Understanding Accounts Receivable and Allowance for Doubtful Accounts for the U.S. FAR CPA Exam
When preparing for the Financial Accounting and Reporting (FAR) section of the U.S. CPA exam, a deep understanding of Accounts Receivable and the Allowance for Doubtful Accounts is vital. These are key components in evaluating a company's liquidity and financial health under U.S. Generally Accepted Accounting Principles (U.S. GAAP). This article aims to provide you with an in-depth look into these topics and their practical implications, complete with journal entry examples suitable for a college-level audience.
Accounts Receivable
Accounts receivable represents amounts owed to a business by customers for goods or services provided on credit. These are short-term assets expected to be collected within a year or within the operating cycle of the business, whichever is longer.
Allowance for Doubtful Accounts
The allowance for doubtful accounts is a contra-asset account that reduces accounts receivable to reflect the estimated amount that is expected to be uncollectible. This provision is based on historical data or other reasonable methods of estimation.
Recognition and Measurement
Under U.S. GAAP, accounts receivable are initially recorded at their transaction price. An allowance for doubtful accounts is established to account for estimated future credit losses.
Examples
Example 1: Journal Entry for Credit Sales
Imagine a company sells goods worth $20,000 on credit. The journal entry would be:
· Debit Accounts Receivable $20,000
· Credit Sales Revenue $20,000
Example 2: Journal Entry for Establishing Allowance for Doubtful Accounts
Based on historical data, the company estimates that 2% of credit sales will be uncollectible. The journal entry to establish the allowance would be:
· Debit Bad Debt Expense $400 (2% of $20,000)
· Credit Allowance for Doubtful Accounts $400
Example 3: Journal Entry for Writing Off Uncollectible Accounts
Suppose the company identifies that a specific $500 receivable will not be collected. The journal entry to write off the receivable would be:
· Debit Allowance for Doubtful Accounts $500
· Credit Accounts Receivable $500
Example 4: Journal Entry for Recovery of Written-Off Accounts
If the company later recovers $200 from an account previously written off, the journal entry would be:
· Debit Accounts Receivable $200
· Credit Allowance for Doubtful Accounts $200
· Debit Cash $200
· Credit Accounts Receivable $200
Disclosures
Companies are expected to provide clear disclosures about their accounting policies related to accounts receivable and bad debts, including how they estimate the allowance for doubtful accounts. This is essential for financial statement users to assess the company's credit risk and liquidity position.