can be argued this is more consistent with the conceptual framework as the change in asset determines the expense. The percentage of credit sales method is based on the sales made during the year. This figure is obviously found in the income statement. The calculation matches the doubtful debts expense to the sales revenue they generated. That expense is then added to the outstanding allowance to calculate a new balance for the contra-asset. This is an older conceptual approach which could be argued to no longer be theoretically correct.

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Exercise 18.2

Bad Debts Direct Write-off and Allowance Method ECHOGNOMICS

Required: A. Assume that EchoGnomics uses the direct write-off method of accounting for bad debts: 1. Show the general journal entry required to write-off the bad debts. 2. What amount would be shown for bad debts expense in the income statement at 30 June 2013? 3. What amount would be shown for accounts receivable in the balance sheet at 30 June 2013? B. Assuming that EchoGnomics uses the allowance method of accounting for bad debts and the following additional information was found after examination of the accounts: Allowance for doubtful debts (1 July 2012) $7920 Cr Allowance calculated based on 1% of net credit sales for the year. 1. 2. 3. A. 1. Bad Debts Expense Accounts Receivable xxx (Bad debts written off using direct write-off method) 2. 3. Bad Debts Expense $6 952 Income Statement Accounts Receivable $271 848 Current Asset Sales $874 000 Sales Returns $45 600 Cash Collected $549 600 Bad debts written off $6 952 = $271 848 [Assumes no opening accounts receivable] B. 1. Allowance for Doubtful Debts Accounts Receivable xxx (Bad debts written off using allowance method) Bad Debts Expense Allowance for Doubtful Debts (Bad debts provided for 1% of net credit sales) 2. 3 Bad Debts Expense $8 284 Income Statement Net Sales (874, 000 45,600) Less: Cash collected Additional Accounts Receivable Less: Bad debt Written off Accounts Receivable ending (assumes no beginning balance) Allowance for doubtful debts (7,920 6,952 + 8,284) Page 2 of 5 828,400 -549,600 278,800 -6,952 271,848 -9252 8 284 8 284 $6 952 $6 952 $6 952 $6 952 Show the general journal entries required to write off the bad debts and recognise the required allowance for doubtful debts. What amount would be shown for bad debts expense in the income statement at 30 June 2013? What amount would be shown for accounts receivable in the balance sheet at 30 June 2013?

Exercise 18.8

Allowance for Doubtful Debts Over 2 Years EASY-CREDIT LTD

Required: Determine the missing amounts in the table in the text. June 2013 $300 000 8 000 9 000 7 000 9 000 June 2014 $320 000 10 000 9 600 10 600 9 600

Accounts receivable Bad debts written off during the year Required balance of allowance for doubtful debts Increase (decrease) in allowance required Allowance for doubtful debts at 30 June

Exercise 18.13

Bills receivable

MOTOR MIRRORS LTD Required: A. What is the maturity value and maturity date of the bill in 1? Give the general journal entry to record the receipt of the bill. B. Refer to the details provided in 2. Show the general journal entries to record receipt of the bill and its collection at its maturity date. C. Refer to the details provided in 3. Show the general journal entries to record receipt of the bill and the discounting of the bill. A. Maturity value = Maturity date = $8 000 + ($8 000 x 0.12 x 120/365) = $8 315.62 April 26 days = 2 August May 31 days June 30 days July 31 days August 2 days 120 days Bills Receivable 8 315.62 Unearned Interest ($8 000 x 0.12 x 120/365) Accounts Receivable/Cash To record receipt of bill on 4 April

April 4

315.62 8 000.00

B. July 5 Bills Receivable Accounts Receivable HK Holden Unearned interest To record receipt of bill. ($6000 + ($6000 x 8% x 60/365) Cash at Bank Bills Receivable To record cash received on bill. Unearned interest Interest income 6 078.90 6 000.00 78.90

Sep. 3

6 078.90 6 078.90

78.90 78.90

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C.

Motor Mirrors Ltd will receive $8 035.56 calculated as follows: Face value of the debt Interest on the debt ($8 000 x 0.10 x 90/365 Maturity value of the note Discount ($8 197.26 x 0.12 x 60/365) Proceeds The entries would be: July 10 Bills Receivable Unearned Interest ($8 000 x .10 x 90/365) Accounts Receivable To record receipt of bill. Cash at Bank Unearned Interest Bills Receivable To record discounting of note. Unearned interest Interest income $8 197.26 197.26 8 000.00 $8 000.00 197.26 8 197.26 161.70 $8 035.56

9 August

8 035.56 161.70 8 197.26

35.56 35.56

Problem 18.5

Required: A. Prepare the journal entries to adjust the Allowance for Doubtful Debts at 30 June 2013 under: 1. the net credit sales method 2. the ageing of accounts receivable method. B. Determine the balance in the Allowance for Doubtful Debts account under both methods. C. Assume that the allowance account had a debit balance of $850 at 30 June 2012. Show the journal entries to record the allowance for doubtful debts at 30 June 2013 under: 1. the net credit sales method 2. the ageing of accounts receivable method. D. Using the journal entries from requirement C, determine the balance in the allowance account under both methods. E. Explain, with reference to requirements B and D, why the two different methods result in different balances. A. 1. 2013 30 June Bad Debts Expense Allowance for Doubtful Debts Allowance made on 2% of net credit sales ($1 070 000 -$90 000) Bad Debts Expense Allowance for Doubtful Debts Allowance made on ageing of accounts receivable. Required allowance is $21 468 - $1 500 = $19 968 $19 600

Doubtful debts net credit sales and ageing methods AUSSI WORLD LTD

$19 600

2.

30 June

19 968

19 968

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B. 1. Allowance for Doubtful Debts 30/6 Balance $21 100 30/6 Adjusting $21 100 30/6 Balance b/d $1 500 19 600 $21 100 $21 100

30/6

Balance c/d

2. Allowance for Doubtful Debts 30/6 Balance $21 468 30/6 Adjusting $21 468 30/6 Balance b/d $1 500 19 968 $21 468 $21 468

30/6

Balance c/d

C. 1. 30 June Bad Debts Expense Allowance for Doubtful Debts Allowance made on 2% of net credit sales. Note the assumption here is that an under-provision of $850 does not represent a significant variation. Bad Debts Expense Allowance for Doubtful Debts Allowance made on ageing of accounts receivable. Required allowance $21 468 + $850 D. 1. 30/6 30/6 Balance Balance c/d Allowance for Doubtful Debts $850 30/6 Adjusting 18 750 $19 600 Balance b/d Allowance for Doubtful Debts $850 30/6 Adjusting 21 468 $22 318 Balance b/d $19 600 $19 600 $18 750 $19 600 $19 600

2. 22 318 22 318

2. 30/6 30/6 Balance Balance c/d $22 318 $22 318 $21 468

E.

The net credit sales method and the ageing of accounts receivable method both calculate a different balance for the Allowance for Doubtful Debts. The net credit sales method calculates the adjusting entry for Bad Debts Expense as a percentage of net credit sales. The calculation forms the basis of the adjusting entry. The ageing of an accounts receivable calculates a required ending balance for the Allowance for Doubtful Debts. The adjusting entry for Bad Debts Expense is calculated by taking into account any opening balance in the allowance account to achieve the desired ending balance. Since the two methods involve calculations based on different amounts the resulting balances on Allowance for Doubtful Debts accounts will be different, and hence the net accounts receivable disclosed in the balance sheet will also be different. Page 5 of 5