 In this discussion we will discuss the discussion question of describe the accounts receivable cycle subsidiary ledgers and allowance method. So we're talking here about accounts receivable and related activities to accounts receivable. If we're given a discussion question like this an essay question similar to this we could first start off with what is accounts receivable and then go into the problems related to accounts receivable which are solved by things such as a subsidiary ledger and an allowance method. So first accounts receivable what is accounts receivable it's going to be an asset type account it's typically a current asset type account a more liquid type account or one that we believe will be converted to cash relatively soon typically within around 30 days and it's a result from us doing work goods or services on account and therefore being owed something in the future typically money or typically owed money in the future due to something happening in the past usually us earning money through providing a good or service. Therefore the accounts receivable is an asset but it's not something really tangible we don't have it yet the money is not with us yet we expect to have it soon it's a claim to future assets and therefore it does have a value however there could be problems with it now we might want to start with the journal entry as well how would that happen well the accounts receivable would happen if we made a sale if we did work or service we would debit the accounts receivable and we would credit some type of revenue account whether that be something called revenue just a revenue account or income or if we sell goods or services then typically it would be called sales if we if we sell services and not goods it might be called fees earned so that would be the normal transaction to increase accounts receivable if we're selling inventory along with that on a perpetual system we would debit cost of goods sold and credit inventory to record the inventory half of the sales transaction then what happens is we're going to get money hopefully in the future so the normal accounts receivable process would then be hopefully within 30 days the customer pays us we debit cash increasing the cash credit the accounts receivable decreasing the accounts receivable at the time we receive the money therefore the accounts receivable should have a pattern it going up with a debit for every time we make a sale going down every time there is a payment on the sale of course at every sale on account meaning sale that we didn't get cash for it was on credit so then we can go into the problems with accounts receivable well one of them being how do we value accounts receivable isn't it the case that we might not get cash if we don't yet have the cash aren't we counting our cash before it's received by recording receivables and the answer is not really because it is just receivable it's not cash so we are claiming we have something of value a promise to pay us and that's the receivable but it is the case that we might not get paid and we might have some knowledge about those types of accounts or at least how many of them will not be paid that's going to be one problem we're going to have to deal with we deal with that with the allowance method under generally accepted accounting principles the other problem is how do we track who's going to pay us in order to send them the invoices in order to make sure that we get payment and that has to do with tracking the receivable by customer which is typically done with a subsidiary ledger type of account so let's start with a subsidiary ledger type of account we know that the accounts receivable represents in total we look at accounts receivable on the balance sheet or trial balance what is owed to us by customers meaning all customers some together owe us whatever's on the trial balance or balance sheet we could call that um let's just say that people owe us a hundred thousand that that's just what it is but it could be obviously multiple customers that owe us that and then we need to know who owes us the money so that we can invoice them and try to collect on the money that would be something done with a subsidiary ledger this is different than the general ledger which every account has a general ledger which supports the data by order of order of date date of operations date the transaction happened gives the activity in other words to every account such as the accounts receivable account by date or an order of date what we need though is another type of ledger a subsidiary ledger which is going to give us the activity first by customer so that we can then track who owes us money and has it yet to been paid so you can imagine if we're a company that the first question the owner would have of where the bookkeeper is how much money do people owe us if there's a hundred thousand in on the books we say they owe us a hundred thousand the next question is going to be well when are we going to get paid who owes us the money right have we sent them out to reminders anytime recently are we expecting to get paid soon to answer that question we need to order things by customer who owes us money by customer that done with a subsidiary ledger next problem to address has to do with the allowance method and that's the idea of us if we don't somehow make some type of estimate for the receivables that we think are going to be uncollectible then we're overstating the receivables we do that with what's called the allowance method and what that means is um note that when we put the receivables on the books we have to do that if we don't put the receivables on the books and we wait till we get paid that really distorts the financial statements because if I'm a creditor I'm the bank and I want to see the financial statements to assess whether we give a loan or not all the receivables on the book is something important that's what we want to know that number however we also want to know how much of that number is not going to be collectible which is something we can't know for sure but we would like to have some type of estimate on that so that's going to be something we want to provide on our financial statement we want the receivables on there but we also want to know how much of those receivables we believe are going to be uncollectible in order to represent where we stand on a balance sheet basis as accurately as possible one way to do that is to try to take the receivables make an aging type of account and determine how much of them based on some type of estimate from past experience or related industry will not be collectible then we're not going to write down the receivable directly one reason being that we can't take the money we can't reduce the receivable to the subsidiary ledgers because we don't really know exactly who's not going to pay us it's just an estimate so we can't go in each individual subsidiary ledger account and say this person's not going to pay us we don't know what we do know is based on an estimate the percentage or how much of the receivables we believe will be uncollectible and therefore we can make a contra asset account one that has an asset cap that has a credit balance most asset accounts have debit balances this one having a credit balance which will match up against the receivable in a similar way as accumulated depreciation matches up against fixed assets and it'll reduce the net receivables that we believe that we're going to get so that's what we'll we'll do in order to deal with this problem of overstating the receivables we'll come up with this allowance for doubtful accounts which we can do one of two methods to do that we can do that with this accounts receivable method or we can look at the sales side to try to figure out what that allowance should be and to understand that it's really we really need to just look at the other side of the equation the accounts receivable the account related to it on the income statement is revenue and revenue we have the same problem that if we made sales on account and it might be overstated meaning we might have some of those revenue accounts that we recorded revenue of which we're never going to actually get the money and if that's the case we shouldn't really have recorded revenue even if we did the work we're not going to get paid so it's not like we really made a sale there because we're never going to get the money so we would like to match that up in the same time period if we would overstate revenue instead of reducing revenue we want to record the bad debt expense the amount of that revenue which we don't believe we're going to get paid on in the same time period in which we generated it and that's going to be the other side of this allowance method when we fix the receivables we'll also be fixing in a way the matching principle on the income statement matching up the amount of those receivables we believe will be non-collectible the amount of sales we made on account which we never think we're going to get the cash for in the same time period that being better than us waiting until a later time period to decide that we're not going to get paid because we'll be matching up then in that circumstance the amount we're not going to get paid with a future revenue and what we want to do is match it up whatever revenue earned we've earned this period this month this year we want to try to match up the amount of it we think is going to be uncollectible to do that we'll do some type of estimate either estimating the type of revenue the total revenue we think is uncollectible or kind of backing into it by figuring out how much of the accounts receivable is uncollectible and thereby getting the bad debt expense as well so this would be a pretty comprehensive type question asking you know really many of the major components of the receivables the receivable being what is the receivable what's the receivable cycle what are the journal entries related to the receivable and then how do we know who we're going to bill or how are we going to bill without having to do with a subsidiary ledger and how do we deal with this fact of the or this problem with the receivables being potentially overstated without having to do with the allowance method