Financial Accounting

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Previous Lessons
Open Chapter Ch. 1: Basics of Financial Accounting
Lesson #1 Introduction to Financial Accounting
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Lesson #2 Structures of a Business
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Lesson #3 Comparing Internal vs. External Users
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Lesson #4 Business Activities
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Lesson #5 Financial Statements
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Lesson #6 Elements of Financial Accounting
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Open Chapter Ch. 2: Assets, Liability, and Equity
Lesson #7 Assets
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Lesson #8 Liabilities
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Lesson #9 Equity
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Open Chapter Ch. 3: The Double-Entry System and Conceptual Framework
Lesson #10 Accounting Equation
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Lesson #11 Conceptual Framework
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Lesson #12 Double Entry Accounting System
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Lesson #13 Debits and Credits
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Lesson #14 Normal Balances and RED Accounts
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Exam Exam 1
Open Chapter Ch. 4: The Accounting Cycle
Lesson #15 Journalizing and the Accounting Cycle
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Lesson #16 Posting to the General Ledger
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Lesson #17 Trial Balance
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Lesson #18 Adjusting Entries for Accrued Expenses
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Lesson #19 Adjusting Entries for Prepaid Expenses
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Lesson #20 Adjusting Entries for Unearned Revenue
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Lesson #21 Adjusting Entries for Accrued Revenue
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Lesson #22 Adjusting Entries for Amortization and Depreciation
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Lesson #23 Adjusted Trial Balance
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Lesson #24 Preparing the Financial Statements
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Lesson #25 Permanent vs. Temporary Accounts
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Lesson #26 Closing Entries
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Open Chapter Ch. 5: Merchandise Inventory
Lesson #27 Introduction to Merchandise Inventory
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Lesson #28 Periodic vs. Perpetual Inventory Systems
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Lesson #29 Journalizing Purchase Entries
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Lesson #30 Journalizing Sales Transactions
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Lesson #31 Preparing a Multiple-Step Income Statement
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Lesson #32 Periodic Inventory System Purchases
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Lesson #33 Periodic System and the Multiple-Step Accounting System
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Exam Midterm Exam
Open Chapter Ch. 6: Cost Flow Assumptions: FIFO, LIFO, and Average Cost Methods
Lesson #34 Specific Identification Method and Inventory Costing
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Lesson #35 FIFO Method and Inventory Costing
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Lesson #36 Average Cost Method and Inventory Costing
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Lesson #37 The LIFO Method
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Lesson #38 Average Cost Method for the Perpetual System
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Lesson #39 Comparing Inventory Costing Methods
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Open Chapter Ch. 7: Receivables and Bad Debts
Lesson #40 Allowance Method and Uncollectibles
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Lesson #41 The Allowance Method
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Lesson #42 Percentage of Sales Method
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Lesson #43 Percentage of Receivables Method
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Lesson #44 Receivables Method and the Aging Table
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Lesson #45 Write Off Receivables Using the Allowance Method
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Lesson #46 Direct Write-Off Method
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Open Chapter Ch. 8: Revenue Recognition
Lesson #47 Revenue Recognition
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Lesson #48 Revenue Recognition Examples
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Lesson #49 Revenue Recognition and Long Term Contracts
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Lesson #50 Percentage of Completion Method
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Lesson #51 Percentage of Completion Method Journal Entries
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Lesson #52 Percentage of Completion Method and Journalizing Losses
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Lesson #53 Cost Recovery Method
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Lesson #54 Completed Contract Method and Journal Entries
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Lesson #55 Completed Contract Method and Losses
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Exam Exam 3
Open Chapter Ch. 9: Depreciation of Fixed Assets and Gains and Losses
Lesson #56 Depreciation, Amortization and Depletion
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Lesson #57 Straight Line and Declining Balance Methods
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Lesson #58 Straight Line and Double Declining Balance Depreciation Examples
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Lesson #59 Gains and Losses on Disposals of Property, Plant & Equipment
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Open Chapter Ch. 10: Intangible Assets
Lesson #60 Intangible Assets
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Lesson #61 Amortizing Intangible Assets
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Lesson #62 Impairment of Intangible Assets
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Lesson #63 Recording Goodwill, Amortization and Impairment
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Open Chapter Ch. 11: The Indirect Cash Flow Statement
Lesson #64 Preparing a Cash Flow Statement Using the Indirect Method Part 1
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Lesson #65 Cash Flow Statement Using Indirect Method Part 2, Receivables
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Lesson #66 Cash Flow Statement Using Indirect Method Part 3, Inventory
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Lesson #67 Cash Flow Statement Using Indirect Method Part 4, Payables
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Lesson #68 Cash Flow Statement Using Indirect Method Part 5, Non Cash Expenses
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Lesson #69 Cash Flow Statement- Investing and Financing Activities
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Exam Final Exam

Assignments:

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Lesson Objectives:

- Sales method rules
- How bad debts are estimated and recorded.
- Example of the adjustment process
- Advantage of the sales method




We just talked about the fact that there are two different methods used to calculate the allowance for doubtful accounts. The first method that we will review in this lesson is the percentage of sales method.

Let's start with the rules that apply to using the sales method, as these rules best demonstrate how the method works.
 
Always use a T-account to record the Allowance for Doubtful Accounts. Use the abbreviation AFDA.
Bad debts adjustment should always be recorded with a debit for the bad debt account and credit for the AFDA.
Only the adjustment for the estimate of the bad debts expense and AFDA should be journalized in the entry. There can be other values such as beginning, ending, write-offs and recovery of receivables, but these will not be recorded on the same journal entry.
Find the ending AFDA for the balance sheet. This will be deducted from the accounts receivable to come up with the net receivables.

Keep these rules in mind as we review a real-world example of how the sales method of estimating the bad debts expense is applied.



Let's go ahead and take a look at a step-by-step example of how this method is applied. We will use the account values listed above; these values are for the year 2015.

When we start 2015, we will use the T-account format to record the beginning balance of $3,000 for AFDA.

For the purpose of this example, management estimates that 2 percent of all sales will be uncollectible. This percentage is multiplied by net sales because the net sales factors in any returns or discounts. This calculation would be 0.02 x 800,000 = $16,000, which would then be recorded on the AFDA T-account as the adjustment amount.
 
The ending balance for AFDA would be $19,000 which is the total of the beginning balance and adjustment amount.

Now that we have the estimate of the bad debts expense, we will go ahead and record the journal entry. Above, the estimate figure of $16,000 is listed as a debit for the bad debts expense and a credit for AFDA.

Finally, we would look at the gross accounts receivable and subtract the ending AFDA value to come up with the net receivables value of $481,000.

We've come up with the bad debts expense and AFDA adjustment as well as the net receivables amount using the percentage of sales method. We will take a look at the receivables method in the next lesson.
 
Each method has its own advantage when it comes to accounting principles. The sales method best demonstrates the matching principle because the bad debts expense is being matched directly to the sales. The estimated bad debt amount is multiplied by the sales, therefore matching the expenses to the revenues earned in the given accounting period.