22208 Chap.5 Receivables and Bad Debts
Receivables and Bad Debts
Week 5 begins Module 2 with receivables. Credit sales create accounts receivable, reduced by sales returns and early-payment discounts, both contra-revenue accounts. Receivables are current assets reported at net realisable value, so expected losses must be estimated.
The direct write-off method expenses a bad debt only when it is abandoned; the allowance method estimates it in advance from credit sales, from a percentage of receivables or from an ageing schedule.
Calculations in this topic come in a fixed family.
You may be asked to record a year of sales, collections and write-offs under each method, to estimate bad debt expense on credit sales or on the receivables balance, to compute net realisable value, or to work backwards from an allowance account to identify which method a company uses. The ageing schedule adds a table of balances by age with a rising loss percentage.
What this chapter covers
- 01
Recording credit sales, returns and discounts
- 02
Net realisable value of receivables
- 03
Direct write-off method and its weaknesses
- 04
Allowance method: percentage of credit sales
- 05
Percentage of receivables and ageing schedules
- 06
Writing off and recovering a specific account
Worked example · free
Topping up the allowance when it starts with a debit balance
- 1Target allowance: 48,000 × 3% = $1,440 credit.
- 1The account starts $260 on the debit side, so the adjustment must cover that and reach the target: 1,440 + 260 = $1,700.
- 1Entry: Dr Bad debt expense 1,700, Cr Allowance for bad debts 1,700.
- 1Net realisable value: 48,000 − 1,440 = $46,560.
Key terms
- Net realisable value
- Gross receivables less the allowance for amounts not expected to be collected.
- Allowance for bad debts
- A contra-asset account holding the estimate of receivables that will not be collected.
- Ageing schedule
- A listing of receivables by how long they have been outstanding, with a higher loss rate applied to older debts.
- Direct write-off method
- Recording bad debt expense only when a specific receivable is judged uncollectible and removed.
- Sales discount
- A reduction given for early payment, recorded in a contra-revenue account.
Receivables and Bad Debts FAQ
Why do accountants prefer the allowance method?
It records the expected loss in the same period as the sale that caused it, which the direct write-off method fails to do. The lecture adds that direct write-off lets managers time write-offs to shape profit and gives a poorer picture of the cash receivables will actually produce.
Does writing off a customer’s debt reduce profit under the allowance method?
No. The write-off debits the allowance and credits the receivable, so the carrying amount is unchanged and no expense arises. Profit was reduced earlier, when the estimate of bad debts was recorded.
What does 2/10, n/30 mean on an invoice?
The customer may deduct 2% by paying within ten days; otherwise the full net amount is due within thirty days. The seller records any discount taken in a sales discounts account, which is deducted from sales.
How can I tell from a company’s accounts which bad debt method it uses?
Look for an allowance account. A company using the allowance method keeps an allowance for bad debts and records write-offs against it, while one using direct write-off has no allowance and expenses each debt when it is abandoned.
Why are receivables reported at net realisable value rather than their full amount?
Because some customers will not pay. Reporting the gross amount would overstate the cash the business can expect, so the allowance for expected losses is deducted and the balance sheet shows the amount likely to be collected, which is more useful to readers.
Exam move
Practise both allowance approaches on the same data so you see why the expense differs. Always sketch the allowance T-account with its opening balance, especially when the question gives a debit opening balance, and finish by stating net realisable value. Keep the two estimating approaches on one sheet with a worked line for each, and practise reading off the closing allowance balance as a separate final step.
Then rehearse a write-off followed by a recovery, writing both recovery entries, because the reversal step is easy to forget, and finish by checking that the carrying amount of receivables is unchanged by the original write-off.
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