account for uncollectible accounts using the balance sheet and income statement approaches 4

Estimating Bad Debts Accounting 101

Under this method, bad debt expense is recorded only when a specific account is determined to be uncollectible. Companies employ different systematic approaches to estimate their allowance for uncollectible accounts. The two most common are the percentage of sales method and the aging of receivables method.

Detailed Explanation of Estimation Methods

(Figure)Laminate Express extended credit to customer Amal Sunderland in the amount of $244,650 for his January 4 purchase of flooring. On April 5, Laminate Express determined that Amal Sunderland’s account was uncollectible and wrote off the debt. On June 22, Amal Sunderland unexpectedly paid 30% of the total amount due in cash on his account. Remember, though, that in most cases the direct write-off method is not allowed.

• This entry assumes a zero balance in Allowance forDoubtful Accounts from the prior period.
• While unexpected, these recoveries require specific journal entries to properly account for the cash received and to adjust the relevant accounts.
• To illustrate, let’s continue to use Billie’s WatercraftWarehouse (BWW) as the example.

Aging of Accounts Receivable Method

• As you’ve learned above, the delayed recognition of bad debt violates GAAP, specifically the matching principle.
• The balance sheet method isanother simple method for calculating bad debt, but it too does notconsider how long a debt has been outstanding and the role thatplays in debt recovery.
• The understanding is that the couple will make payments each month toward the principal borrowed, plus interest.
• (Figure)Window World extended credit to customer Nile Jenkins in the amount of $130,900 for his purchase of window treatments on April 2.
• In addition, under the percentage of credit sales approach, we ignore any existing balance in the allowance when calculating the amount of the year-end adjustment.
• The result is “Accounts Receivable, Net Realizable Value,” the amount the company anticipates collecting.

When the account defaults for nonpayment onDecember 1, the company would record the following journal entry torecognize bad debt. In addition, under the percentage of credit sales approach, we ignore any existing balance in the allowance when calculating the amount of the year-end adjustment. You may notice that all three methods use the same accounts for the adjusting entry; only the method changes the financial outcome.

Categories

This method relies on historical data to determine a consistent percentage of credit sales that are expected to become uncollectible. The primary advantage of this method account for uncollectible accounts using the balance sheet and income statement approaches is its simplicity and ease of implementation, making it particularly useful for companies with steady sales patterns and predictable bad debt rates. Accurate financial reporting is essential for businesses, and managing uncollectible accounts, or bad debts, is a key component.

Methods for Accounting for Uncollectible Accounts

In the case of the allowance for doubtful accounts, it is a contra account that is used to reduce the Controlling account, Accounts Receivable. The first entry reverses the bad debt write-off by increasing Accounts Receivable and decreasing Bad Debt Expense for the amount recovered. With this method, accounts receivable is organized intocategories by length of time outstanding, and an uncollectiblepercentage is assigned to each category. For example,a category might consist of accounts receivable that is 0–30 dayspast due and is assigned an uncollectible percentage of 6%. Anothercategory might be 31–60 days past due and is assigned anuncollectible percentage of 15%. All categories of estimateduncollectible amounts are summed to get a total estimateduncollectible balance.

How to record allowance for doubtful accounts journal entries

On the balance sheet, uncollectible accounts affect the reported value of accounts receivable. Under the allowance method, a contra-asset account called “allowance for doubtful accounts” is established. This account directly reduces the gross accounts receivable to arrive at the net realizable value, which is the amount of accounts receivable a business realistically expects to collect. Uncollectible accounts are customer debts that a business determines are unlikely to be recovered. While an account may simply be past due, an uncollectible account is identified as a loss because payment is not anticipated.

Reversing a write-off involves reinstating the accounts receivable and recognizing the recovered amount as income. The aging method aligns with GAAP and IFRS principles, providing a systematic way to estimate and record allowances for doubtful accounts. It can also integrate into broader financial metrics, like the accounts receivable turnover ratio, offering insights into credit and collection efficiency. For example, a customer takes out a $15,000 car loan on August1, 2018 and is expected to pay the amount in full before December1, 2018. For the sake of this example, assume that there was nointerest charged to the buyer because of the short-term nature orlife of the loan.

In the percentage-of-receivables method, the company may use either an overall rate or a different rate for each age category of receivables. Let’s say your business brought in $60,000 worth of sales during the accounting period.Let’s say that on April 8, it was determined that Customer Robert Craft’s account was uncollectible in the amount of $5,000. This can significantly increase current year’s tax reductions compared to the simple write off. The caveat is that it must be completed PRIOR to the date of final foreclosure and loss. The process is simple, but finding a charity to cooperate is difficult since there will be no cash value as soon as the 1st mortgage forecloses. This contra-asset account reduces the loan receivable account when both balances are listed in the balance sheet.

When a specific customer has been identified as an uncollectible account, the following journal entry would occur. As you’ve learned, the delayed recognition of bad debt violates GAAP, specifically the matching principle. Notice that the AFDA entries cancel each other out so that the net effect is a debit to bad debt expense and a credit to accounts receivable.

Businesses regularly extend credit to customers, allowing them to receive goods or services now and pay later. This practice generates accounts receivable, which represents a significant asset on a company’s financial statements. Not all these outstanding amounts are ultimately collected, leading to uncollectible accounts, which significantly impacts financial reporting, profitability, and asset valuation.