Cash Discounts (continued)
If collection is made beyond the discount period, the records will reveal the following:
Cash will be increased by $76,950, placing the amount at the left side of Cash. The Allowance for Sales Discount, $1,539, will be closed by placing the amount at the left side of the account, bringing the account balance to zero. The Accounts Receivable of $76,950 will be closed, too, by placing the amount at the right side; and a new account called Sales Accounts Forfeited is created with an amount of $1,539, placing the said amount at its right side.
Credit Card Sales
The use of credit cards is popular and involves another type among the accounts receivable formulas. Because the company wants to maximize its sales, it allows customers to pay in cards. Credit card companies earn card fees, ranging from one to five percent of net credit card sales, thereby reducing the value of the company's accounts receivables. The account Credit Card Service Charge would be reported as an operating expense in the income statement.
Going back to RidgeLeg, if the owner accepts credit card transactions and signs a Memorandum of Agreement with Citibank Mastercard, the following transactions and the corresponding records will be made:
The company receives Citibank Mastercard drafts or receipts amounting to $1,200,000.
Accounts Receivable-Citibank Mastercard will be created with an amount corresponding to $1,200,000 and, at the same time, increasing Sales by placing the same amount of $1,200,000 at the right side of Sales.
RidgeLeg sends the receipts to Citibank, which will send back to RidgeLeg a check for $1,200,000 less its service fees. A 2% service charge that RidgeLeg would recognize as a selling expense will be created. This transaction effects the accounts as follows:
Cash is increased by $1,176,000; such amount is placed at the left side, increasing the amount of Cash by $1,176,000. An account called Credit Card Service Charge is created with a corresponding amount of $24,000 placed at the left side. The account Accounts Receivable - Citibank Mastercard will be closed by placing the total amount of $1,200,000 at its right side.
In granting credit to clients in trading activities, past due accounts cannot be avoided. Some of these accounts may not be collected, which is the reason why the company must regard a portion of these bulk amounts as uncollectible. Under IAS 39, Loans and Receivables are also stated to be measured on the balance sheet at its amortized cost using the effective interest method.
There are two methods of accounting for uncollectible accounts: direct write off and the allowance method.
The direct write off method recognizes bad debts expense by reducing directly the receivables account. In the case of RidgeLeg, if $40,000 proves to be uncollectible, the following accounts will be affected: An account called Bad Debts Expense amounting to $40,000 will be established, and there will be a reduction of the receivables with the amount of $40,000. The $40,000 Bad Debts Expense will be placed at its left side while $40,000 will be placed at the right side of the Receivables account to take into effect the reduction of the said account.
If, for example, the amount of $40,000 is recovered, the accountant will simply reinstate the account by placing again the amount of $40,000 at the left side of the Accounts Receivable and the corresponding effect is the creation of an account called Bad Debts Recovery with the amount of $40,000 placed at its right side. After doing this, the collection is recorded by placing an amount of cash at its left side with the amount of $40,000 and placing again the $40,000 at the right side of the Accounts Receivable.
Please turn to Page 3 for more on Fundamental Accounts Receivable Formulas