An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. However, the actual payment behavior of customers may differ substantially from the estimate. Show
Key Takeaways
1:22 Allowance for Doubtful AccountsUnderstanding the Allowance for Doubtful AccountsRegardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned. The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account. Recording the Allowance for Doubtful AccountsTwo primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected. Percentage of Sales MethodThe sales method applies a flat percentage to the total dollar amount of sales for the period. For example, based on previous experience, a company may expect that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. If the following accounting period results in net sales of $80,000, an additional $2,400 is reported in the allowance for doubtful accounts, and $2,400 is recorded in the second period in bad debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. Accounts Receivable Aging MethodThe second method of estimating the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount. For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding. Based on previous experience, 1% of accounts receivable less than 30 days old will be uncollectible, and 4% of those accounts receivable at least 30 days old will be uncollectible. Therefore, the company will report an allowance of $1,900 (($70,000 * 1%) + ($30,000 * 4%)). If the next accounting period results in an estimated allowance of $2,500 based on outstanding accounts receivable, only $600 ($2,500 - $1,900) will be the adjusting entry amount. What Is a Chart of Accounts (COA)?A chart of accounts (COA) is an index of all the financial accounts in the general ledger of a company. In short, it is an organizational tool that provides a digestible breakdown of all the financial transactions that a company conducted during a specific accounting period, broken down into subcategories. Key Takeaways
How Charts of Accounts (COA) WorksCompanies use a chart of accounts (COA) to organize their finances and give interested parties, such as investors and shareholders, a clearer insight into their financial health. Separating expenditures, revenue, assets, and liabilities help to achieve this and ensure that financial statements are in compliance with reporting standards. The list of each account a company owns is typically shown in the order the accounts appear in its financial statements. That means that balance sheet accounts, assets, liabilities, and shareholders' equity are listed first, followed by accounts in the income statement—revenues and expenses. For a small corporation, COAs might include these sub-accounts under the assets account:
Liabilities account may have sub-accounts, such as:
Shareholders' equity can be broken down into the following accounts:
To make it easier for readers to locate specific accounts, each chart of accounts typically contains a name, brief description, and an identification code. Each chart in the list is assigned a multi-digit number; all asset accounts generally start with the number 1, for example. Here is a way to think about how COAs relate to your own finances. Say you have a checking account, a savings account, and a certificate of deposit (CD) at the same bank. When you log in to your account online, you’ll typically go to an overview page that shows the balance in each account. Similarly, if you use an online program that helps you manage all your accounts in one place, like Mint or Personal Capital, what you’re looking at is basically the same thing as a company’s COA. You can see all your assets and liabilities, all on one page. Example of a COAWithin the accounts of the income statement, revenues and expenses could be broken into operating revenues, operating expenses, non-operating revenues, and non-operating losses. In addition, the operating revenues and operating expenses accounts might be further organized by business function and/or by company divisions. Many organizations structure their COA so that expense information is separately compiled by department; thus, the sales department, engineering department, and accounting department all have the same set of expense accounts. Examples of expense accounts include the cost of goods sold (COGS), depreciation expense, utility expense, and wages expense. Special ConsiderationsCOAs can differ and be tailored to reflect a company’s operations. However, they also must respect the guidelines set out by the Financial Accounting Standards Board (FASB) and generally accepted accounting principles (GAAP). Of crucial importance is that COAs are kept the same from year to year. Doing so ensures that accurate comparisons of the company’s finances can be made over time. What is the difference accounts receivable and accounts payable?A company's accounts payable (AP) ledger lists its short-term liabilities — obligations for items purchased from suppliers, for example, and money owed to creditors. Accounts receivable (AR) are funds the company expects to receive from customers and partners. AR is listed as a current asset on the balance sheet.
What is the difference between receivables and accounts receivable?Accounts receivable are the amounts owed to a company by its customers. Receivables are only created when sales are made on credit.
What is the difference between accounts receivable and accounts payable quizlet?Accounts Payable are the current bills a business owes to suppliers. Money owed a business enterprise for merchandise bought on open account. It is also called "A/R" or just "Receivables". Accounts Receivable are the amounts owed to a company by its customers and/or employees.
What is the difference between account receivable and account payable give one concrete example of each?Whereas accounts payable represents money that your business owes to suppliers, accounts receivable represents money owed to your business by customers. In addition, accounts receivable is considered a current asset, whereas accounts payable is considered a current liability.
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