Uncollectible accounts expense allowance method explanation, journal entries, example

This journal entry takes into account a debit balance of $20,000 and adds the prior period’s balance to the estimated balance of $58,097 in the current period. Continuing our examination of the balance sheet method, assume that BWW’s end-of-year accounts receivable balance totaled $324,850. This entry assumes a zero balance in Allowance for Doubtful Accounts from the prior period. This journal entry takes into account a debit balance of $2000 and adds the prior period’s balance to the estimated balance of $4608 in the current period, providing for a bad debt of $6608 ($4608+2000). For example, when companies account for bad debt expenses intheir financial statements, they will use an accrual-based method;however, they are required to use the direct write-off method ontheir income tax returns.

Uncollectible Accounts in Accounting

It is calculated by multiplying the total accounts receivable by the percentage of uncollectible accounts, based on historical data and industry trends. The Allowance for Uncollectible Accounts is then subtracted from the total accounts receivable to arrive at the Net Realizable Value of the accounts receivable. The journal entry for the Bad Debt Expense increases (debit) the expense balance, and the Allowance for Doubtful Accounts increases (credit) the balance in the Allowance. When setting up the allowance, the allowance account is a contra asset account, and is subtracted from Accounts Receivable to determine the Net Realisable Value of the Accounts Receivable account on the balance sheet. This means that when it is subtracted from Accounts Receivable, the difference represents an estimate of the cash value of accounts receivable. The contra account may also be called the Provision for Bad Debts or the Allowance for Bad Debts in practice.

Double Entry Bookkeeping

Based on this review, ABC increases the allowance for doubtful accounts by $500 by debiting the allowance for doubtful accounts account and crediting the bad debt expense account. When an account is determined to be uncollectible, the journal entry to write off the uncollectible account involves debiting the allowance for doubtful accounts account and crediting the accounts receivable account. The journal entry for allowance for doubtful accounts involves debiting the bad debt expense account and crediting the allowance for doubtful accounts account. On December 31, 2021, the total accounts receivable of the company are $350,000; out of which, company estimates that the receivables amounting to $4,500 will turn out to be uncollectible. On February 12, 2022, Weak trader, who is a receivable of $1,200, becomes bankrupt and nothing can be recovered from him.

The Allowance for Uncollectible Accounts is a contra-asset account that represents the estimated amount of uncollectible accounts.
Notice that once again that there is no effect on total assets by either of the above two entries.
Companies must estimate the amount of uncollectible accounts based on historic data.
As the accountant for a large publicly traded food company, you are considering whether or not you need to change your bad debt estimation method.
Creating this allowance doesn’t require knowing exactly which customers will default.
The following table reflects how the relationship would be reflected in the current (short-term) section of the company’s Balance Sheet.

For example, based on experience, a company can expect only 1% of the accounts not yet due to be uncollectible. At the other extreme, a company can expect 50% of all accounts over 90 days past due to be uncollectible. For each age category, the firm multiplies the accounts receivable by the percentage estimated as uncollectible to find the estimated amount uncollectible.

On the income statement, Bad Debt Expense would still be 1%of total net sales, or $5,000.
ABC writes off the account by debiting the allowance for doubtful accounts account and crediting the accounts receivable account for $500.
The net effect of this transaction is to reduce the accounts receivable balance and the allowance for doubtful accounts by $1,000.
Accounts receivable is reported on the balance sheet; thus, it is called the balance sheet method.

Income Statement

Then all of thecategory estimates are added together to get one total estimateduncollectible balance for the period. The entry for bad debt wouldbe as follows, if there was no carryover balance from the priorperiod. Carefully consider that the allowance methods all result in the recording of estimated bad debts expense during the same time periods as the related credit sales. The bad debt expense for the accounting period is recorded with the following percentage of accounts receivable method journal entry. The final point relates to companies with very little exposure to the possibility of bad debts, typically, entities that rarely offer credit to its customers. When a company sets up its allowance for doubtful accounts, it creates two simultaneous accounting entries.

Percentage of Credit Sales Method Example

However, the company is owed $90,000 and will still try to collect the entire $90,000 and not just the $85,200. Has an opposite normal balance to its paired account, thereby reducing or increasing the balance in the paired account at the end of a period; the adjustment can be an addition or a subtraction allowance for uncollectible accounts on balance sheet from a controlling account. 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. The allowance for doubtful accounts is a contra-asset account that nets against accounts receivable, which means that it reduces the total value of receivables when both balances are listed on the balance sheet. This allowance can accumulate across accounting periods and may be adjusted based on the balance in the account.The historical records indicate an average 5% of total accounts receivable become uncollectible.

At the end of the year, the accounts receivable are reevaluated and a new allowance for doubtful accounts is determined to make a new adjusting entry (just like the entry No. 1). In the preceding illustration, the $25,500 was simply given as part of the fact situation. If Ito Company’s management knew which accounts were likely to not be collectible, they would have avoided selling to those customers in the first place. Units should consider using an allowance for doubtful accounts when they are regularly providing goods or services “on credit” and have experience with the collectability of those accounts. The following entry should be done in accordance with your revenue and reporting cycles (recording the expense in the same reporting period as the revenue is earned), but at a minimum, annually. As you’ve learned, the delayed recognition of bad debt violates GAAP, specifically the matching principle.

2: Account for Uncollectible Accounts Using the Balance Sheet and Income Statement Approaches

Our tailored approach ensures compliance with accounting standards and provides actionable financial insights, ultimately strengthening your financial stability and decision-making capabilities. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. (2) Adjust the Allowance for Bad Debts account to the balance calculated in step (1). Notice that once again that there is no effect on total assets by either of the above two entries.

Unit 10: Receivables

The direct write-off method delays recognitionof bad debt until the specific customer accounts receivable isidentified. Once this account is identified as uncollectible, thecompany will record a reduction to the customer’s accountsreceivable and an increase to bad debt expense for the exact amountuncollectible. The bad debt expense required is recorded with the following aging of accounts receivable method journal entry. The allowance method is the more widely used method because it satisfies the matching principle. The allowance method estimates bad debt during a period, based on certain computational approaches.