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. The journal entry for allowance for doubtful accounts involves debiting the bad debt expense account and crediting the allowance for doubtful accounts account. This can be done using different methods, such as the percentage of sales method or the aging of accounts receivable method. Once the estimated amount for the allowance account is determined, a journal entry will be needed to bring the ledger into agreement. Assume that Ito’s ledger revealed an Allowance for Uncollectible Accounts credit balance of $10,000 (prior to performing the above analysis). The projected bad debt expense is matched to the same period as the sale itself so that a more accurate portrayal of revenue and expenses is recorded on financial statements.
With a balance sheet approach the ending balance on the allowance account is calculated, and the bad debt expense is the balancing figure. Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account. By following these steps, companies can maintain accurate financial statements and account for the possibility of bad debts.
At this point, the company believes that receiving all or part of the outstanding amount is doubtful, and will, therefore, debit the bad debt amount and credit allowance for doubtful accounts. The specific identity and the actual amount of these bad accounts will probably not be known for several months. No physical evidence exists at the time of sale to indicate which will become worthless (buyers rarely make a purchase and then immediately declare bankruptcy or leave town). For convenience, accountants wait until financial statements are to be produced before making their estimation of net realizable value. The bad debt expense is entered as a debit to increase the expense, whereas the allowance for doubtful accounts is a credit to increase the contra-asset balance.
In March, ABC determines that another customer who owes $1,000 is unlikely to pay. ABC writes off the account by debiting the allowance for doubtful accounts account and crediting the accounts receivable account for $1,000. In February, ABC determines that a customer who owes $500 is unlikely to pay. ABC writes off the account by debiting the allowance for doubtful accounts account and crediting the accounts receivable account for $500.
Balance Sheet Aging of Receivables Method for Calculating Bad Debt Expenses
The allowance for doubtful accounts is then used to approximate the percentage of “uncollectible” accounts receivable (A/R). The outstanding balance of $2,000 that Craft did not repay will remain as bad debt. For the taxpayer, this means that if a company sells an item on credit in October 2018 and determines that it is uncollectible in June 2019, it must show the effects of the bad debt when it files its 2019 tax return. This application probably violates the matching principle, but if the IRS did not have this policy, there would typically be a significant amount of manipulation on company tax returns. For example, if the company wanted the deduction for the write-off in 2018, it might claim that it was actually uncollectible in 2018, instead of in 2019. You could just post the credit to allowance for doubtful accounts, but the proper way to handle this is to re-establish the receivable by reversing the write-off (partially) and then recording the payment against the account.
- In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses.
- In this article, we will explain the basics of telecom billing, the methods of estimating bad debts, and the journal entries for recording and writing off uncollectible accounts.
- Let’s consider a situation where BWW had a $20,000 debit balance
from the previous period.
Yes, allowance accounts that offset gross receivables are reported under the current asset section of the balance sheet. This type of account is a contra asset accelerated development program that reduces the amount of the gross accounts receivable account. The second method of estimating the allowance for doubtful accounts is the aging method.
Writing off uncollectible accounts
A company uses this account to record how many accounts receivable it thinks will be lost. The company can recover the account by reversing the entry above to reinstate the accounts receivable balance and the corresponding allowance for the doubtful account balance. Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the “Adjusting the Allowance” section above. An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable.
Example of Writing off an Account
However, the company is owed $90,000 and will still try to collect the entire $90,000 and not just the $85,200. Notice, other than the amount and description, this is the same entry we made under the percentage of sales method. As a result, the estimated allowance for doubtful accounts for the high-risk group is $25,000 ($500,000 x 5%), while it’s $15,000 ($1,500,000 x 1%) for the low-risk group. Thus, the total allowance for doubtful accounts is $40,000 ($25,000 + $15,000). For example, a jewelry store earns $100,000 in net sales, but they estimate that 4% of the invoices will be uncollectible. Further details of the use of this allowance method can be found in our aged accounts receivable tutorial.
Is Allowance for Doubtful Accounts a Credit or Debit?
This entry reduces the accounts receivable balance by $1,000 and reduces the allowance for doubtful accounts balance by $1,000. For example, if accounts receivable that are days past due historically have a bad debt rate of 5%, the company may estimate that 5% of the current day past due accounts will also be uncollectible. This involves reviewing the accounts receivable balance and assessing the likelihood of customers not paying their bills.
Therefore, the direct
write-off method is not used for publicly traded company reporting;
the allowance method is used instead. The first entry reverses the bad debt write-off by increasing
Accounts Receivable (debit) and decreasing Bad Debt Expense
(credit) for the amount recovered. The second entry records the
payment in full with Cash increasing (debit) and Accounts
Receivable decreasing (credit) for the amount received of
$15,000. Let’s look at what is reported on Coca-Cola’s Form 10-K regarding its accounts receivable.
The company must record an additional expense for this amount to also increase the allowance’s credit balance. Assume a company has 100 clients and believes there are 11 accounts that may go uncollected. Instead of applying percentages or weights, it may simply aggregate the account balance for all 11 customers and use that figure as the allowance amount. Companies often have a specific method of identifying the companies that it wants to include and the companies it wants to exclude. At the end of February, ABC reviews the allowance for doubtful accounts and determines that the estimate of uncollectible accounts was accurate. To create the allowance, the company debits the allowance for doubtful accounts account and credits the bad debt expense account.
If there is a carryover balance, that must be considered before recording Bad Debt Expense. The balance sheet aging of receivables method is more complicated than the other two methods, but it tends to produce more accurate results. This entry decreases net income by $2,000 and creates a contra asset account for the allowance for doubtful accounts, which is used to reduce the accounts receivable balance.
Journal Entry for Write Off Uncollectible Accounts
Rather than waiting to see exactly how payments work out, the company will debit a bad debt expense and credit allowance for doubtful accounts. The bad debt expense for the accounting period is recorded with the following percentage of accounts receivable method journal entry. The allowance for doubtful accounts is a general ledger account that is used to estimate the amount of accounts receivable that will not be collected.
Notice that bad debt expense in this case is simply the other half of the entry to get the balance sheet account adjusted. The focus in this case is on the net realizable value of the receivables, and the income statement (bad debt expense) is relegated to second place. Ideally, you’d want 100% of your invoices paid, but unfortunately, it doesn’t always work out that way. Assuming some of your customer credit balances will go unpaid, how do you determine what is a reasonable allowance for doubtful accounts? The bad debt expense is then the difference between the calculated allowance for doubtful accounts at the end of the account period and the current allowance for doubtful accounts before adjustment. You record the allowance for doubtful accounts by debiting the Bad Debt Expense account and crediting the Allowance for Doubtful Accounts account.
The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400. 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. Percentage-of-receivables method The percentage-of-receivables method estimates uncollectible accounts by determining the desired size of the Allowance for Uncollectible Accounts. Rankin would multiply the ending balance in Accounts Receivable by a rate (or rates) based on its uncollectible accounts experience. In the percentage-of-receivables method, the company may use either an overall rate or a different rate for each age category of receivables.