Financial Services: Accrual Accounting

Types of Accounts

• Asset Accounts: Represent economic resources owned or controlled by an entity. Examples include cash, inventory, real estate, prepaid expenses, and accounts receivable.
• Liability Accounts: Reflect economic obligations of an entity, such as accounts payable, loans, and accrued expenses.
• Equity Accounts: Indicate the residual interest in assets after deducting liabilities, including common stock and retained earnings.
• Revenue Accounts: Document the company's earnings from sales and services.
• Expense Accounts: Capture expenditures like utilities, rent, and depreciation.
• Contra-Accounts: Have negative balances that offset other accounts; examples include accumulated depreciation and allowance for bad debts.

Chart of Accounts

• An organized index for classifying individual accounts in the general ledger.
• Typically structured by ranges, such as:
  • Assets: 1000-1999
  • Liabilities: 2000-2999
  • Equity: 3000-3999
  • Revenues: 4000-4999
  • Expenses: 5000-5999

General Journal Entry Example

• Record transactions in a systematic way, with debits and credits clearly defined.
• Example entries illustrate typical business transactions, such as accounts receivable and accounts payable.

Contra Account Overview

• Used to reduce the value of related accounts; their balances are oppositional to associated accounts.
• Presented in financial statements to provide clearer insights into net values, such as accounts receivable less an allowance for doubtful accounts.

Doubtful Debts

• Bad debts arise when customers default on payments.
• Direct Write-Off Method: Bad debts are recorded as expenses when deemed uncollectible.
• Allowance Method: Estimates uncollectible accounts in advance, creating a reserve account for anticipated losses.

Steps in Allowance Method

• Estimated Uncollectibles: Adjust the accounts receivable to reflect expected losses, recorded as bad debts expense and allowance for doubtful accounts.
• Write-Off Uncollectibles: Formal approval is needed to write off bad debts, adjusting both accounts receivable and allowance accounts.
• Recovery of Uncollectibles: If previously written-off amounts are collected, adjustments are made to reflect the recovery.

Example of Allowance Method

• If accounts receivable total BD 200,000 and estimated uncollectibles are BD 12,000:
  • Adjusting entry includes debiting bad debts expense and crediting allowance for doubtful accounts.
  • The net accounts receivable presents a more accurate figure after accounting for expected losses.

Collection Efforts for Past-Due Accounts

• Strategies include ensuring invoice delivery, follow-ups, sending reminders, and possibly pursuing legal action.
• Writing off accounts when collection efforts fail is a necessary accounting process that requires management approval.

Key Takeaway

• Understanding and maintaining an accurate chart of accounts, alongside methods for handling uncollectible accounts, is vital for effective financial management and reporting.

This quiz covers the essentials of establishing and maintaining an accrual accounting system within financial services. It explores various types of accounts, including asset accounts that represent economic resources owned by an entity. Test your knowledge on the classifications and functionalities of these accounts in a company.