1.

2.

3.

4.

Types of receivables
Direct write-off vs allowance method to
account for bad debts
Assessment of impairment under
allowance method
Financial ratios to manage receivables

Receivables: amounts owed to company

Accounts receivables (or trade receivables)
Notes receivables
Other receivables

Fairly liquid assets after cash and current

investments in Balance Sheet

Company sells on account/ on credit to

customer
Delivers goods and services now, but
customer promises (informally) to pay in
the future, eg within 30 days

Non-interest bearing

Common payment terms: e.g. 2/10, n/30

Date

Journal entry

7-Oct-11

Accounts receivable - Co A

Dr

Cr

5,000

Sales revenue

5,000

(Sales to Co A)
Date

Journal entry

2-Nov-11

Cash
Accounts receivable - Co A
(Receipt from Co A)

Dr

Cr

5,000
5,000

Subsidiary accounts:
A/R - Co A
1-May

150

4-May

50

31-May

200

General ledger:
Accounts Receivable

A/R - Co B
1-May

10-May

300

31-May

300
A/R - Co C

1-May

500
10-May

31-May

100

400

1-May

650

4-May

50

10-May

300 20-May

31-May

600

400

Written, formal promise to pay the

company a specific sum at a future date
Characteristics:
Usually interest-bearing
Large amounts
Longer credit period

Can arise from:

1. Sales, similar to A/R, but for larger sales

transactions and/or longer credit period

2. Extension of A/R payment terms (the

company accepts a note from a customer on

account)

3. Lending to a supplier or business partner

Details will not be covered under ACC1002

Learning Objective 2:
Direct Write-Off
vs Allowance Method
to Account for
Bad Debts

Benefit of selling on credit: increase sales

But part of the accounts receivable may
not be collectible
Debtors in financial difficulty
Disputes about payment amount, etc

Q: should the entire amount of A/R be

reported on the balance sheet @ periodend?
FRS 39: A/R should be assessed for any
objective evidence of impairment

Impairment of A/R = a portion of A/R may

not be collectible ultimately


1.

2.

Actions if evidence exists:

Net A/R balance is reduced to reflect just the
estimated collectible portion (B/S impact)
The uncollectible portion = a cost of doing
business, so recognized as an expense (I/S
impact)
- names for expense: bad debt expense,
doubtful debt expense, uncollectible account
expense, impairment loss on A/R

Uncollectible Debts
Direct Write-Off method*

Allowance method

Individual assessment

Group assessment
Aging of A/R

* Strictly speaking, FRS does not advocate Direct Write-Off method.

It is included here, because
it is useful in illustrating the superiority of the Allowance method
in practice, some companies use it under certain circumstances

Company waits until a debt actually turns bad, to

record the bad debt expense:
Dr Bad debt expense
Cr Accounts receivable

E.g. company sells to Co X on credit in 2011. Co

X goes bankrupt in 2012, and is unable to pay co
Under Direct Write-Off Method, company records
the above JE only in 2012

Problem is, this would result in:

Poor matching of bad debt expense (recorded

in 2012 in e.g.) against revenue (recorded in
2011)
-> overstatement of net profit in 2011
Overstatement of assets as at end-2011

Acceptable only if bad debts are insignificant

Company doesnt wait for debts to actually turn bad

Company estimates the portion of debts that may
eventually turn bad (based on signs of impairment)
Bad debt expense is recorded in the same period as
when the relevant revenue is generated
better matching

In previous e.g. of selling to Co X, under Allowance Method,

company records Bad Debt Expense in 2011 (same year
that Revenue is recorded):

2011:

Dr Bad debt expense

Cr Allowance for bad debts*

Balance Sheet (partial)

Accounts receivable
less Allowance for bad debts
Accounts receivable, net

xx
(xx)
xx

a contra account
to A/R

Income Statement
(partial)
Revenue

xx

Expenses:
Bad debt expense

(xx)

* Alternative names: Allowance for Doubtful Debts, Allowance for

Uncollectible Accounts, Allowance for Impairment Losses

In 2012, when Co X goes bankrupt and amount

due is confirmed uncollectible, company records:
Dr Allowance for bad debts
Cr Accounts receivable

The write-off here has no effect on 2012s income

statement
Because bad debt expense was already
estimated and recorded in 2011

E.g. to illustrate:

Direct write-off
method

Allowance method

1. Sale to Co X in 2011

Sale to Co X in 2011

Dr A/R
Cr Revenue
2. End-2011
No action

100

Dr A/R

100

100 Cr Revenue

100

End-2011
Dr Bad debt exp

20

Cr Allowance of bad debt

It is estimated that 20% of
debt will not be collectible

20

Direct write-off method

Partial I/S (2011)
Revenue
100
Bad debt exp
(-)
Net profit
100
Overstated

Partial B/S (end-2011)

A/R
100

Allowance method
Partial I/S (2011)
Revenue
100
Bad debt exp
(
)
Net profit

80

Partial B/S (end-2011)

A/R
100
Less: Allowance (
)
A/R, net
80

3. In

2012, Co X pays up 80% of debt --> 20% is

confirmed not collectible
Direct write-off
method
Dr Bad debt exp
Dr Cash
Cr A/R

Allowance method
20
80

Dr Allowance of bad debt 20

Dr Cash
80
100 Cr A/R
100

Direct write-off method

Partial I/S (2012)
Revenue
Bad debt exp
(
)
Net profit
(20)
Understated

Allowance method
Partial I/S (2012)
Revenue
Bad debt exp
Net profit

(-)
-

Partial B/S (end-2012)

A/R

Partial B/S (end-2012)

A/R
-

Less: Allowance
A/R, net

(-)
-

1) Allowance for bad debt

made in 2011

Allowance for Bad Debts

1/1/11
31/12/11 Exp
31/12/11 Bal.

Bad Debt Expense

31/12/11
20

1/5/12 Write-off

20
20

20
1/5/12 Bal.

Accounts Receivable
1/1/11

2) Write-off in 2012 against

Allowance account

1/9/11 Sale 100

31/12/11 Bal. 100

1/5/12 Bal.

1/5/12 Cash

80

1/5/12 Write-off

20

1) No allowance for bad debt in 2011

2) Write-off in 2012 against income statement directly
Accounts Receivable
1/1/11
1/9/11 Sale
31/12/11 Bal.

1/5/12 Bal.

Bad Debt Expense

1/5/2012
20

100
100

1/5/12 Cash

80

1/5/12 Write-off

20

Recall the sale transaction with Co X:

1. Sale to Co X in 2011
Dr A/R

100

Cr Revenue

100

2. End-2011 (estimated 20% not collectible)

Dr Bad debt exp
Cr Allowance of bad debt

20
20

3. On 1 May 2012, Co X pays up 70% of debt

--> 30% is confirmed uncollectible
1/5/2012 Dr Allowance of bad debt

Dr Cash
Cr A/R

30
70
100

(To record cash collection of $70 and writing off of

bad debt of $30 against the Allowance account)

1) Allowance for bad debt made

in 2011

Allowance for Bad Debts

1/1/11
31/12/11 Exp
31/12/11 Bal.

Bad Debt Expense

31/12/11
20

1/5/12 Write-off
1/5/12 Bal.
Accounts Receivable
1/1/11

1/9/11 Sale 100

31/12/11 Bal. 100
1/5/12 Cash
1/5/12 Write-off
1/5/12 Bal.

70

20
20

10

2) In 2012, write the

entire $30 bad debt
against the Allowance
account this will result in
a net Dr balance of $10

For simplicity, assume that @ the year-end review, the

company opines that all existing A/R are collectible*, ie
zero Allowance of Bad Debt is required @ 31/12/2012
JE required:
31/12/2012

Dr Bad debt expense

Cr Allowance of bad debt

10
10

(To recognize an additional bad debt expense of

$10 and to correct the prevailing net debit
Allowance balance)
* This assumption is released in the example on slides 61-63

impact on Allowance and Bad Debt Expense accounts

Allowance for Bad Debt

Bad Debt Expense

31/12/11 Bal. 20
1/5/12 Write-off

30

1/5/12 Bal.

10

31/12/12
31/12/12 Exp
31/12/12 Bal.

Underestimation of bad
debt expense in 2011
necessitates recognizing
an additional bad debt
expense in 2012

3. On 1 May 2012, Co X pays up 90% of debt

--> only 10% is confirmed uncollectible
1/5/2012

Dr Allowance of bad debt

Dr Cash
Cr A/R

10
90
100

(To record cash collection of $90 and writing off of

bad debt of $10 against the Allowance account)

1) Allowance for bad debt made

in 2011

Allowance for Bad Debts

1/1/11
31/12/11 Exp
31/12/11 Bal.

Bad Debt Expense

31/12/11
20

20
20

1/5/12 Write-off
1/5/12 Bal.
Accounts Receivable
1/1/11

1/9/11 Sale 100

31/12/11 Bal. 100
1/5/12 Cash
1/5/12 Write-off
1/5/12 Bal.

90

10

2) In 2012, write the $10

bad debt against the
Allowance account this
will result in a net Cr
balance of $10

Again, assume that @ the year-end review, the

company opines that all existing A/R are collectible, ie
zero Allowance of Bad Debt is required @ 31/12/2012
JE required:
31/12/2012

Dr Allowance of bad debt

Cr Bad debt exp recovered

10
10

(To reverse bad debt expense of $10 and to correct the

prevailing net credit Allowance balance)

impact on Allowance and Bad Debt Expense accounts

Allowance for Bad Debt

1/5/12 Write-off

31/12/11 Bal.

20

1/5/12 Bal.

10

Bad Debt Expense

10
31/12/12

31/12/12 BD exp

recovered
31/12/12 Bal

As an excess of $10 of bad debt exp was

recognized in 2011, it is now recovered
in 2012 (ie a reversal of expense)

Scenario
A. Under-estimation in
2011

Income statement
impact
Additional BD exp. to be
recognized in 2012

B. Over-estimation in
2011

BD exp. to be recovered
in 2012

FRS 39: an A/R is considered impaired if there is

objective evidence that the entire A/R amount/a

portion of it may ultimately be uncollectible,
as a result of a loss event

Loss events include:

Significant financial difficulty of debtor
Payment defaults on principal or interest
Probable bankruptcy of debtor
Data indicating decreased repayment ability of a
group e.g. poor economic conditions

How to Estimate Bad Debt Expense under the

Allowance Method?
FRS 39:
For A/R amounts which are individually significant,
evaluate each separately for impairment (any loss
event?)
For A/R amounts which are not individually
significant, evaluate separately or collectively

FRS 39 (continued):
For those A/R amounts assessed separately, if no
evidence of impairment exists, they are grouped
with other A/R amounts with similar credit risk
characteristics for collective assessment
A/R with similar credit risk characteristics exhibit
similar ability to repay, e.g. industry type, location,
past-due status

An example is given below to illustrate the

execution of the FRS requirements
E.g. total A/R @ 31 Dec 2011: $100k
Comprising
Co A
$50k
Co B
$30k
Other 90 customers
$20k
(includes 1 Co Z owing $1k)
Q: how to estimate bad debt expense?

Step 1: Individual assessment

- pick out the individually significant A/Rs
- evaluate each separately for possible impairment

Individually
significant A/R

Amount owed

Co A

$50k

Co B

$30k

Results of
assessment

Action

Evidence that
Step 2
50% may be provide for bad
uncollectible
debt
No evidence of Step 3 group
uncollectibility with others for
group
assessment

Step 2: If a significant A/R is impaired @

balance sheet date, record Bad Debt Expense for
the portion estimated to be uncollectible
E.g., JE for Co A (50% of $50k estimated to be
uncollectible):
Dr Bad debt expense
25k
Cr Allowance for bad debts
25k

Step 3: If no evidence of individual impairment

- combine these significant A/R with the
insignificant A/Rs
- to evaluate as a group in Step 6
In e.g., group Co B with the other smaller
customers for group assessment

Step 4: For the insignificant A/Rs, pick out any A/

R known to be individually impaired

Individually
insignificant A/
R
Co Z

Amount
owed

Other 89
customers

$19k

$1k

Known status
(without in-depth
evaluation)
Known that 20%
may be
uncollectible
No obvious
evidence of
uncollectibility

Action

Step 5 provide
for bad debt
Step 6 group
assessment with
A/R in Step 3

Step 5: For an insignificant A/R known to be

impaired, record Bad Debt Expense for the
portion estimated to be uncollectible
E.g., JE for Co Z (20% of $1k estimated to be
uncollectible):
Dr Bad debt expense
Cr Allowance for bad debts

Step 6: Combine these A/R to evaluate as a

group
1) significant A/R with no negative evaluation
2) insignificant A/R not known to be impaired
1) Co B
2) 89 insignificant customers

30k
19k
49k

Q: how to execute Step 6?

Ie, out of the $49k owed (by Co B and 89
insignificant customers), how much is estimated
to be uncollectible?
A common way to estimate amount of bad debt
under group assessment:
Aging of A/R

All invoices are categorized according to how

long they have been outstanding @ balance
sheet date, e.g. 1-30 days, 31-60 days, etc
Uncollectible amounts are estimated for each
age category
A balance sheet approach, as method focuses on
net realizable value of receivables

Days Outstanding @ 31 Dec 11

Accounts

1 - 30

31 - 60

61 - 90

> 90

Total

Co B

30k

30k

Co C

0.2k

0.3k

0.5k

Co Y

0.1k

0.1k

Total

35k

5k

5k

4k

49k

For each age category (eg 1-30 days)

Total amount in category
x
Estimated % of
uncollectibility for category
=
Estimated uncollectible
amount for category

higher % estimated for longer

outstanding accounts (deemed
more likely to become
uncollectible)

Sum of computed amounts

in all categories
=
Target balance to be achieved for
the Allowance for Bad Debts
account as at year-end

How do we estimate the % of uncollectibility

for each age category?

Based on historical loss experience

Adjusted by assessment of current economic
conditions

Days Outstanding @ 31 Dec 11

Accounts

1 - 30

31 - 60

61 - 90

> 90

Total

Co B

30k

30k

Co C

0.2k

0.3k

0.5k

Co Y

0.1k

0.1k

Total

35k

5k

5k

4k

49k

Estimated % of
uncollectibility

1%

5%

20%

50%

0.35

0.25

Estimated bad
debt

3.6

Allowance of Bad Debt account

is to be adjusted to this
target balance

Having a target balance of $3.6k in the Allowance

account means
Partial balance sheet:
Accounts receivable
Less: Allowance for bad debt
Accounts receivable, net

$x
(

)*
$y

* To simplify the illustration, this number reflects the

allowance under group assessment only. Allowances
made for Co. A and Co. Z under individual assessment will
be added later see summary table

$y represents the net realizable value of A/R,

after deducting an estimated bad debt amount
of $3.6k from the gross A/R amount of $x
$y + other assets = total assets of company
Note: $3.6k is the ending-balance of the
Allowance account, it is not necessarily the
periods bad debt expense in income statement

Assume the Allowance for Bad Debt account has

a $1k balance before the adjusting entry
Q: what adjusting entry is needed to bring the
Allowance balance to its target balance of $3.6k?

A: the required adjusting entry is one that will

bring the existing balance ($1k) to the target
balance ($3.6k)
= $(3.6k 1k)
= $2.6k
Allowance for Bad Debts
1-Dec 1k
Adj
2.6k
31-Dec 3.6k

Dr Bad debt expense

Cr Allowance for bad debts
Accounts Receivable (partial)
31-Dec

49k

Allowance for Bad Debts

1-Dec
1k
Adj
2.6k
31-Dec

unchanged

Bad Debt Expense

Adj
2.6k

3.6k

Allowance is
adjusted to achieve
the target ending
balance of $3.6k

Individual
assessment
Balance Sheet (partial)
Accounts receivable

Co A

Group assessment
(Aging method)

Total
Co

Co B + 89
insignificant others

Co Z

50k

1k

49k

Less:
Allowance for bad debts

(25k)

(0.2k)

(3.6k)

(28.8k)

Accounts receivable, net

25k

0.8k

45.4k

71.2k

Income Statement
(partial)

100k

to B/S

Expenses:
Bad debt expense

(25k)

(0.2k)

(2.6k)

(27.8k)
to I/S

Cash

$ xx

Accounts receivable

$100k

Less: Allowance for bad debt

(28.8k)

Accounts receivable, net

71.2k

Inventory

xx

Current assets

$xx

Revenue

$ xx

Cost of goods sold

(xx)

Gross profit

xx

Operating expenses:
Bad debt expense
Net profit

(27.8k)
$xx

Days sales in receivables =

net receivables
1 day's net credit sales *

* 1 days net credit

sales

the years net credit sales

365

Net credit sales = credit sales sales returns and allowances

sales discounts

Measures how much A/R there is @ year-end

The lower the ratio, the better

A/R turnover

net credit sales

average net receivables *

* Average net =
receivables

beginning + ending net receivables

2

Measures how fast A/R is being collected

The higher the ratio, the better