Headquartered in London, England, Pearson is an international company with businesses in education, business information, and consumer publishing. Pearson education operations provide learning materials, technologies, assessments, and services to educational institutions, corporations, and professional organizations. They also serve teachers and students of all ages. In its business information division, Pearson operates FT Publishing, which includes the Financial Times, FT.com, and various financial magazines, online services, and financial databases. Pearson’s consumer operations, Penguin, runs a series of national publishing houses. With sales of £5.6 billion in 2009, Pearson operates in over 60 countries. The company’s financial statements are prepared according to IFRS. Pearson’s shares are traded on both the London and New York stock exchanges (Source: Company Annual Report and Form 20-F).
Refer to the financial statements for 2009 of Pearson plc for information regarding account receivable. All figures are in millions of pounds sterling (L).
Inquiry a:
What is the definition of an account receivable? Are there any other names for this asset?
Inquiry b:
What are the differences between accounts receivable and notes receivable?
c. What is a contra account? Two contra accounts associated with Pearson’s trade receivables (see Note 22) are…These contra accounts capture different types of activities. Factors that managers consider when estimating the balance in each contra account include…
d. Two commonly used approaches for estimating uncollectible accounts receivable are the percentage-of-sales procedure and the aging-of-accounts procedure. The percentage-of-sales procedure involves… The aging-of-accounts procedure involves… Managers need certain information to determine the activity and final account balance under each approach. In terms of accuracy, I believe the [percentage-of-sales/aging-of-accounts] procedure provides a more accurate estimate of net accounts receivable.
e. If Pearson expects some accounts to be uncollectible, why did the company grant credit to those customers initially? Managers must consider the risks associated with accounts receivable.
f. Note 22 discloses the balance in Pearson’s provision for bad and doubtful debts (for trade receivables) and the account activity during [specific period]. It is important to note that Pearson refers to the trade receivables contra account as a “provision,” while U.S. GAAP typically refers to it as an “allowance.” The term provision is used to describe the current-period income statement charge for uncollectible accounts, also known as bad debt expense.i. Use the information in Note 22 to complete a T-account for the provision for bad and doubtful debts account during the year. Describe the line items that explain the change in the account during 2009.
ii. Create journal entries that Pearson recorded in 2009 for: 1) bad and doubtful debts expense (income statement movement) for the year, and 2) write-offs of accounts receivable (utilized amount) during the period. Indicate whether each account is a balance sheet or income statement account in your journal entries.
iii. The provision for bad and doubtful debts expense in the income statement.
g. At December 31, 2008, the balance in Pearson’s provision for sales returns was £372, and at December 31, 2009, it was £354. In U.S. GAAP, this contra account is commonly referred to as an “allowance” and represents the anticipated sales returns of the company.
i. A T-account is necessary to show the activity in the provision for sales returns account during the year. Assuming Pearson estimated £425 million in returns related to 2009 sales, two types of journal entries are needed to reconcile the change in the account. One entry records the estimated sales returns for the period, while the other records the actual book returns.
ii. The journal entries recorded by Pearson in 2009 include: 1) £425 million for estimated sales returns and 2) the amount of actual book returns during 2009. It should be noted whether each account in these journal entries is a balance sheet or income statement account.
ii. The amount of 2009 estimated sales returns appears in a specific line item on the income statement.
h. A T-account must be created for total or gross trade receivables (before deducting provisions for bad and doubtful debts and sales returns). The change in this T-account between December 31, 2008 and 2009 can be analyzed, with the solution to parts f and g being helpful in this analysis. It is assumed that all sales in 2009 were made on account.Please prepare the journal entries to record the credit sales and accounts receivable collection activity during the year. Note 22 contains information regarding the age of Pearson’s trade receivables and their outstanding status. The auditor has analyzed historical collection information and estimated the percentage of uncollectible accounts within each age category, as reported in the table below. Using these percentages and the trade receivable aging information from Note 22, estimate the uncollectible accounts at December 31, 2009, and complete the table. Based on your estimate, determine if the auditor would find the balance of the provision for bad and doubtful debt account reported in Note 22 to be adequate.
Balance of trade receivables
Estimated %
uncollectible
Accounts that are estimated to be uncollectible within the due date.
2%
Up to a maximum of three months overdue
4%
The payment is three to six months overdue.
25%
Six to nine months overdue.
The text “50%” remains the same.
Nine to 12 months overdue
60%
Over a year overdue
90%.
The exhibits provided in class for Pearson PLC include the following:
Consolidated Income Statement
Consolidated Balance Sheet
Notes to Consolidated Financial Statements (partial)
a. What is account receivable?
Account receivable refers to credit sales or sales on account.
b. How do accounts receivable differ from notes receivable?
Notes receivable is created when a seller replaces an accounts receivable with a promissory note. This typically occurs when a customer requires more time to settle an past-due account. A promissory note is a written promise to pay a specified amount, typically with interest, at a later date.
c. What is a contra asset?
An account that offsets another account is called a contra account. A contra-asset account has a credit balance and it offsets the debit balance of the corresponding asset. On the other hand, a contra-liability account has a debit balance and it offsets the credit balance of the corresponding liability. Two examples of provisions are provisions for bad and doubtful debts, which involve allowing for uncollectible accounts receivable, and provisions for sales returns, which estimate sales return.
Managers take into account various factors when determining the collectability of accounts receivable. These factors include the buyer’s credit quality, the age of the receivable, and the overall state of the economy. Estimating uncollectible accounts can be approached in two ways. The first method is based on a percentage of sales, using previous business experience as a basis. This approach does not consider the current balance of the allowance account. The second method involves aging of accounts, which analyzes the length of time they remain outstanding. Lastly, it is important to understand why the company chose to extend credit to customers.
They would not have extended credit to companies that eventually would not pay. iii: Bad and doubtful debts expense is part of the operating expenses.
