CHAPTER FIVE

ACCOUNTING FOR CASH AND RECEIVABLE

Cash is any medium of exchange that a bank will accept at face value, such as: coins, paper
money, currency, checks, bank deposit, money orders, bank drafts, Bankers’ acceptance,
Certificate of Deposit, traveler's checks, and the charge slips signed by customers using bank
credit cards, such as VISA and master card etc.
Cash is listed first in the balance sheet, because it represents resources that can be used
immediately to pay any type of obligation.
Cash equivalents are short term investment and they are liquid. Example- Treasury bills,
commercial paper, Certificate of Deposit, Bankers’ acceptance, Repurchase Agreements (Repo),
money market fund, and so on. Not all short - term investments are viewed as cash equivalents.
Investments in stocks and bonds, for instance, are not considered cash equivalents. Such
investments appear in the balance sheet as "Marketable securities" which usually is listed
second among the current assets. 0
5.1 Internal control over cash

Due to the reason that cash is the most likely transportable, easily hidden
and used improperly by employees, it is therefore necessary that cash be
effectively safeguarded by a special control. The two controlling devices for
controlling cash are:

a) The bank account &

b) Petty cash

a. The bank account

It is one of the major devices for maintaining control over cash. To get the most benefit from the
bank account, all cash received must be deposited in the bank and all payments must be made by
checks drawn on the bank or from special cash funds. When such system is strictly followed,
there is a double record of cash, one maintained by the business and the other by the bank. In
some cases a bank may require a business to maintain a minimum cash balance called
compensating balance. This requirement is generally imposed by the bank as a part of a loan
agreement or line of credit (an amount the bank is willing to lend).

Forms used in a bank account

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A) Signature card: At the time account is opened, an identifying number is assigned to the
account which is used for verification. The depositor will sign on. It is a written check.

B) Deposit ticket (slip): Used by the business as a receipt to record the cash deposit. A copy is
given by the bank to the depositor.

C) Check: is a written document signed by the depositor, ordering the bank to pay a sum of
money to an individual or business entity (to the order of a designated person). Three parties
involved in a check:
1) Maker (drawer): The one who signs the check.
2) Payer (drawee): the bank on which the check is drawn.
3) Payee: the one (party) to whom payment is made. Is the one (party) to whose order the
check is drawn.

Make check payee check Bank

Money
Check register: A modified form of the cash payment journal used to record all transaction paid
by check. Usually in a check the address and the name of the depositor are printed.
D) Record the checks drawn: A memorandum record of the basic details of a check should be
prepared at the time the check is written. Business firms may prepare a copy of each check
drawn and then use it as a basis for recording the transaction in the cash payment journal.
Checks issued to a creditor on account are usually accompanied by a notification of the specific
invoice that is being paid. The purpose of such notification, sometimes called a remittance
advice, is to make sure that proper credit is recorded in the accounts of the creditor.
Bank statement
Bank statement is the monthly statement send by the bank to the depositor. The bank statement
usually indicates the beginning and ending cash balance of the depositor in the bank and the
monthly transaction (additions and deductions). It also includes cancelled checks (paid checks)
and which the bank has make payment on behalf of the depositor. It also includes the deposits
made by the depositor and other thing.
5.2 Bank reconciliation
Bank reconciliation is a schedule explaining any difference between the balance shown in bank
statement and the balance shown in the company or depositor's account (cash ledger of the
depositor). At the end of each month, the depositor should prepare bank reconciliation to verity
that these independent sets of records are in agreement. For strong internal control, the employee
who reconciles the bank statement should not have any other responsibilities for cash.

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It might seem that the two balances should be equal but they are not likely to be equal on any
specific date because of the following:
a) Items recorded by the company but not yet recorded by the bank.
1) Deposit in transit: is the deposit that the Depositor has recorded but not recorded by
the bank.
2) Outstanding checks: These have been issued by the company and recorded on its
book but have not yet been paid by the bank.
b) Items recorded by the bank only.
1) Bank collection: notes receivable and interest accrued on notes receivable may be
collected by the bank. The bank will notify (remind) the amount of collection whenever the
bank is sending the bank statement to the depositor.
2) Service charge: the amount of banks fee for processing check. The bank will notify when
the bank provides the bank statement to the depositor.

c) Not sufficient fund (NSF) received from customer.

d) Interest revenue on checking account.

e) Checks collected, deposited and returned to payee by the bank for reason other than NSF
The bank return checks to the payee because: If the maker account has closed, if the signature is
not authorized, if the check form is improper, if the check has been altered. Accounting for all
returned check is the same for NSF.

f) The cost of printing check.

g) Error by either the company or the bank or both.
E.g. 1) a check written for $225 is drawn by the bank as $252.
2) A check written for $225 is journalized by the depositors as $522 that will understate the cash
ledger balance of the depositor.
A/p…………………………………….522
Cash……………………………………………522
To record the balance of cash:
Cash……………………………………..297
A/p………………………………………………297

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Bank credit memorandums: are additions by bank not recorded by depositor. They are traced
to the cash receipt journal that can be added to the balance according to depositor’s record.
Bank debit memorandums: are the deductions by bank not recorded by the depositor. They are
traced to the cash payment journals that have to be deducted from the balance according to
depositor’s record.
Format for bank reconciliation
XXX Company
Bank Reconciliation
Sep.30, XXXX
Bank balance according to bank record ………………………………………………………..xxx
Add: Additions of depositor not on bank statement (deposit in transit) .....................................xxx
Bank error that under state bank balance ………………….……………………………..xxx
Subtotal …………………………………………………………………………………….….xxx
Deduct: deduction by the depositor not by bank (outstanding Checks ………………………..xxx
Bank error that overstate bank balance …………………………………………………..xxx
Adjusted cash balance……………………………………………………………………….. xxx
Bank balance according to depositor records…………………………………………………..xxx
Add: additions by bank not recorded by depositor (credit memorandum: Notes &interest
collection, interest revenue on checking accounts) ………………………………………….....xxx
Depositor error that understate the depositor cash ledger balance…………….………..xxx
Subtotal……………………..…………………………………………………………………xxx
Deduct: Deduction by bank not recorded by the depositor (Debit memorandum:
NSF checks, service charges) ……………………………………….…………………………xxx
Depositor error that overstate cash ledger balance………………………………………..xxx
Adjusted cash balance………………………………………………………………………...xxx
For instance
The bank statement for ABC Company indicates a balance of $3359.78 as of July 31, 2013. The
balance in cash in ABC Company ledger of same date is $2549.99.
Additional information:
-Deposit of July 31, not recorded on bank statement --------816.20

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-Outstanding checks: #812-----------1061.00, #878-----------435.39, #883----------48.60
-Note plus interest of $8 collected by bank (credit memorandum) not recorded in cash receipt
journal -------408.00.
-Bank service charge (debit memorandum) not recorded in cash payment journal is 18.00
-Check #879 for $732.26 to X “Company on account, recorded in cash payment journal as
$723.26.
-NSF checks is $300.00
Instruction
a) Prepare bank reconciliation.
b) Journalize the necessary journal entries.
Solution: A) Bank reconciliation
ABC Company
Bank reconciliation
July 31, 2013
Cash balance according to bank record ----------------------------------------------------------- 3359.78
Add: Additions of depositor not on bank statement (deposit in transit) ----------------------- 816.20
Deduct: outstanding Checks ------#812------------------- 1061.00
#878------------------ 435.39
#883------------------- 48.60 ----------------------------1544.99
Adjusted cash balance ---------------------------------------------------------------------------- 2630.99
Cash balance according to depositor records------------------------------------------------------2549.99
Add: additions by bank not recorded by depositor (Note plus interest collection) ---------- 408.00
Subtotal----------------------------------------------------------------------------------------------2957.99
Deduct: NSF checks----------------------------------------------------------------300.00
Service charge------------------------------------------------------------18.00
Depositor error that overstate cash ledger balance-------------------9.00 ----------- 327.00
Adjusted cash balance------------------------------------------------------------------------------2630.99
B) Journal entries

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 July 31/ Cash----------------------------------408.00
Notes receivable---------------------------------------400.00
Interest revenue-----------------------------------------8.00
Accounts payable------------------300.00
Cash ------------------------------------------------300.00
Miscellaneous administrative expense-----18
Cash--------------------------18.00
Accounts payable -----------------------------9.00
Cash-----------------------------------------------------9.00
5.3 Petty cash and change fund
It is the small fund used to make payment for small expenditures. There are three steps involved
in the operation of the petty cash.
1) Establishing the petty cash
2) Making payment from the petty cash.
3) Replenishing (reimbursing) the petty cash.
1) Establishing the petty cash: In establishing the petty cash fund, the first step is to estimate
the amount of cash needed for disbursement of relatively small amounts during certain period,
such as week or a month and appointing the petty cash custodian, the one who is responsible for
the operation of the petty cash fund and for making disbursements from the petty cash fund.
Checks payable to the petty cash fund custodian will be issued.
Petty cash----------------------------xx
Cash in bank----------------------------xx
No entrée will be made to the petty cash account unless the petty cash fund is changed (increased
or decreased).
2) Making payment from the petty cash:
Petty cash receipt: The employee who request for payment and the petty cash custodian will sign
on it. The petty cash custodian will make payment for the specified employee who request
disbursement.
NB: No journal entry will be made at the time of disbursement (payment) from the petty cash
fund.

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 3)Replenishing (reimbursing ) the petty cash: When the money in the petty cash fund
reaches a minimum level the fund is replenished (reimbursed).replenishing the petty cash fund
restores to its original amount. The request for this is initiated by the petty cash custodian. The
custodian will provide the summery of the petty cash payment with the petty cash receipt to the
treasurer .Then the treasurer approves the request and check is prepared to restore the fund to its
established amount.
Journal entry will be made to restore the petty cash fund to previously established amount and to
record all expenditures.
Example: If “X” company desires to establish a $100 fund on August 1, the entry will be

August 1/ Petty cash-------------100

Cash in bank---------------100
Assume that on August 31, the petty cash custodian request check number 3 for $87. The fund
contains $13 cash and petty cash receipt for postage expense $44, freight in, $38 and
miscellaneous expense, $5.
The entry to record the replenishment on August 31 will be

August 31/ Postage expense--------------------44

Freight in---------------------------38
Miscellaneous expense------------5
Cash in bank----------------------------87
Receivables are all claims against individuals, organization or other debtors. They are
acquired by business enterprises in various types of transactions common being the sale of goods
(merchandise) or services on a credit basis.

5.4 Classifications of Receivables

Receivables that are based on oral agreements are known as open accounts. Receivables that are
based on formal (written) instruments are called promissory notes .Receivables based on open
accounts are known as accounts receivables. Receivables based on promissory notes are known
as Notes receivables.

The sales of equipment on the installment plan involving a large amount of money also come
under note receivables. Promissory notes may also be used installment of an open account and
in borrowing and lending.

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From the point view of the creditor, a claim evidenced by a note has same advantages over a
claim in the form of A/R. By signing a note, the debtor acknowledges the debts and agrees to pay
in accordance with the terms specified. The note is therefore strong legal claim in the account of
court action. It is also more liquid than an open account because the holder cans usually
transfers it more readily to a bank or other financial agency in exchange for cash.

Accounts and notes receivables originating from sales transactions are called Trade
Receivables. Receivables originating from such sources as interest on N/R, loans to the officer
or employees and loans to affiliated companies are referred to as other receivables.

All receivables that are collectible in cash within a year are classified under current assets on the
balance sheet. If the period of collection is longer than a year such long term loan are listed
under investments.

5.5 Internal control over Receivables

The management of a business enterprise installs the means of internal control over their
receivables. Thus, controls include the separation of the business operations and the accounting
for receivables, so that the accounting records can serve as an independent check on options.
Thus, the employee who handles the accounting for notes and account receivables should not be
involved with credit approvals or collection of receivables. Separation of these functions
reduces the possibility of errors and embezzlement. The controls would also include the
separation of responsibilities for related functions, so that the work of one employee can serve as
a check on the work of another employee.

Adequate control over account receivable begins with the approval of the sale by a responsible
company official or the credit department, after the customer’s credit rating has been reviewed.
Likewise, adjustments of account receivable, such as for sales returns and allowances and sales
discounts should be authorized or reviewed by a responsible party. Effective collection
procedures should also be established to ensure timely collection of account receivable and to
minimize losses from uncollectible accounts.

Characteristics of Notes Receivables

A note is a written promise to pay a sum of money on a demand or at a definite time. A note is
payable to the order of a particular person, firm or bearer. A note must be signed by the person
who makes it. The one to whose order the note is payable is a payee and the one making the
promise is a maker.

Notes have several characteristics that have accounting implications. These characteristics are
described as follows:

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 Due date: the date a note is to be paid is called the due date or maturity date. The period of
time between the issuance date and the due date of a short term note may be stated in either
days or months.
When the term of a note is stated in days, the due date is the specified number of days after its
issuance.
Example: Zamra construction makes a note receivable from sunshine construction on
October 2, 2008 of 60 days $2500 payable at Dashen bank with interest at 7%. The due date for
the note is:
Term of the note----------------------------------60 days
October (days) ----------------31
Date of note------------------- 2 ……………. 29
Number of days remaining----------------------31
November (days) -------------------------------- 30
Due date (December) ---------------------------- 1
When the term of a note is stated as certain number of months after the issuance date, the due
date is determined by counting the number of months from the issuance date.
For instance: a 3 month note dated June 5 would be due on September 5.
NB: if there is no date in the month of maturity that corresponds to the issuance date, the due
date becomes the last day of the month. For example 2 month note dated July 31 would be due
on September 30.
Types of Notes
 Interest bearing notes and non-interest bearing notes: there are two types of notes.
Interest bearing note: a note that provides for the payment of interest for the period between the
issuance date and the due date.
Non-interest bearing note: a note that does not provide for the payment of interest.
 Maturity Value: the amount that is due on a note on date of maturity or due date is maturity
value. The maturity value of non-interest bearing note is the same with the face amount or
principal of the note. The maturity of an interest bearing note is the sum of the principal and
the interest due on the note.
Example: the maturity value of the note receivable from sunshine construction is:
Maturity value = principal + interest
= 2500 + (2500x 7% x 60/360 = 29.17)
= $2529.17
5.6 Accounting for Notes Receivable

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 The typical retail enterprise makes most of its sales for cash or on account. If the account of a
customer becomes delinquent, the creditor may insist that the account be converted into a note.
In this way, the debtor is given more time, if the creditor needs more fund, the note may be
endorsed and transferred to a bank or other financial agency. Notes may also be received by
retail firms that sell merchandise on long term credit.
When a note is received from a customer to apply on account, the facts are recorded by debiting
the N/R account of the customer from whom the note is received.
Example: assume that the account of BM co., which has a debit balance of $900, is past due a
20 day, 8% note for that amount, dated April 23, and is accepted in settlement of the account.
The entry for the acquisition of the note is as follows
April 23 Notes Receivable----------------900
Accounts Receivable-----------900
After 20 days may 13 the note matures. The necessary entries on this date is
May 13 Cash--------------------904
Notes Receivable---------------900
Interest Income----------------- 4
If the above information is non-interest bearing note the entry on maturity date is
May 13 Cash--------------------900
Notes receivable---------------900
Example: A 30 day, 12% note dated Dec.21, 2008, is accepted in settlement of the account of
Ambassel Company which has a balance of $4000. The entry to record the transaction on:
1. December 21 settlement of the account
2. Adjusting entry for accrued ones, Dec.31,2008
3. Reversing entry Jan. 1, 2009
4. The necessary entry on the maturity date
Dec 21 Note receivable----------4000
Account receivable----------4000
Dec 31 Interest receivable-------13.33 (4000 x 10/360 x 12% = 13.33)
Interest Income----------------13.33
Jan. 1 Interest Income------------13.3
Interest receivable---------------13.3
Jan 21 Cash---------------------------4040

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 Note Receivable---------------4000
Interest income-------------------40 (4000 x 30/360 x 12% = 40)
Discounting Notes Receivable
A business may keep the note it has received until the due date or transfer it to a bank by
endorsement. If a note is transferred to a bank, it is said to be discounted and bank charges
interest for discounting the note. The discount (interest) charged is computed on the maturity
value of the note for the period of time the bank must hold the note. The amount paid to the
endorser is the excess of the maturity value over the discount or interest charged by the bank.
This amount is known as proceeds.
Example: Assume that a 90 day non-interest bearing note for $1350, dated August 21 is
discounted at Lion Bank on September 20 at the rate of 7%.
Required: What is the maturity value of the note?
What is the number of days in the discount period?
What is the amount of the discount?
What is the amount of the proceeds?
Solution
Face value of the note dated Aug. 21------------------------------$1350
Maturity value of the note due Nov. 19 --------------------------- 1350
Discount period (Sep.20 - Nov.19) ----------------60 days
Discount on maturity value (1350 x 7% x6/36) -----------------15.75
Proceeds------------------------------------------------------------$1334.25
The entry for the transaction is
Sep. 20 Cash----------------------------------1334.25
Interest expense----------------------15.75
Notes Receivable----------------------1350
For instance: Misrak enterprise which has a 90 day, 9% notes receivable for $2000, dated Nov.8
is discounted at Awash bank on Dec.3 at the rate of 10%.
Required: What is the maturity value of the note?
What is the number of days in the discount period?
What is the amount of the discount?
What is the amount of the proceeds?
Solution
Face value of the note dated Nov.8------------------------------------$2000
Interest on note (2000 x 90/360 x 9% = 45) 45
Maturity value of the note due Feb 6 ---------------------------------- 2045
Discount period (Dec 3 - Feb 6) -------------------------- 65 days
Discount on maturity value (2045 x 65/360 x 10%) ----------------- 36.92
Proceeds------------------------------------------------------------------$2008.08

The entry for the transaction is:

Dec 3 Cash ---------------------2008.08
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 Notes receivable----------------2000
Interest income------------------8.08
When the proceeds from discounted note is less than the face value is recorded as interest
expense and to the reverse the face value is less than the proceed the difference is recorded as
interest income.

Contingent liability
In the absence of a statement limiting responsibility, the endorser of a note is committed in
paying the note if the maker should default. Such potential obligations that will become actual
liabilities only if certain events occur in the future are called Contingent liability that is in effect
until the due date. Significant Contingent liabilities are disclosed on the balance sheet or in an
accompanying note.

Dishonored notes receivable

If the maker of the note fails to pay the obligation on the due date, the note is said to be
dishonored. A dishonored note is not negotiable, and for this reason the holder usually transfers
the claim including any interest due to the accounts receivable account. This action is necessary
in order to make the subsidiary ledger disclose the dishonor of the note.
Example: If the $900, 20 day, 8% note received and recorded on April 23 had been dishonored
at maturity, the entry to charge the note, including the interest, back to the customer’s account
would have been as follows:
May 13 Account receivable B.M co-----------904
Notes receivable---------------------------900
Interest income -----------------------------4
When the discounted N/R is dishonored, the holder usually notifies the endorser of such fact and
asks for payment. If request payment and notification of dishonor are timely, the endorser is
legally obliged to pay the amount due on the note. The entire amount paid to the holder by the
endorser including the interest, should be debited to account receivable of the maker.
Example: assume that the $2000, 90 day, 9% note discounted on Dec 3 is dishonored at maturity
by the maker, the entry to record the payment by the endorser, in general journal form, would be
as follows:
Feb 6 A/R ------------------2045

Cash----------------------2045

In some cases, the holder of the dishonored note gives the endorser a notarized statement of the
facts of the dishonor. The fee for this statement known as a protest fee is charged to the endorser,
who intern charges it to the maker of the note. If there had been a protest fee of $5 in connection
with the dishonor and the payment recorded above, the debit to the maker’s account and the
credit to cash would be $2013.08.

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 5.7 Uncollectible receivables
When merchandise or services are sold without the immediate receipt of cash, a portion of claims
against customers ordinarily proves to be uncollectible. This is usually the case regardless of the
care used in granting credit and the effectiveness of the collection procedures employed.
The operating expense incurred because of the failure to collect receivables is variously termed
as expense or loss from uncollectible accounts or bad debts.
There are generally accepted methods of accounting for receivables that are deemed to be
uncollectible.
1) The allowance method or the reserve method, which makes advance provision for
uncollectible receivables.
2) The direct write off method or direct charge off method, which recognizes the expense only
when specific accounts are believed to be worthless.

Allowance method of Accounting for Uncollectible

Most large business enterprise provide currently for the amount of their trade receivables
estimated to become uncollectible in the future. The advance provision for future un
collectability is made by an adjusting entry at the end of the fiscal period. As with all periodic
adjustments, the entry serves two purposes. In this instance, it provides for:

 The allocation to the current period of the expected expense resulting from such
reduction
 The reduction of the value of receivable to cash expected to be realized from them in the
future
Example: a business enterprise has a balance of receivables $45,000 at the end of the year.
$2,500 is estimated to be uncollectible. The adjusting entry at the end of the year is:
Uncollectible accounts expense----------------$2,500
Allowance for doubtful accounts-----------2,500

The balance in account receivable is the amount of the total claims against customers on open
account, and the credit balance of $2500 in allowance for doubtful accounts is the amount to be
deducted from account receivable to determine the expected realizable value, frequently called
the net realizable value (NRV). $2500 reduction in the asset was transferred to uncollectible
accounts expense, which will in turn be closed to income summary.
Uncollectible account expense is generally reported on the income statement as an
administrative expense because the credit granting and collection duties are responsibilities of
department within the general administrative frame work.

Write – offs to the Allowance Account

When an account is believed to be uncollectible, it is written off against the allowance account as
in the following entry:
Allowance for doubtful accounts------------xxx

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 Accounts receivable-----------------------------xxx
During the year, as more accounts or portions of accounts are determined to be uncollectible,
they are written off against allowance for doubtful accounts in the same manner. Instructions for
write-offs should originate with the credit manager or other designated official. The
authorizations, which should always be written, serve as objective evidence in support of the
accounting entry.

Sometimes a customer will pay the A/R after it was written off i.e. an A/R that has been written
off against the allowance account may be later collected. Recording the receipt of cash is always
a two-step process: first, the account receivable is reinstated (added back into the general ledger),
the exact reverse of the write-off entry, and second, the cash is recorded and accounts receivable
is reduced for the payment.

To reinstate the accounts receivable:

Accounts Receivable xxx
Allowance for Uncollectible Accounts xxx
To apply the cash received:
Cash xxx
Accounts Receivable xxx
Estimating Uncollectible
Before the accounts are closed and the financial statements are prepared at the end the
accounting period, an estimate of the expected amount of uncollectible should be made.
This estimate will usually be based up on past experience and modified in accordance with
current business conditions. Losses from uncollectible receivable tend to be greater during
periods of recession than in period of growth and prosperity.
The estimate is customarily based on either:
1) Percentage of Sales Method or
2) Percent of account receivable Method (Estimate based on Analysis of Receivable)
1) Estimate Based on Sales (Percentage of Sales Method)

A/R s is acquired as a result of sales on account. The volume of such sales during the year
therefore is used as an indication of the probable amount of the account that will be
uncollectible. For instance if it is known from past experience that about 1% of charge sales be
uncollectable and the charge sales for particular year amount to birr 300,000 the adjust entry for
uncollectible accounts at the end of the year would be as follow :
Dec. 31 Uncollectible Account Expense----------------------3,000
Allowance for Doubtful Accounts------------------------3,000
The Percent of Sales Method uses one income statement account, Sales, to estimate the change in
another income statement account, Bad Debt Expense, for the period. This is the amount of the
required adjusting entry. This method is typically used by businesses with a large number of
customers with relatively uniform A/R balances. The balance in the Allowance account is the

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balance in the ledger before adjustment plus the adjusting entry for bad debt expense. The bad
debt expense for the period is calculated by multiplying the uncollectible percentage times the
credit sales in the period to determine the uncollectible accounts expense for the period. This will
be the amount of the adjusting entry.
The estimate based on sales method of determining uncollectible account expense widely used.
In addition to its simplicity, it provides the best basis uncollectible account expense to the period
in which the related sales were made.

Estimate based on Analysis of Receivable

The process of analysis the receivable accounts some time called aging receivables. The number
and breadth of the time interval used will vary according to the credit term granted to the
customers.
The Percent of Receivables Method uses the balance in one balance sheet account, Accounts
Receivable, to estimate the balance in another balance sheet account, Allowance for
Uncollectible Accounts, at the end of the period. The adjusting entry for bad debt expense is the
difference between the balance in the ledger for the allowance account before adjustment and the
estimated balance in the allowance account. After adjusting entry is posted, the balance in the
allowance account will be the desired amount (estimated balance).
The current balance of A/R is analyzed by use of an aging schedule to determine the desired
ending balance for the Allowance for Doubtful Accounts. The uncollectible accounts expense
for the period is determined based on the current (unadjusted) balance in the Allowance, the
desired ending balance in the Allowance account and any write-offs of uncollectible accounts
during the period.
Allowance for Doubtful Accounts
Beginning balance

Write-offs Solve for bad debt expense

Ending balance
Bad debt expense = ending balance + write-offs – beginning balance

However, if there have been more write-offs than expected, the balance before adjustment in the
allowance account may be a debit:

Allowance for Doubtful Accounts

Beginning balance

Write-offs Solve for bad debt expense

Ending balance

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Bad debt expense = ending balance + write-offs+ beginning balance

Example: The balance of Allowance for Doubtful Accounts before adjustment at the end of the
period is $400 debit. Based on an analysis of Accounts Receivable, it was estimated that $9,000
would become uncollectible. Determine the following:
a) The uncollectible accounts expense for the year.
b) The adjusting entry to be made of December 31.
c) The balance in Allowance for Doubtful Accounts after adjustment.
Solution:
a) Uncollectible accounts expense = 400 + 9,000 + 0 = 9,400
b) Uncollectible accounts expense ---------------9,400
Allowance for doubtful accounts--------------------- 9,400
c) 9,000

Direct Write-off Method of accounting for Uncollectible

The Direct Write-off Method records uncollectible accounts expense in the period when the
customer’s account is determined to be uncollectible. The entry to write-off the account
receivable is:
Uncollectible accounts expense ----------------------- xxx
Accounts receivable ---------------------------------------- xxx
In the period when a specific account is determined to be uncollectible. The Direct Write-off
Method violates the matching principle because it does not match revenues and expenses in the
same period.
The direct write-off method or the direct charge-off method is reasonable under some
situations:
1) If a company makes most of its sales for cash, and
2) If a company sells all or most of its output to few companies which financially strong.

In such situations and in many small business and professional enterprise, it is satisfactory to
defer recognition of uncollectible until the period in which specific accounts are deemed to be
worthless and are actually written off as an expense. Accordingly, when the direct- write- off
method is in use, the A/R will be listed on the balance sheet at their gross amount, and no
evaluation allowance will be used, and there is no necessity for an adjusting entry at the end of
the period.

Under this method, it is only when an account is believed to be uncollectible that it is written-off
as an expense.
The entry to write-off an account when it is believed to be uncollectible $42 is as follows:
May 10 Uncollectible Accounts Expense…………………. $4,200
A/Receivable-Horn Co………………………………….4, 200

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If an account that has been written off is collectible later, the account should be reinstated. If the
recovery is in the same fiscal year as the write-off, the earlier entry should be reversed to
reinstate the account.
To illustrate, let us assume that the account written off in the May 10 entry above is collected in
November 21 of the same fiscal year. This entry to reinstate the account written off earlier in the
year would be as follows:
Nov.21 Accounts Receivable-Horn Co………………………4, 200
Uncollectible Account Expense…………………….4, 200

Cash received in payment of the reinstated amount is recorded as:

Cash ……………………………………….. 4, 200
Account Receivable ……………………………… 4, 200

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