Accounts Receivables | External Financial Reporting Decision | Section A CMA USA Part 1 | Episode 11

Introduction

This tutorial provides a comprehensive overview of accounts receivables, focusing on how to estimate credit losses, including different methods such as the Direct Write-Off Method, Allowance for Credit Loss Method, and the Percentage of Sales and Receivables Methods. Understanding these concepts is crucial for external financial reporting and effective decision-making in accounting.

Step 1: Understand Credit Loss on Accounts Receivables

• Credit loss refers to the risk that customers will default on their payments.
• It is essential to estimate credit losses to maintain accurate financial statements.
• Factors affecting credit loss estimates include customer creditworthiness, economic conditions, and historical data.

Step 2: Explore Approaches to Estimate Credit Loss

• There are various methods to estimate credit loss, each with its own advantages:
  • Historical Loss Rate
  • Aging of Receivables
  • Forecasted Losses
• Selecting the right method depends on your organization's specific circumstances and the quality of available data.

Step 3: Direct Write-Off Method

• This method involves writing off an account when it is deemed uncollectible.
• Steps to implement the Direct Write-Off Method:
  1. Identify accounts that are uncollectible.
  2. Record the write-off using the following journal entry:

     Debit: Bad Debt Expense
     Credit: Accounts Receivable
     

• Practical Tip: Use this method for smaller amounts or when the likelihood of recovery is low.

Step 4: Allowance for Credit Loss Method

• This method estimates uncollectible accounts based on past experience and current economic conditions.
• Steps to implement the Allowance Method:
  1. Estimate the total amount expected to be uncollectible.
  2. Create an allowance by making the following journal entry:

     Debit: Bad Debt Expense
     Credit: Allowance for Doubtful Accounts
     

  3. When an account is written off, adjust it against the allowance rather than direct income.
• Common Pitfall: Failing to regularly update estimates based on recent data can lead to inaccurate financial reporting.

Step 5: Percentage of Sales and Receivables Methods

• These are two common approaches to estimate the allowance for credit losses:
  • Percentage of Sales Method: Apply a percentage to total credit sales for the period.
    • Example Calculation:
      • If total credit sales are $100,000 and the estimated uncollectible percentage is 5%, the allowance is $5,000.
  • Percentage of Receivables Method: Apply a percentage to total accounts receivable.
    • Example Calculation:
      • If accounts receivable is $80,000 with an estimated uncollectible percentage of 10%, the allowance is $8,000.
• Practical Tip: Use historical data to determine the appropriate percentages for these calculations.

Conclusion

Understanding and implementing effective methods for estimating credit losses on accounts receivables is essential for accurate financial reporting. The Direct Write-Off Method, Allowance for Credit Loss Method, and both Percentage of Sales and Receivables Methods provide various approaches to manage and report these losses. Regularly review and update your estimates to ensure they reflect the current financial environment and your organization's performance. For further study, refer to the provided links for additional notes and multiple-choice questions.