Question

Q1 a) Explain the methods that can estimate bad debt expenses in business. (Give numerical examples)

Q2. Differentiate between Accounts receivable and Notes receivable.

Q3. . Distinguish between Current/Short term Liabilities and Non-current/Long term Liabilities. Illustrate your answer with journal entries as examples.

Answer 1

A1) The Bad Debts can be estimated using sales approach, using % of total sales of a business for the period, or % of accounts receivable method.

Percentage of Accounts receivable method

Business estimates the value of bad debts b calculating bad debs as a % of accounts receivable balance

For example, if year-end accounts receivable balance of the business is $50,000, as per historical records it is 5% of total accounts receivable become uncollectable, here allowance for bad debts $2500 of (5%50000). However business should also create aging schedule estimate bad debts

Percentage sales method

This method calculates bad debts as % of total of credit sales which is uncollectable . past experience with the customer and the anticipated credit policy to calculate the %.

Then multiple the % with credit sales to estimate bad debt expense.

Example, this year the net sales for the business was $100000 and 5% as per credit policy considered as uncollectable. Here, $5000 would be bad expense.

A2)

Main differences between note receivable and accounts receivable:

Both are line items of the financial statements and fall under the same head CA- current asset; there exist some fundamental differences between them.

a) concept :

Notes receivables are written promissory note extending line of credit to other party, receivable in the future at a specified date along with interest.

while, the money owed by customers for purchasing goods or services on credit is known as accounts receivable.

b) Time-period:

Notes receivables is either a current asset or a non-current asset. If it matures within one year period, it is reported under current assets. If it is payable a period of more than one year, the portion maturing within one year will be reported under current assets and the rest of the amount will be reported under non-current assets.

Accounts receivable is current asset, the amount is mostly payable within twelve months of issuance of invoice. normally, a time period of thirty to ninety days is provided to clear the debt.

c) Legal impact:

Note receivables is legally binding agreement between the issuer and the payee.

Accounts receivable, , has no written agreement between the buyer and customer. The only document available is the sales invoice.

d) Transferability:

Notes receivables are negotiable instrument & can be transferred further to clear dues. It needs to be highlighted, that the transferability doesn’t affect the ownership of a notes receivable as each bearer has exactly the same claim over it as the original lender had.

Accounts receivable can be sold to a financial institution for a fee. This is known as discounting or factoring accounts receivable. Accounts receivable can’t be used as a negotiable financial instrument like note receivable.

e) Financial cost involved:

Notes receivables are financial instruments that has an interest component attached to it.

Accounts receivables has no financial component attached to it.

A3)

Current Liabilities: obligations which are due within one year. These types of liabilities are generally paid with current assets. Some examples include accounts payable, which are amounts due to vendors, shortterm bank loans, employee benefits etc.

Example: Dr Purchases A/C                                3,500

                 Cr Accounts Payables A/C                                              3,500

( purchases done on credit)

Dr Accounts Payables A/C                                    3,500

                 Cr Cash A/C                                                                3,500

( credit purchases paid)

Non current/long-term liabilities: these are debts of the business that are due beyond one year. Long-term debt is an example of a long-term liability and may include: leases, bank notes, bonds payable, and mortgage loans. Other examples of long-term liabilities include: pension benefit obligations and deferred taxes etc.

Examples: Dr Bank       A/C                         3,500,000

                 Cr 10% Notes Payables A/C                                              3,500,000

( cash received through bank on10% notes payable )

Dr Interest payable     A/C                         3,500,000

Dr 10%Notes payables    A/C                            350,000

                 Cr Bank A/C                                              3,850,000

(10%notes payable paid along with interst)