LECTURE TWO: ACCOUNTING FOR RECEIVABLES
1.1 Introduction
This topic is aimed at providing the learners with basic knowledge on accounting for receivables.
.You already know how to prepare journal and ledger entries when sales are supplied to
customers on credit. This chapter is designed to take you through the task of accounting for
debtors in a scenario where some debts are declared as bad debts and a provision for bad debts is
provided.
1.2 Specific objectives:
By the end of this topic the student should be able to
Record transactions in the ledgers when sales are made on credit
Explain how bad debts are treated in the books of accounts
Explain how provision for bad debts are treated in the books of accounts
Definition of Accounts Receivable
Accounts receivable is the amount owed to a company resulting from the company providing
goods and/or services on credit. The term trade receivable is also used in place of accounts
receivable.
The amount that the company is owed is recorded in its general ledger account entitled Accounts
Receivable. The unpaid balance in this account is reported as part of the current assets listed on
the company's balance sheet.
When goods are sold on credit, the seller is likely to be an unsecured creditor of its customer.
Therefore, the seller should be cautious when selling goods on credit.
Good accounting requires that an estimate should be made for any amount in Accounts
Receivable that is unlikely to be collected. The estimated amount is reported as a credit balance
in a contra- receivable account such as Allowance for Doubtful Accounts. This credit balance
will cause the amount of accounts receivable reported on the balance sheet to be reduced. Any
adjustment to the Allowance account will also affect Uncollectible Accounts Expense, which is
reported on the income statement.
BAD DEBTS
Definition of Bad Debts Expense
Bad debts expense is related to a company's current asset accounts receivable. Bad debts expense
is also referred to as uncollectible accounts expense or doubtful accounts expense. Bad debts
expense results because a company delivered goods or services on credit and the customer did
not pay the amount owed.
, Examples of Bad Debts Expense
There are two methods for reporting the amount of bad debts expense:
direct write-off method
allowance method
The direct write-off method requires that a customer's uncollectible account be removed from
Accounts Receivable and at that time the following entry is made: debit Bad Debts Expense and
credit Accounts Receivable.
The allowance method anticipates and estimates that some of the accounts receivable will not be
collected. In other words, prior to knowing exactly which customers or clients will not be paying,
the company will debit Bad Debts Expense and will credit Allowance for Doubtful Accounts for
the estimated amount. (The Allowance for Doubtful Accounts is a contra asset account that when
presented along with Accounts Receivable indicates a more realistic amount that will be turning
to cash.)
For financial statement purposes the allowance method is the better method since 1) the balance
sheet will be reporting a more realistic amount that will be collected from the company's
accounts receivable, and 2) the bad debts expense will be reported on the income statement
closer to the time of the related credit sales. However, for income tax purposes the direct write-
off method must be used.
The journal entry is a debit to the bad debt expense account and a credit to the accounts
receivable account.
Thus
Dr; Bad debts account
Cr; Debtors account
N.B Bad debts is treated as an expense in the income statement.
Provision for Bad Debts
The provision for doubtful debts is the estimated amount of bad debt that will arise from
accounts receivable that have been issued but not yet collected. It is identical to the allowance
for doubtful accounts.
Accounting Treatment for Provisions in Financial Statements:
The effects of provision for doubtful debts in financial statements may be summed up as follows:
(1) Income Statement: Only change (increase or decrease) in provision for doubtful is shown in
the income statement. When increase then expense (deducted from profit) and when decrease
then income (added in profits).
1.1 Introduction
This topic is aimed at providing the learners with basic knowledge on accounting for receivables.
.You already know how to prepare journal and ledger entries when sales are supplied to
customers on credit. This chapter is designed to take you through the task of accounting for
debtors in a scenario where some debts are declared as bad debts and a provision for bad debts is
provided.
1.2 Specific objectives:
By the end of this topic the student should be able to
Record transactions in the ledgers when sales are made on credit
Explain how bad debts are treated in the books of accounts
Explain how provision for bad debts are treated in the books of accounts
Definition of Accounts Receivable
Accounts receivable is the amount owed to a company resulting from the company providing
goods and/or services on credit. The term trade receivable is also used in place of accounts
receivable.
The amount that the company is owed is recorded in its general ledger account entitled Accounts
Receivable. The unpaid balance in this account is reported as part of the current assets listed on
the company's balance sheet.
When goods are sold on credit, the seller is likely to be an unsecured creditor of its customer.
Therefore, the seller should be cautious when selling goods on credit.
Good accounting requires that an estimate should be made for any amount in Accounts
Receivable that is unlikely to be collected. The estimated amount is reported as a credit balance
in a contra- receivable account such as Allowance for Doubtful Accounts. This credit balance
will cause the amount of accounts receivable reported on the balance sheet to be reduced. Any
adjustment to the Allowance account will also affect Uncollectible Accounts Expense, which is
reported on the income statement.
BAD DEBTS
Definition of Bad Debts Expense
Bad debts expense is related to a company's current asset accounts receivable. Bad debts expense
is also referred to as uncollectible accounts expense or doubtful accounts expense. Bad debts
expense results because a company delivered goods or services on credit and the customer did
not pay the amount owed.
, Examples of Bad Debts Expense
There are two methods for reporting the amount of bad debts expense:
direct write-off method
allowance method
The direct write-off method requires that a customer's uncollectible account be removed from
Accounts Receivable and at that time the following entry is made: debit Bad Debts Expense and
credit Accounts Receivable.
The allowance method anticipates and estimates that some of the accounts receivable will not be
collected. In other words, prior to knowing exactly which customers or clients will not be paying,
the company will debit Bad Debts Expense and will credit Allowance for Doubtful Accounts for
the estimated amount. (The Allowance for Doubtful Accounts is a contra asset account that when
presented along with Accounts Receivable indicates a more realistic amount that will be turning
to cash.)
For financial statement purposes the allowance method is the better method since 1) the balance
sheet will be reporting a more realistic amount that will be collected from the company's
accounts receivable, and 2) the bad debts expense will be reported on the income statement
closer to the time of the related credit sales. However, for income tax purposes the direct write-
off method must be used.
The journal entry is a debit to the bad debt expense account and a credit to the accounts
receivable account.
Thus
Dr; Bad debts account
Cr; Debtors account
N.B Bad debts is treated as an expense in the income statement.
Provision for Bad Debts
The provision for doubtful debts is the estimated amount of bad debt that will arise from
accounts receivable that have been issued but not yet collected. It is identical to the allowance
for doubtful accounts.
Accounting Treatment for Provisions in Financial Statements:
The effects of provision for doubtful debts in financial statements may be summed up as follows:
(1) Income Statement: Only change (increase or decrease) in provision for doubtful is shown in
the income statement. When increase then expense (deducted from profit) and when decrease
then income (added in profits).
