Transcript SESSION XIV: - University of North Carolina at Chapel Hill

ACCOUNTS RECEIVABLE &
REVENUE RECOGNITION
Accounting ASW
Summer 2006
Issue: What to do about bad debts?
• So far:
Accounts Receivable
Sales Revenue
340
340
Two potential approaches
• Direct write-off method
• Allowance method
• Problem 6.21
Direct Write-Off Method
• Only allowed for financial reporting if bad
debts are immaterial, but required for tax
• At the time of sale:
No entry
• When the account is deemed uncollectible:
Bad Debt Expense
1.8
Accounts Receivable
1.8
If the account is later collected:
Accounts Receivable
1.8
Bad Debt Expense
Cash
Accounts Receivable
1.8
1.8
1.8
(The entry is made through accounts receivable
rather than directly to cash for a record of the
accounts receivable having been collected.)
Problems with Direct Write-Off
• Accounts Receivable are overstated (in
terms of expected receipts)
• Net income is overstated
• Revenue and expenses are not matched
• Discretion affecting net income in when to
call “uncollectible”
Allowance Method
• Generally required for financial reporting
• Record bad debts estimate at time of sale to
expense and account receivable contra
Bad Debt Exp. ($340 x 3%)
10.2
Allow. for Doubtful
Accts. (AR contra)
10.2
• Net income effect at time of sale
• When the account is deemed uncollectible:
All. for Doubtful Accts.
1.8
Accounts Receivable
1.8
• No net income or total asset effect at the
time of write-off
If the account is later collected:
Accounts Receivable
1.8
All. for Doubtful Accts.
Cash
Accounts Receivable
1.8
1.8
1.8
• Advantages of allowance method
- Matches revenue and expenses in period
of sale
- Records net accounts receivable at
expected cash collection
• Problem with allowance method
- Discretion in estimating bad debt expense
- Only works well if your estimates are good
• Problem 6-21
How to estimate bad debts under
the allowance method
•
•
•
•
Percentage of sales
Aging of accounts receivable
Observation of large accounts
Often use all three together
Other Applications
• Sales returns
• Cash discounts
• Sales allowance
ACCOUNTS RECEIVABLE AND
BAD DEBTS T-ACCOUNTS
(Gross) Accounts Receivable
Allowance for Doubtful Accounts
Beg. Bal.
Credit Sales
Beg. Bal.
Collections
Write-offs
Bad Debt Exp.
Write-offs
Ending Bal.
Ending Bal.
Income Recognition Issues
• Review of revenue recognition criteria
– provided all (or substantial portion) of goods or
services
– have received an asset which can be measured
• Issue: What if completion spans several
periods?
Long-Term Contracts
• Construction spans several periods
• Customers and terms decided in advance
• May satisfy revenue recognition criteria
before completion
• Problem 6-33
– $200M contract,
– Costs of $42M, $54M and $24M in years 1-3
Completed Contract Method
• Delay revenue recognition until completed
• For our example,
– recognize no income or expense in years 1&2
– accumulate costs in “construction in progress”
account (just like “work in progress”)
– recognize $200M in revenue and $120M in
expense in year 3
• Often used if:
– construction in period is too short to justify
spreading
– buyer or terms are not set
– total cost (and hence income) is too uncertain
Percentage Completion Method
• Generally preferred by companies
• Only used if:
– construction spans multiple periods
– contract terms are set and collection is likely
– total cost (and profit) are reasonably estimable
• Recognize revenue each period in
proportion to costs during the period
• In our example,
– 35% of costs occur in year 1, so 35% of
revenue, costs and net income would be
recognized in year 1
– 45% of revenue, costs and NI in year 2
– 20% of revenue, costs and NI in year 3