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  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 1

    ACCT652 Week 6 11

    ACCT 652 Accounting

    Week 6Receivables, notes, plant assets, natural resources and

    intangible assets

    Some slides Times Mirror Higher Education Division, Inc. Used by permission Michael D. Kinsman, Ph.D.

    ACCT652 Week 6 222

    Bad debts The best of all worlds is when you grant

    your customers credit and all of them pay exactly as and when they are supposed to.

    I can tell you from personal experience that doesnt happen in the real world.

    Trick question: What are the entries Kinsman & Kinsman makes on our books when a client doesnt pay us?

    ACCT652 Week 6 333

    Answer to trick question None. We are a cash basis business, as we

    discussed last time, and therefore nothing has been entered on our books for accounts receivable or sales from those receivables to start with. Therefore, we need make no entry.

    We do whimper when this happens to us. If the amount is large enough, we cry.

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 2

    ACCT652 Week 6 444

    Bad Debts: Direct Write-Off Method

    This method is only appropriate in a limited number of cases where the company experiences little or no bad debt losses.

    No effort is made to estimate uncollectible accounts or bad debts expense.

    No adjusting entry is made at year-end. Bad debts expense is recorded when specific

    accounts are written off.

    ACCT652 Week 6 555

    Direct write-offexample

    Your company has few bad debts, and finally you get a call that John Smith has died with no assets. He owed you $50.

    GENERAL JOURNAL Page

    D ate D escriptionP ost. R ef. D ebit C redit

    M M DD Bad debts expense 50.00 Accounts receivable (Smith) 50.00

    Write off bad debt of Smith

    ACCT652 Week 6 666

    Bad Debts The reporting of bad debts is normally

    governed by the matching principlebad debts expense should be recognized in the period in which the revenue was produced.

    Managers realize that some portion of credit sales will eventually result in bad debts.

    To match bad debts expense with revenue produced in an accounting period we use the allowance method

    PAST DUE

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 3

    ACCT652 Week 6 777

    Allowance Method of Accounting for Bad Debts

    At the end of the accounting period, we estimate total bad debts expected to be realized from sales in the current period.

    Advantages of this method are:Matches expenses with revenuesReports accounts receivable at the estimated

    cash to be collected.

    ACCT652 Week 6 888

    Estimating the Amount of Bad Debts Expense

    There are two approaches to estimating the amount of bad debts expense . . .Focus on the income statement relationship

    between bad debts expense and sales.Focus on the balance sheet relationship between

    accounts receivable and the allowance for doubtful accounts.

    ACCT652 Week 6 999

    Income Statement Focus

    This approach is based on the notion that a certain percentage of a companys credit sales will become uncollectible.

    We must determine the percentage relationship between credit sales and bad debts.

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 4

    ACCT652 Week 6 101010

    Income Statement Focus Based on history, we determine the percentage

    of credit sales that result in bad debts.

    Bad debts expense is computed as follows: Current Year Credit Sales

    x Bad Debt % Estimated Bad Debt Expense

    ACCT652 Week 6 111111

    As of 12/31/X1 Melton, Inc. had total sales of $1,000,000 of which $250,000 were cash sales.

    Historically, the bad debt percentage based on credit sales has been 0.5%.

    Prepare the adjusting journal entry required for Melton, Inc. to record bad debts expense for 20X1.

    Income Statement Focus Example

    ACCT652 Week 6 121212

    Income Statement Approach

    GENERAL JOURNAL Page 7

    D ate D escrip tionPost. R ef. D eb it C red it

    D ec . 31 Bad D eb ts Expense 3,75 0 A llowance fo r D oubtfu l A ccounts 3 ,75 0

    S ales revenue 1,000,000$Cash sales (250,000) Credit sales 750,000 Historical bad debts percent 0.50%E stim ated bad debts expense 3,750$

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 5

    ACCT652 Week 6 131313

    Balance Sheet Focus The assumption is that some portion of the

    end-of-period accounts receivable will prove to be uncollectible.

    The goal of the adjusting entry is to state the Allowance for Doubtful Accounts at the estimated uncollectible amount.

    ACCT652 Week 6 141414

    Aging Accounts Receivable This balance sheet method produces a more

    refined estimate of uncollectible amounts. It is useful after a company has considerable

    experience estimating bad debts. The assumption we make is that the more past

    due an account is, the less likely we are to collect the account.

    ACCT652 Week 6 151515

    Balance sheet method of Allowance for Doubtful Accounts

    On December 31, 20X1, the balance in Allowance for Doubtful Accounts of Eastco is $500 (credit) before the adjustment to recognize bad debts expense. What is the companys addition to Allowance for Doubtful Accounts?

    First, we do an aged account receivables schedule for Eastco.

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 6

    ACCT652 Week 6 161616

    Aging Accounts Receivable We classify each account receivable by how long it

    has been outstanding.We generally classify receivables as current, 1 to 30

    days past due, 31 to 60 days past due, etc. We estimate an uncollectible amount for each class

    of receivables. We add together the estimate for each class to

    determine the balance in the allowance account.

    ACCT652 Week 6 171717

    Aging Accounts ReceivableAt December 31,20X1 the receivables for EastCo, Inc. were categorized as follows:

    $45,000 * .01 = $450

    ACCT652 Week 6 181818

    Aging Accounts ReceivableAt December 31,20X1 the receivables for EastCo, Inc. were categorized as follows:

    Desired balance in the Allowance for Doubtful Accounts

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 7

    ACCT652 Week 6 191919

    Allowance for Doubtful AccountsBalance Sheet method

    What is the journal entry required to enter the bad debts expense and the allowance for doubtful accounts?

    ACCT652 Week 6 202020

    Aging Accounts Receivable

    GENERAL JOURNAL Page 23

    D ate D escrip tionPost. R ef. D eb it C red it

    D ec . 31 Bad D eb ts Expense 8 50 A llowance fo r D oubtfu l A ccounts 85 0

    Desired allowance balance $1,350 Current account balance 500 Adjustment required $ 850

    ACCT652 Week 6 212121

    Writing off an account using the allowance methods

    Suppose you need to write off an account using the allowance methods. How do you do it?

    For example, suppose John Smith (of our earlier example) died, owing us $50. What entries are required to write it off?

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 8

    ACCT652 Week 6 222222

    Writing off bad debts using an allowance method

    We dont need to make any entry to Bad Debts Expensethat was done at the start of the period. Our entry is:

    GENERAL JOURNAL Page

    D ate D escriptionP ost. R ef. D ebit C redit

    M M DD Allowance for doubtful accounts 50.00 Accounts receivable (Smith) 50.00

    Write off bad debt of Smith

    ACCT652 Week 6 232323

    What if a written off account is paid?

    Simple. Just reverse the entry that was the write off.

    ACCT652 Week 6 242424

    Property, plant and equipment

    And now well start an entirely new subjectlong lived assets.

    These are sometimes called property, plant and equipment.

    They are on the assets side of the balance sheet, usually as the lowest thing on the assets side.

    They have a contra accountaccumulated depreciation

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 9

    ACCT652 Week 6 252525

    Plant Assets Compared to Other Types of Assets

    Plant assets are long-term, tangible assets used in the operation of the business.Useful life is more than one accounting period.They are used to produce revenue in the primary

    business operations rather than being held for resale.

    ACCT652 Week 6 262626

    Cost of a Plant Asset

    Purchased plant assets are recorded at cost. Cost includes all normal and reasonable

    expenditures necessary to get the asset in place and ready for its intended use.

    ACCT652 Week 6 272727

    Cost of a Plant Asset

    Suppose I were going to purchase a computer system. I will give you specifics as we go along. Please divide my specifics into four categories:Basis of the assetExpense itemBasis of something elseSomething elsenone of the above.

  • 1/1/16

    ACCT 652 Week 6ACCT652 Week 6 10

    ACCT652 Week 6 282828

    Cost of a Plant Asset Self-Constructed Assets

    Cost includes all materials and labor cost directly traceable to the construction as well as a reasonable amount of indirect costs such as utilities and supervision.

    ACCT652 Week 6 292929

    Cost of a Plant Asset Land & Buildings

    When land and building are purchased together, the land cost and the building cost are placed

    in separate ledger accounts.

    The total cost of the purchase is separated on the basis of relative market values.

    ACCT652 Week 6 303030

    Nature of Depreciation The useful life of p

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