Question

Compute the company’s AR turnover and average days to collect receivables; Think about what Bill told you as written in item number 13 above. Write a memo explaining to Bill how the known and estimated uncollectible receivables must be accounted for and presented in the financial statements. Further explain the difference between the direct write-off and allowance methods and furnish Bill with your opinion on which method should be used for his business. Lastly, explain how an AR Aging report is compiled and what it is used for. How might the Company use an aging report to manage its collection activity?

(13) Based on past history, Bill estimates that 5% of sales on account would probably not be collected even with diligent collection efforts. Bill also tells you that he is sure that two of his customers with balances totaling $3,000 will not be able to pay him.

	Bagel Company Inc.
	Balance Sheet
	At 12/31/Yr2
Assets
Current Assets
Cash	$       19,673
Accounts Receivable, net	70,300
Inventory	78,000
Prepaid Expenses	3,000
Total Current Assets		$     170,973
Property, Plant, & Equipment
Equipment	40,000
Less: Accumulated Depreciation	(21,000)
Total Property, Plant & Equipment		$       19,000
Total Assets		$     189,973
Liabilities
Current Liabilities
Accounts Payable	$       16,200
Corporate Income Taxes Payable	14,156
Other Current Liabilities	21,050
Total Current Liabilities		$       51,406
Long Term Liabilities
Notes Payable	$       46,744
Total Long Term Liabilities		$       46,744
Total Liabilities		$       98,149
Owner's Equity
Common Stock	$       20,000
Retained Earnings	71,823
Total Owner's Equity		$       91,823
Total Liabilities&Owner's Equity		$     189,973

	Bagel Company Inc.
	Income Statement
	FYE 12/31/Yr2
Sales, net		$    378,000
Cost of Goods Sold		132,000
Gross Profit		246,000
Operating Expenses:
Payroll and Related Expense	$    110,000
Rent	18,000
Utilities	14,000
Insurance Expense	3,000
Advertising&Promotion	4,200
Other	7,700
Total Operating Expenses		156,900
EBITDA		89,100
Depreciation Expense		14,000
EBIT		75,100
Interest Expense		4,321
EBT		70,779
Income Tax Expense		14,156
Net Income		$      56,623

Answer 1

Account Receivable Turnover =

Net credit sales/Average receivable

$3,78,000/ $45,400

8.32 Times.

Note- Average receivables is $70,300 -$18,900(5%of credit sales)- $3,000-$3,000=$45,400

Average Collection Period=

365days/Account Receivable turnover ratio

365 days / 8.32

44 days

The Effect of Allowance for Doubtful Accounts on the financial statements is that it is first the contra asset account. It is shown on the Assets side of the Balance sheet below the accounts receivable line. It is the estimate of management to clear accounts receivable which are not in moving conditions means from whom money is not going to come in, its rather bad debts and providing (provision) for such accounts receivable is called allowance for doubtful accounts. Therefore its effect will be it would be shown as is listed as deduction immediately below the accounts receivable line item on the assets side of the balance sheet.

Difference between direct write off and allowance method is-

Under the direct write-off method, a bad debtis charged to expense as soon as it is apparent that an invoice will not be paid. Under the allowance method, an estimate of the future amount of bad debt is charged to a reserve account as soon as a sale is made. This results in the following differences between the two methods:

Timing. Bad debt expense recognition is delayed under the direct write-off method, while the recognition is immediate under the allowance method. This results in higher initial profits under the direct write-off method.
Accuracy. The exact amount of the bad debt expense is known under the direct write-off method since a specific invoice is being written off, while only an estimate is being charged off under the allowance method.
Receivable line item. The receivableline item in the balance sheet tends to be lower under the allowance method, since a reserve is being netted against the receivable amount.

Allowance method would be suitable for Bill because an estimate of the future amount of bad debt is charged to a reserve account as soon as a sale is made.

Accounts Receivable Aging (sometimes called an accounts receivable reconciliation) is a process of categorizing all the amounts owed by all customers, including the length of time the amounts have been outstanding (unpaid), thus you are considering their age, or "aging" this information. The standard categories for this type of report are:

Current - due immediately
1 - 30 days - due within the next 30 days
31-60 days - a month overdue
61 - 90 days - two months overdue
91 and over - more than two months overdue

If a customer has several bills that were incurred at different times, the report will show how much is due at what time. For example, for Jim Jones:

$230 30 days

$120 60 days

$390 Over 90 days.

The purpose of this accounts receivable aging is to show the business owner what receivables need to be dealt with more urgently because they have been overdue longer.

The Accounts Receivable Aging Report is a standard report provided with all business accounting software programs, including online systems.

An aging report is useful because it gives you a snapshot of the money that is outstanding and due to you by your customers. It also helps you identify customers that are falling behind on their payments – a clear sign of an underlying problem. Note that slow payments do notalways indicate financial problems; it could indicate a possible dispute or misunderstanding. Many companies use this report when planning collections calls and when trying to forecast their cash flow.