TVET PROGRAM TITLE: Accounts and Budget Support Level –III

MODULE TITLE: Administering Subsidiary Accounts and Ledgers

LEARNING OUTCOMES:

At the end of this module the trainer will be able to

LO1: Review accounts receivable process

LO2: Identify bad and doubtful debts

LO3: Review compliance with terms and conditions and plan recovery action

LO4: Prepare reports and file documentation

LO5 Distribute creditor‟s invoices for authorization

LO6 Remit payments to creditors

LO7 Prepare accounts paid report and reconcile balances outstanding

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Contents

LO1: Review accounts receivable process ..................................................................................... 3

Introduction to Accounts Receivable and Bad Debts Expense ................................................... 3
Recording Services Provided on Credit ...................................................................................... 3
Recording Sales of Goods on Credit ........................................................................................... 4
FOB Shipping Point ......................................................................................................... 4
FOB Destination ............................................................................................................... 5
Credit Terms with Discounts ...................................................................................................... 6
Costs of Discounts....................................................................................................................... 8
LO2: Identify bad and doubtful debts .......................................................................................... 10
Credit Risk................................................................................................................................. 10
Direct Write-off Method ........................................................................................................... 10
Allowance Method for Reporting Credit Losses....................................................................... 11
Difference between Expense and Allowance ............................................................................ 18
Aging of Accounts Receivable .................................................................................................. 19
LO3: Review compliance with terms and conditions and plan recovery action.......................... 21
LO4: Prepare reports and file documentation ............................................................................... 26
Preparing Required Documentation ...................................................................................... 26
Completing the Analysis ....................................................................................................... 26
LO5 Distribute creditors invoices for authorization ..................................................................... 28
Mailing Statements to Customers ............................................................................................. 28
Pledging or Selling Accounts Receivable .............................................................................. 28
LO6 Remit payments to creditors ................................................................................................. 29
Remittance advice ..................................................................................................................... 29
Creditor Reference ........................................................................................................................ 29
Customer Account Settings ............................................................................................................ 29
LO7 Prepare accounts paid report and reconcile balances outstanding ........................................ 30
What is meant by reconciling an account? ................................................................................ 30
Reconciliation of Balance Sheet Accounts ............................................................................... 30
Budget Reconciliation ............................................................................................................... 31

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LO1. Review accounts receivable process

Introduction to Accounts Receivable and Bad Debts Expense

If we imagine buying something, such as groceries, it's easy to picture ourselves standing at the
checkout, writing out a personal check, and taking possession of the goods. It's a simple
transaction—we exchange our money for the store's groceries.

In the world of business, however, many companies must be willing to sell their goods (or
services) on credit. This would be equivalent to the grocer transferring ownership of the
groceries to you, issuing a sales invoice, and allowing you to pay for the groceries at a later date.

Whenever a seller decides to offer its goods or services on credit, two things happen: (1) the
seller boosts its potential to increase revenues since many buyers appreciate the convenience and
efficiency of making purchases on credit, and (2) the seller opens itself up to potential losses if
its customers do not pay the sales invoice amount when it becomes due.

Under the accrual basis of accounting (which we will be using throughout our discussion) a
sale on credit will:

1. Increase sales or sales revenues, which are reported on the income statement, and

2. Increase the amount due from customers, which is reported as accounts receivable—an
asset reported on the balance sheet.

If a buyer does not pay the amount it owes, the seller will report:

1. A credit loss or bad debts expense on its income statement, and

2. A reduction of accounts receivable on its balance sheet.

With respect to financial statements, the seller should report its estimated credit losses as soon as
possible using the allowance method. For income tax purposes, however, losses are reported at a
later date through the use of the direct write-off method.

Recording Services Provided on Credit

Assume that on June 3, Malloy Design Co. provides $4,000 of graphic design service to one of
its clients with credit terms of net 30 days. (Providing services with credit terms is also referred
to as providing services on account.)

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Under the accrual basis of accounting, revenues are considered earned at the time when the
services are provided. This means that on June 3 Malloy will record the revenues it earned, even
though Malloy will not receive the $4,000 until July. Below are the accounts affected on June 3,
the day the service transaction was completed:

In this transaction, the debit to Accounts Receivable increases Malloy's current assets, total
assets, working capital, and stockholders' (or owner's) equity—all of which are reported on its
balance sheet. The credit to Service Revenues will increase Malloy's revenues and net income—
both of which are reported on its income statement.

Recording Sales of Goods on Credit

When a company sells goods on credit, it reports the transaction on both its income statement
and its balance sheet. On the income statement, increases are reported in sales revenues, cost of
goods sold, and (possibly) expenses. On the balance sheet, an increase is reported in accounts
receivable, a decrease is reported in inventory, and a change is reported in stockholders' equity
for the amount of the net income earned on the sale.

If the sale is made with the terms FOB Shipping Point, the ownership of the goods is transferred
at the seller's dock. If the sale is made with the terms FOB Destination, the ownership of the
goods is transferred at the buyer's dock.

In principle, the seller should record the sales transaction when the ownership of the goods is
transferred to the buyer. Practically speaking, however, accountants typically record the
transaction at the time the sales invoice is prepared and the goods are shipped.

 FOB Shipping Point

Quality Products Co. just sold and shipped $1,000 worth of goods using the terms FOB Shipping
Point. With its cost of goods at 80% of sales value, Quality makes the following entries in its
general ledger:

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(While there may be additional expenses with this transaction—such as commission expense—
we are not considering them in our example.)

FOB Shipping Point means the ownership of the goods is transferred to the buyer at the seller's
dock. This means that the buyer is responsible for transporting the goods from Quality Product's
shipping dock. Therefore, all shipping costs (as well as any damage that might be incurred
during transit) are the responsibility of the buyer.

 FOB Destination

FOB Destination means the ownership of the goods is transferred at the buyer's dock. This
means the seller is responsible for transporting the goods to the customer's dock, and will factor
in the cost of shipping when it sets its price for the goods.

Let's assume that Gem Merchandise Co. makes a sale to a customer that has a sales value of
$1,050 and a cost of goods sold at $800. This transaction affects the following accounts in Gem's
general ledger:

Because Gem chooses to ship its goods FOB Destination, the ownership of the goods transfers at
the buyer's dock. Therefore, Gem Merchandise assumes all the risks and costs associated with
transporting the goods.

Now let's assume that Gem pays an independent shipping company $50 to transport the goods
from its warehouse to the buyer's dock. Gem records the $50 as an operating expense or selling

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expense (in an account such as Delivery Expense, Freight-Out Expense,or Transportation-Out
Expense). If the shipping company allows Gem to pay in 7 days, Gem will make the following
entry in its general ledger:

Credit Terms with Discounts

When a seller offers credit terms of net 30 days, the net amount for the sales transaction is due 30
days after the sales invoice date.

To illustrate the meaning of net, assume that Gem Merchandise Co. sells $1,000 of goods to a
customer. Upon receiving the goods the customer finds that $100 of the goods are not
acceptable. The customer contacts Gem and is instructed to return the unacceptable goods. This
means that Gem's net sale ends up being $900; the customer's net purchase will also be $900
($1,000 minus the $100 returned). It also means that Gem's net receivable from this customer
will be $900.

Unfortunately, companies who sell on credit often find that they don't receive payments from
customers on time. In fact, one study found that if the credit term is net 30 days, the money, on
average, arrived 45 days after the invoice date. In order to speed up these payments, some
companies give credit terms that offer a discount to those customers who pay within a shorter
period of time. The discount is referred to as a sales discount, cash discount, or an early payment
discount, and the shorter period of time is known as thediscount period. For example, the
term 2/10, net 30 allows a customer to deduct 2% of the net amount owed if the customer pays
within 10 days of the invoice date. If a customer does not pay within the discount period of 10
days, the net purchase amount (without the discount) is due 30 days after the invoice date.

Using the example from above, let's illustrate how the credit term of 2/10, net 30 works. Gem
Merchandise Co. ships $1,000 of goods and the customer returns $100 of unacceptable goods to
Gem within a few days. At that point, the net amount owed by the customer is $900. If the
customer pays Gem within 10 days of the invoice date, the customer is allowed to deduct $18
(2% of $900) from the net purchase of $900. In other words, the $900 amount can be settled for
$882 if it is paid within the 10-day discount period.

Let's assume that the sale above took place on the first day that Gem was open for business, June
1. On June 6 Gem receives the returned goods and restocks them, and on June 11 it receives

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$882 from the buyer. Gem's cost of goods is 80% of their original selling prices (before
discounts). The above transactions are reflected in Gem's general ledger as follows:

If the customer waits 30 days to pay Gem, the June 11 entry shown above will not occur. In its
place will be the following entry on July 1:

Examples of Amounts Due Under Varying Credit Terms

The following chart shows the amounts a seller would receive under various credit terms for a
merchandise sale of $1,000 and an authorized return of $100 of goods.

Credit
Brief Description Amount To Be Received
Terms

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 The net amount is due within 10 days of the
Net 10 days invoice date. $900

The net amount is due within 30 days of the

Net 30 days invoice date. $900

The net amount is due within 60 days of the

Net 60 days invoice date. $900

If paid within 10 days of the invoice date, the

buyer may deduct 2% from the net amount. ($900
2/10, n/30 minus $18) $882

If paid in 30 days of the invoice date, the net

2/10, n/30 amount is due. $900

If paid within 10 days of the invoice date, the

buyer may deduct 1% from the net amount. ($900
1/10, n/60 minus $9) $891

If paid in 60 days of the invoice date, the net

1/10, n/60 amount is due. $900

The net amount is due within 10 days after the

end of the month (EOM). In other words,
Net EOM payment for any sale made in June is due by July
10 10. $900

Costs of Discounts
Some people believe that the credit term of 2/10, net 30 is far too generous. They argue that
when a $900 receivable is settled for $882 (simply because the customer pays 20 days early) the

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seller is, in effect, giving the buyer the equivalent of a 36% annual interest rate (2% for 20 days
equates to 36% for 360 days). Some sellers won't offer terms such as 2/10, net 30 because of
these high percentage equivalents. Other sellers are discouraged to find that some customers take
the discount and ignore the obligation to pay within the stated discount period.

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LO2. Identify bad and doubtful debts
Credit Risk
When a seller provides goods or services on credit, the resultant account receivable is normally
considered to be an unsecured claim against the buyer's assets. This makes the seller (the
supplier) an unsecured creditor, meaning it does not have a lien on any of the buyer's assets—not
even on the goods that it just sold to the buyer.

Sometimes a supplier's customer gets into financial difficulty and is forced to liquidate its assets.
In this situation the customer typically owes money to lending institutions as well as to its
suppliers of goods and services. In such cases, it's the secured creditors (the banks and other
lenders that have a lien on specific assets such as cash, receivables, inventory, equipment, etc.)
who are paid first from the sale of the assets. Often there is not enough money to pay what is
owed to the secured lenders, much less the unsecured creditors. In other words, the suppliers will
never be paid what they are owed.

To avoid this kind of risk, some suppliers may decide not to sell anything on credit, but require
instead that all of its goods be paid for with cash or a credit card. Such a company, however, may
lose out on sales to competitors who offer to sell on credit.

To minimize losses, sellers typically perform a thorough credit check on any new customer
before selling to them on credit. They obtain credit reports and check furnished references. Even
when a credit check is favorable, however, a credit loss can still occur. For example, a first-rate
customer may experience an unexpected financial hardship caused by one of its customers,
something that could not have been known when the credit check was done. The point is this:
any company that sells on credit to a large number of customers should assume that, sooner or
later, it will probably experience some credit losses along the way.

Direct Write-off Method

Generally accepted accounting principles (GAAP) require that companies use the allowance
method when preparing financial statements. The use of the allowance method isnot permitted,
however, for purposes of reporting income taxes in the United States because the Internal
Revenue Service (IRS) does not allow companies to anticipate these credit losses. As a result,
companies must use the direct write-off method for income tax reporting.

In the direct write-off method, a company will not use an allowance account to reduce its
Accounts Receivable. Accounts Receivable is only reduced if and when a company knows with
certainty that a specific amount will not be collected from a specific customer.

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For example, let's assume that on October 21, Gem Merchandise Co. is convinced that a specific
customer's account receivable originating on June 5 in the amount of $1,238 is definitely
uncollectible. Using the direct write-off method, the following entry is made:

Usually many months will pass between the time of the sale on credit and the time that the seller
knows with certainty that a customer is not going to pay. It is difficult to adhere to the matching
principle and the concept of conservatism when a significant amount of time elapses between the
time of the sales revenues and the time that the bad debts expense is reported. This is why, for
purposes of financial reporting (not tax reporting), companies should use the allowance method
rather than the direct write-off method.

Allowance Method for Reporting Credit Losses

Accounts receivable are reported as a current asset on a company's balance sheet. Since current
assets by definition are expected to turn to cash within one year (or within the operating cycle,
whichever is longer), a company's balance sheet could overstate its accounts receivable (and
therefore its working capital and stockholders' equity) if any part of its accounts receivable is not
collectible.

To guard against overstatement, a company will estimate how much of its accounts receivable
will never be collected. This estimate is reported in a balance sheet contra asset account called
Allowance for Doubtful Accounts. (Some companies call this account Provision for Doubtful
Accounts or Allowance for Uncollectible Accounts.) Any increases to Allowance for Doubtful
Accounts are also recorded in the income statement account Bad Debts Expense (or
Uncollectible Accounts Expense).

This method of anticipating the uncollectible amount of receivables and recording it in the
Allowance for Doubtful Accounts is known as the allowance method. (If a company does not use
an allowance account, it is following the direct write-off method, which is discussed above.)

 Allowance for Doubtful Accounts and Bad Debts Expense - June

As we stated above, the account Allowance for Doubtful Accounts is a contra asset account
containing the estimated amount of the accounts receivable that will not be collected. For
example, let's assume that Gem Merchandise Co.'s Accounts Receivable has a debit balance of

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$100,000 at June 30. Gem anticipates that approximately $2,000 of this is not likely to turn to
cash, and as a result, Gem reports a credit balance of $2,000 in Allowance for Doubtful
Accounts. The accounting entry to adjust the balance in the allowance account will involve the
income statement account Bad Debts Expense.

Since June was Gem's first month in business, its Allowance for Doubtful Accounts began June
with a zero balance. At June 30, when it issues its first balance sheet and income statement, its
Allowance for Doubtful Accounts will have a credit balance of $2,000. This is done using the
following adjusting journal entry:

Here are some of the accounts in a T-account format:

With Allowance for Doubtful Accounts now reporting a credit balance of $2,000 and Accounts
Receivable reporting a debit balance of $100,000, Gem's balance sheet will report a net amount

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of $98,000. Since this net amount of $98,000 is the amount that is likely to turn to cash, it is
referred to as the net realizable value of the accounts receivable.

Under the allowance method, the Gem Merchandise Co. does not need to know specifically
which customer will not pay, nor does it need to know the exact amount. This is acceptable
because accountants believe it is better to report an approximate amount that is uncollectible
rather than imply that every penny of the accounts receivable will be collected.

Gem's Bad Debts Expense will report credit losses of $2,000 on its June income statement. This
expense is being reported even though none of the accounts receivables were due in June. (Recall
the credit terms were net 30 days.) Gem is attempting to follow the matching principle by
matching the bad debts expense as best it can to the accounting period in which the credit sales
took place.

Here's a Tip

Since the net realizable value of a company's accounts receivable cannot be more than the debit
balance in Accounts Receivable, the balance in the Allowance for Doubtful Accounts must be a
credit balance or a zero balance.

Allowance for Doubtful Accounts and Bad Debts Expense - July

Now let's assume that at July 31 the Gem Merchandise Co. has a debit balance in Accounts
Receivable of $230,000. (The balance increased during July by the amount of its credit sales and
it decreased by the amount it collected from customers.) The Allowance for Uncollectible
Accounts still has the credit balance of $2,000 from the adjustment on June 30. This means
Gem's general ledger accounts before the July 31 adjustment to Allowance for Uncollectible
Accounts will be reporting a net realizable value of $228,000 ($230,000 minus $2,000).

Gem reviews the details of its accounts receivable and estimates that as of July 31 approximately
$10,000 of the $230,000 will not be collectible. In other words, the net realizable value (or net
cash value) of its accounts receivable as of July 31 is only $220,000 ($230,000 minus $10,000).
Before the July 31 financial statements are released, Gem must adjust the Allowance for
Doubtful Accounts so that its ending balance is a credit of $10,000 (instead of the present credit
balance of $2,000). This requires the following adjusting entry:

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After this journal entry is recorded, Gem's July 31 balance sheet will report the net realizable
value of its accounts receivables at $220,000 ($230,000 debit balance in Accounts Receivable
minus the $10,000 credit balance in Allowance for Doubtful Accounts).

Here's a recap in T-account form:

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As seen in the T-accounts above, Gem estimated that the total bad debts expense for the first two
months of operations (June and July) is $10,000. It is likely that as of July 31 Gem will not know
the precise amount of actual bad debts, nor will Gem know which customers are the ones that
won't be paying their account balances. However, the matching principleis better met by Gem
making these estimates and recording the credit loss as close as possible to the time the sales
were made.

By reporting the $10,000 credit balance in Allowance for Doubtful Accounts, Gem is also
adhering to the accounting principle of conservatism. In other words, if there is some doubt as to
whether there are $10,000 of credit losses or no credit losses, Gem's accountant "breaks the tie"
by choosing the alternative that reports a smaller amount of profit and a smaller amount of
assets. (It is reporting a net realizable value of $220,000 instead of the $230,000 of accounts
receivable.) If a company knows with certainty that every penny of its accounts receivable will
be collected, then the Allowance for Doubtful Accounts will report a zero balance. However, if it
is likely that some of the accounts receivable will not be collected in full, the principle of
conservatism requires that there be a credit balance in Allowance for Doubtful Accounts.

 Writing Off an Account under the Allowance Method

Under the allowance method, if a specific customer's accounts receivable is identified as

uncollectible, it is written off by removing the amount from Accounts Receivable. The entry to
write off a bad account affects only balance sheet accounts: a debit to Allowance for Doubtful
Accounts and a credit to Accounts Receivable. No expense or loss is reported on the income
statement because this write-off is "covered" under the earlier adjusting entries for estimated bad
debts expense.

Let's illustrate the write-off with the following example. On June 3, a customer purchases $1,400
of goods on credit from Gem Merchandise Co. On August 24, that same customer informs Gem
Merchandise Co. that it has filed for bankruptcy. The customer states that its bank has a lien on
all of its assets. It also states that the liquidation value of those assets is less than the amount it
owes the bank, and as a result Gem will receive nothing toward its $1,400 accounts receivable.
After confirming this information, Gem concludes that it should remove, or write off, the
customer's account balance of $1,400.

Under the allowance method of recording credit losses, Gem's entry to write off the customer's
account balance is as follows:

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The two accounts affected by this entry contain this information:

Note that prior to the August 24 entry of $1,400 to write off the uncollectible amount, the net
realizable value of the accounts receivables was $230,000 ($240,000 debit balance in Accounts
Receivable and $10,000 credit balance in Allowance for Doubtful Accounts). After writing off
the bad account on August 24, the net realizable value of the accounts receivable is still $230,000
($238,600 debit balance in Accounts Receivable and $8,600 credit balance in Allowance for
Doubtful Accounts).

The Bad Debts Expense remains at $10,000; it is not directly affected by the journal entry write-
off. The bad debts expense recorded on June 30 and July 31 had anticipated a credit loss such as

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this. It would be double counting for Gem to record both an anticipated estimate of a credit
loss and the actual credit loss.

 Recovery of Account under Allowance Method

After a seller has written off an accounts receivable, it is possible that the seller is paid part or all
of the account balance that was written off. Under the allowance method, if such a payment is
received (whether directly from the customer or as a result of a court action) the seller will take
the following two steps:

1. Reinstate the account that was written off by reversing the write-off entry. If we assume
that the $1,400 written off on Aug 24 is collected on October 10, the reinstatement of the
account looks like this:

2. Process the $1,400 received on October 10:

The seller's accounting records now show that the account receivable was paid, making it more
likely that the seller might do future business with this customer.

 Bad Debts Expense as a Percent of Sales

Another way sellers apply the allowance method of recording bad debts expense is by using
the percentage of credit sales approach. This approach automatically expenses a percentage of its
credit sales based on past history.

For example, let's assume that a company prepares weekly financial statements. Past experience
indicates that 0.3% of its sales on credit will never be collected. Using the percentage of credit
sales approach, this company automatically debits Bad Debts Expense and credits Allowance for
Doubtful Accounts for 0.3% of each week's credit sales. Let's assume that in the current week

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this company sells $500,000 of goods on credit. It estimates its bad debts expense to be $1,500
(0.003 x $500,000) and records the following journal entry:

The percentage of credit sales approach focuses on the income statement and the matching
principle. Sales revenues of $500,000 are immediately matched with $1,500 of bad debts
expense. The balance in the account Allowance for Doubtful Accounts is ignored at the time of
the weekly entries. However, at some later date, the balance in the allowance account must be
reviewed and perhaps further adjusted, so that the balance sheet will report the correct net
realizable value. If the seller is a new company, it might calculate its bad debts expense by using
an industry average until it develops its own experience rate.

Difference between Expense and Allowance

The account Bad Debts Expense reports the credit losses that occur during the period of time
covered by the income statement. Bad Debts Expense is a temporary account on the income
statement, meaning it is closed at the end of each accounting year. (Closed means the account
balance is transferred to retained earnings, perhaps through an income summary account.) By
closing Bad Debts Expense and resetting its balance to zero, the account is ready to receive and
tally the credit losses for the next accounting year.

The Allowance for Doubtful Accounts reports on the balance sheet the estimated amount of
uncollectible accounts that are included in Accounts Receivable. Balance sheet accounts are
almost always permanent accounts, meaning their balances carry forward to the next accounting
period. In other words, they are not closed and their balances are not reset to zero.

Because the Bad Debts Expense account is closed each year, while the Allowance for Doubtful
Accounts is not, these two balances will most likely not be equal after the company's first year of
operations.

For example, let's assume that at the end of its first year of operations a company's Bad Debts
Expense had a debit balance of $14,000 and its Allowance for Doubtful Accounts had a credit
balance of $14,000. Because the income statement account balances are closed at the end of the
year, the company's opening balance in Bad Debts Expense for the second year of operations is
$0. The credit balance of $14,000 in Allowance for Doubtful Accounts, however, carries forward
to the second year. If an adjusting entry of $3,000 is made during year 2, Bad Debts Expense will

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report a $3,000 debit balance, while Allowance for Doubtful Accounts might report a credit
balance of $17,000.

Again, the reasons for the account balance differences are 1) Bad Debts Expense is a temporary
account that reports credit losses only for the period shown on the income statement, and 2)
Allowance for Doubtful Accounts is a permanent account that reports an estimated amount for
all of the uncollectible receivables reported in the asset Accounts Receivable as of the balance
sheet date.

Aging of Accounts Receivable

The general ledger account Accounts Receivable usually contains only summary amounts and is
referred to as a control account. The details for the control account—each credit sale for every
customer—is found in the subsidiary ledger for Accounts Receivable. The total amount of all the
details in the subsidiary ledger must be equal to the total amount reported in the control account.

The detailed information in the accounts receivable subsidiary ledger is used to prepare a report
known as the aging of accounts receivable. This report directs management's attention to
accounts that are slow to pay. It is also useful in determining the balance amount needed in the
account Allowance for Doubtful Accounts.

The aging of accounts receivable report is typically generated by sorting unpaid sales invoices in
the subsidiary ledger—first by customer and then by the date of the sales invoices. If a company
sells merchandise (or provides services) and allows customers to pay 30 days later, this report
will indicate how much of its accounts receivable is past due. It also reports how far past due the
accounts are.

With the click of a mouse, most accounting software will provide the aging of accounts
receivable report. For example, Gem Merchandise Co.'s software looks at each of its customer's
accounts receivable activity and compares the date of each unpaid sales invoice to the date of the
report. If we assume the report is dated August 31 and that Gem's credit terms are net 30 days,
any unpaid sales invoices with an August date will be classified as current. Any unpaid invoices
with a date in July are classified as 1 - 30 days past due. Any unpaid invoices with a date of June
are classified as 31 - 60 days past due, and so on. The sorted information is present in a report
that looks similar to the following:

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If a customer realizes that one of its suppliers is lax about collecting its account receivable on
time, it may take advantage by further postponing payment in order to pay more demanding
suppliers on time. This puts the seller at risk since an older, unpaid accounts receivable is more
likely to end up as a credit loss. The aging of accounts receivable report helps management
monitor and collect the accounts receivable in a more timely manner.

Aging Used in Calculating the Allowance

The aging of accounts receivable can also be used to estimate the credit balance needed in a
company's Allowance for Doubtful Accounts. For example, based on past experience, a company
might make the assumption that accounts not past due have a 99% probability of being collected
in full. Accounts that are 1-30 days past due have a 97% probability of being collected in full,
and the accounts 31-60 days past due have a 90% probability. The company estimates that
accounts more than 60 days past due have only a 60% chance of being collected. With these
probabilities of collection, the probability of not collecting is 1%, 3%, 10%, and 40%
respectively.

If we multiply the totals from the aging of accounts receivable report by the probabilities of not
collecting, we arrive at the expected amount of uncollectible receivables. This is illustrated
below:

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This computation estimates the balance needed for Allowance for Doubtful Accounts at August
31 to be a credit balance of $8,585.

LO3: Review compliance with terms and conditions and plan recovery action

INTRODUCTION

Journal is subdivided into various parts known as subsidiary books or subdivisions of

journal. Each one of the subsidiary books is a special journal and a book of original or
prime entry. There are no journal entries when records are made in these books.
Recording the transactions in a special journal and then in the ledger accounts is the
practical system of accounting which is also referred to as English System. Though the
usual type of journal entries are not passed in these sub-divided journals, the double entry
principles of accounting are strictly followed.

BASIC DOCUMENT FOR SUBSIDIARY BOOKS

Inward Invoice:

This is the document sent by the suppliers of goods giving details of goods sent, price,
value, discount etc. It is the basis for entries in purchases book.

Outward Invoice:

This is a document sent by the firm to the customers, showing the details of goods
supplied, their price and value, discounts etc., it is the basis for writing sales book.

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Debit Note:

It is a simple statement sent by a person to another person showing the amount debited to
the account of the latter along with a brief explanation. The debit notes are issued by a
trader relating to purchase returns in order to put up his claim for abatement of his dues to
the other party. Debit notes are serially numbered and are similar to invoices although
they are usually printed in red ink.

Credit Note:

It is nothing but a statement sent by one person to another person showing the amount
credited to the account of the latter along with a brief explanation. The credit notes are
used for sales return in order to intimate related abatement and are similar to invoice
although they are usually printed in red ink.

Cash Receipts and Vouchers:

These are the vouchers and receipts for cash received and paid. Entries in cash book are
made on the strength of the vouchers and receipts. They are also useful for auditing
purpose.

Contra Entries

For any single transaction the same account cannot be debited and credited.

But since cash and bank accounts are maintained in the cash book, the debit and credit
may be found in the two different accounts in the Cash Book. They are transactions
which affect both the sides of the Cash Book. For instance, when cash is deposited into
the bank, bank account should be debited and cash account should be credited.

Hence, on the debit side of the Cash Book. „To Cash‟ is written in the particulars column
and the amount is entered in the bank column. Similarly, on the credit side of the Cash
Book, „By Bank‟ is written in the particulars column and the amount is entered in the
cash column.

When cash is withdrawn from the bank, on the debit side of the Cash Book,

„To Bank‟ is written in the particulars column and the amount is written in the cash
column. Likewise, on the credit side of the Cash Book, „By

Cash‟ is written in the particulars column and amount is entered in the bank column.

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Therefore, those entries which appear on both the sides of the Cash Book are called

Contra Entries and they are identified and denoted in the Cash Book itself by writing the
letter „C‟ in the Ledger Folio Columns on either side. For these transactions, as double
entry procedure is completed in the cash book itself, no further positing is made in the
ledger.

In a three columnar Cash Book, cash and bank columns are balanced as any other ledger
account and discount columns are imply totaled. To know the balance of the discount
columns, a separate account, viz., discount account is opened in the ledger. While the
cash column will always show a debit balance, the bank column may show a credit
balance at times. The credit balance in the bank column represents nothing but bank
overdraft.

KINDS OF SUBSIDIARY BOOKS

There are different types of subsidiary books which are commonly used in any big
business concern. They are:

 Purchases Book
 Sales Book
 Purchases Returns Books
 Sales Returns Books
 Bills Receivable Books
 Bills Payable Books
 Journal Proper
 Cash Book
 Purchases Book

This book is used to record all credit purchases made by the business concern from its
suppliers. This book is also known as „Purchases Books‟, „Purchases Journal‟ or „Invoice
Book‟. It contains five columns, viz., Date, Particulars, Ledger Folio, Inward Invoice
Number and Amount. Whenever any credit purchase is made, the date on which the
transaction has taken place is entered in the „Date Column‟, the name of the party from
whom the purchase has been made the particulars column, the inward invoice number
with which the purchase has been made in the „inward Invoice

Number Column‟ and the money value of the purchase in the „Amount Column‟. The

„L.F. Column‟ is to record the ledger folio number while posting is made.

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Posting: The total of purchases book for a specified period is debited to the purchases
account in the Ledger. The personal accounts are posted by crediting the individual
accounts.

 Sales books

This book is used to record all credit sales effected by the business to its customers. This
book is also called as „Sales Book‟, „sales Journal‟ or „Sold Book‟. It contains five
columns, viz., Date, Particulars, L.F., Outward Invoice Number and Amount. When any
credit sales is effected, the date is entered in the „Date Column‟, the name of the party to
whom the sale is made in the „Particulars Column‟, the invoice number with which the
sales have been effected in the „Out-ward Invoice

Number Column‟ and the money value of the sales in the „Amount Column‟, The LF
column is entered while posting is affected.

Posting: The total of the Sales Book for a specified period is credited to the

Sales Account in the Ledger. The personal account is posted by debiting the individual
accounts

 Purchases Returns Books

This book is used to record all transactions relating to the goods returned to suppliers.
This book is also known as „Purchases Returns journal‟ or „Returns

Outward Book‟

 Sales Returns Books

This book is used to record all transactions relating to goods returned by customers. This
book is also known as „Sales Return Journal‟ or „Returns Inwards

Book‟,

 Bills Receivable Book:

This book is used to record all the bills received by the business from its customers. It
contains details regarding the name of the acceptor, date of the bill, place of payment,
term of the bill, due date and the amount of the bill.

 Bills Payable Book:

This book is used to record all the bills accepted by the business drawn by its creditors. It
contains details regarding the name of the drawer, payee and date of acceptance, due
date, place of payment, term and amount of the bill.

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  Journal Proper

This book is used to record all the residual transactions which cannot find place in any of
the subsidiary books. While recording, the entries are made in the journal covering both
the aspects of the transaction. The following are some of the examples of transactions
which are entered in this book.

1. Opening entries and closing entries.

2. Adjusting entries

3. Transfer entries from one account to another account.

4. Rectification entries.

5. Bills of Exchange Entries

6. Credit Purchase/sale of an asset other than goods.

 Cash Book

Cash Book is a sub-division of Journal recording transactions pertaining to cash receipts

and payments. Firstly, all cash transactions are recorded in the Cash

Book wherefrom they are posted subsequently to the respective ledger accounts. The

Cash Book is maintained in the form of a ledger with the required explanation called as
narration and hence, it plays a dual role of a journal as well as ledger. All cash receipts
are recorded on the debit side and all cash payments are recorded on the credit side. All
cash transactions are recorded chronologically in the Cash Book. The Cash

Book will always show a debit balance since payments cannot exceed the receipts at any
time.

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LO4: Prepare reports and file documentation

Preparing Required Documentation

Prepare a separate work paper for each balance sheet account to document the reconciliation.
The work paper must contain the following information:

a. The balance sheet account number and account name.

b. A statement of purpose for the account.

c. A brief description of the debit/credit activity that normally processes through the
account.

d. The accounting period for which the analysis is being completed.

e. Key as to the presentation in the account (e.g., is credit shown as a positive or negative
number).

f. Activity for the period - presentation will be determined based on the nature of the
account and the volume of activity that is recorded monthly in that account.

g. Substantiation of the account's ending balance through review of underlying supporting

documentation.

h. The name and phone number of individual preparing the reconciliation.

i. The date the reconciliation was completed.

j. A list of contact names and phone numbers/email addresses for questions relating to the
account.

k. Keep account information updated for changes in processing and other information.

Completing the Analysis

Perform the following activities after each month end close:

a. Confirm the opening balance with previous work papers, or that balance was zero if this
is a new account.

b. Review the activity posted to the account to ensure that detail items are:

1. Properly classified to the account,

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2. Authorized in accordance with University policies, State and Federal laws and
regulations, and specific sponsor or donor requirements or restrictions, and

3. Within the guidelines of the stated purpose of the account.

c. Ensure that all expected charges, receipts or other activity appears in the account.

d. Take appropriate actions to record necessary adjustments.

e. Take immediate action to resolve errors or discrepancies noted during the reconciliation
process and follow up to ensure that errors are corrected.

f. Maintain copies of supporting documentation for activity processed for the account.

g. Confirm the ending balance per the reconciliation agrees to the general ledger balance.

Reviewing the Analysis

Submit the account analysis at the end of each quarter for review to the Office of the Controller.
The reviewer verifies that:

a. Analysis includes all of the funds within this balance sheet account.

b. Ending balances agrees to the general ledger.

c. Ending balances are substantiated with supporting documents.

d. All activity is appropriate and reasonable.

e. Adjustments or corrections, if necessary, have been initiated.

f. The account (fund and reporting category) has been assessed for the need to retain.

Retaining Documentation

Supporting documentation for detail items comprising the balance in the account should be
retained until open items have cleared. Supporting documentation for items relating to period
activity (Accounts Receivable records, Vendor Invoices, Cash Receipts, Journal Entries, etc.) in
the account analysis should be kept in accordance with record retention guidelines.

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LO5 Distribute creditors invoices for authorization

Mailing Statements to Customers

To improve the probability of collection (and avoid bad debts expense) many sellers prepare and
mail monthly statements to all customers that have accounts receivable balances. If worded
skillfully, the seller can use the statement to say "thank you for your continued business" while at
the same time "reminding" the customer that receivables are being monitored and payment is
expected. To further prompt customers to pay in a timely manner, the statement may indicate
that past due accounts are assessed interest at an annual rate of 18% (1.5% per month). Because
transactions are usually itemized on the statement, some customers use the statement as a means
to compare its records with those of the seller.

Pledging or Selling Accounts Receivable

A company's accounts receivable are considered to be a type of asset, and as such can be pledged
as collateral for a loan. Asset-based lenders will often lend a company an amount equal to 80%
of the value of its accounts receivable.

Some companies sell their accounts receivable to a factor. A factor buys the accounts receivables
at a discount and then goes about the business of collecting and keeping the money owed through
the receivables. Sometimes the factor will purchase the accounts receivables with recourse. This
means the company that sold the receivables remains financially responsible if a customer does
not remit the full amount to the factor. When the factor purchases the receivables without
recourse, the company selling the receivables is not responsible for unpaid amounts.

Accounts Receivable Ratios

There are two commonly used financial ratios that address the relationship between the amount
of a company's accounts receivable as reported on the balance sheet and the amount of credit
sales as reported on the income statement. These ratios are:

1. Accounts receivable turnover ratio, and

2. Day‟s sales in accounts receivable.

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LO6 Remit payments to creditors

Remittance advice
A document that describes payments that are being made. The person or company that
is making the payment will sometimes include a remittance advice, which is like a receipt of the
payment. A remittance advice is usually used by companies processing either a purchase or a
filed claim. This term is frequently used in the United Kingdom.

Creditor Reference

The Creditor Reference (also called the Structured Creditor Reference) is an international
business standard based on ISO (International Organization for Standardization) 11649,
implemented at the end of 2008.

Using Creditor Reference, a company can automatically match its remittance information to
its account receivable. This means that the company's financial supply chains straight through
processing will be increased.

The Creditor Reference was first implemented within the SEPA (Single Euro Payment
Area) rulebook 3.2.

Implementation of creditor reference

A vendor adds the Creditor Reference to its invoices. When a customer pays the invoice, the
company writes the Creditor Reference instead of the invoice number in the message section, or
places a Creditor Reference field in its payment ledger.

When the vendor receives the payment, it can automatically match the remittance information to
its Accounts Receivable system.

Customer Account Settings

To view an account's settings within the Customers table or Administrators table, click on the ID
number of the account.

Each customer account has a variety of settings you can configure - depending on the customer
type or how you wish to manage customers. Note that not all fields need to be used, depending
on the account type. To view the full list of customer account settings.

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LO7 Prepare accounts paid report and reconcile balances outstanding

What is meant by reconciling an account?

Reconciling an account often means proving or documenting that an account balance is correct.
For example, we reconcile the balance in the general ledger account Cash in Checking to the
balance shown on the bank statement. The objective is to report the correct amount in the general
ledger account Cash in Checking. You will often need to adjust the general ledger
account balance for items appearing on the bank statement that were not entered in the general
ledger account.

I recall being asked to reconcile the general ledger account Freight Payable. What I needed to do
was provide documentation that the balance in Freight Payable was proper. I proceeded to look
at the shipments of recent sales and then determined how much we would be obligated to pay for
the freight on those sales. We then adjusted the balance inFreight Payable to my documented
amount. This reconciliation was done to have the correct account balance and to provide the
outside auditors with documentation which could easily be reviewed.

I also reconciled the balance in Utilities Payable by computing the daily cost of each utility that
the company used. The cost per day was then multiplied by the number of days since the last
meter reading date shown on the utility bills already entered in our accounting system. We then
adjusted the Utilities Payable account balance to be equal to the documented amount.

Reconciliation of Balance Sheet Accounts

Reconciliation is the process of comparing information that exists in two systems or locations,
analyzing differences and making corrections so that the information is accurate, complete and
consistent in both locations. Balance sheet accounts must be reconciled on a periodic and timely
basis to verify that all items were correctly posted to the account. All funds within the balance
sheet account must be included in the reconciliation unless previous arrangements have been
made. Without performing reconciliations, inaccurate recording of transactions may occur that
would result in incorrect reporting and could impact resources.
The Office of the Controller will maintain a master list of balance sheet account assignments.
This list will show the unit and person responsible for completing individual account analysis on
a monthly basis, where the supporting files (system and documents) are located and the period
through which accounts have been reviewed.

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Budget Reconciliation
This information is intended to provide guidelines for a regular budget reconciliation process. Please
review all of the content provided in the sections below.

What is budget reconciliation, and why do we need to do it?

Definition: Budget reconciliation is the process of reviewing transactions and supporting documentation,
and resolving any discrepancies that are discovered.

The process encompasses two different activities or roles:

 Detailed review of transactions and supporting documentation (department staff)

 High level budget review and analysis by a person accountable for the budget (budget reviewer).

Purpose: Regular reconciliation should be done in your department to provide reasonable assurance that
transactions are authorized, reasonable, allowable, and correct.

Who should reconcile?

All colleges, schools, departments and units should perform regular budget reconciliation for all budget
types.

(Note: For the purposes of these guidelines, we will use “department” as the standard word for any
university organization, whether college, school, department, or unit)

Department staff knowledgeable of University and departmental policies, budget restrictions, and
reconciliation guidelines should be involved in regular reconciliation of department budgets. This often
includes department Administrators and Fiscal Specialists.

Ideally, the reconciliation process involves someone who did not initiate, record, or authorize the
transactions. Your department process should have separation of duties. This means that no one person
has sole control over the lifespan of a transaction.

A budget reviewer reviews budget activity for reasonableness and appropriateness. A reviewer is
someone:

 Accountable for the budget

 Conversant with all rules and regulations applicable to the budget
 Who does not pose any separation of duties conflicts

Special Notes on Sponsored Budgets: The Principal Investigator (PI) is responsible for their grant
budgets, unless the PI has delegated authority to another person who has direct knowledge of the needs of
the project. See Reconciliation Best Practices for additional guidance.

How often should we reconcile?

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When possible reconciliation should be completed monthly, within 45 days of month-end close, but no
less frequently than quarterly. For sponsored agreements a final reconciliation should be completed within
45 days of the budget end date. Keep in mind that special situations such as biennium close may take
longer to finish than “regular” months.

What does Budget Reconciliation Cover?

1) Review transactions

 Review all departmental transactions.

 When reviewing transaction amounts, keep in mind that sales tax may not have been charged by
the vendor. The transaction amount posted to UW systems will typically include sales or use tax,
and may therefore differ from the vendor charge amount.
 Look for any suspicious transactions or abrupt changes from an established pattern or trend.

2) Match transactions with supporting documentation

Validate that supporting documentation (electronic or paper), including source documents, matches
expense or revenue transactions on the official university record (e.g. MyFD Transaction Summary or
Reconciliation Report, Enterprise Data Warehouse (EDW) Reports, BAR).

A transaction may be reconciled without physically matching supporting documentation if:

 The person accountable for the budget has knowledge of the nature of the transaction, is able to
explain what it is for, and the transaction originated from a UW source. The source document
needs to be reproducible and available according to the record retention schedule. Examples may
include: regular salary charges originating in UW payroll system, and internal recharges (e.g
ISDs, CTIs).
 It is less than $75 and your department has other compensating controls in place regarding
expenditures. The strength of your department‟s documented internal controls over purchasing
and receiving may affect the depth of your reconciling activity, and departments may choose to
be more restrictive with their threshold of review.

Special Note on Federally-Sponsored Budgets: Federal auditors may ask you to provide supporting
documentation for these transactions. If sufficient documentation is not available, your department may
be responsible for reimbursing for these charges.

3) Manage supporting documentation as specified by Records Management:

 State and Endowment budgets

 Grant and Contract budgets

4) Investigate and resolve any discrepancies or concerns

Your departmental reconciliation procedures should document who is responsible for investigating and
resolving discrepancies, taking into account appropriate separation of duties.

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For errors involving transactions of $10 or less, see guidance provided in GIM 15 Attachment B: Cost
Transfer Minimum Thresholds (applies to all budget types).

5) High level review and analysis of budget activity by someone accountable for the budget

When Budget Reconciliation Is Considered Complete?

 Transactions have been reviewed and matched as described above,

 Errors have been detected and resolved, and
 Any corrections initiated have been verified as complete.

Final Words and Recommendations

Remember that department records should provide evidence that the budget reconciliation has been
completed and reviewed.

We recommend that departments document their reconciliation policies and procedures, addressing any
areas that are not in accordance with the reconciliation guidelines provided here. Documented
departmental reconciliation policies and procedures should be kept current.

If your department does not maintain its own budget reconciliation policy, auditors may use these
Reconciliation Guidelines and/or department internal controls to assess your reconciliation practices as
part of an audit.

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