15-11-1McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Accounts Receivable and Uncollectible Accounts

Accounts Receivable and Uncollectible Accounts Section 1: The Allowance Method Of

Accounting For Uncollectible Accounts

Chapter

15

Section Objectives

1. Record the estimated expense from uncollectible accounts receivable using the allowance method.

2. Charge off uncollectible accounts using the allowance method.3. Record the collection of accounts previously written off using the allowance method.

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Methods used for writing off accounts that are determined to be uncollectible include the:

Allowance Method

Direct Charge-Off Method

Losses from uncollectible accounts are a normal cost of doing business.

Bad Debts

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Allowance Method

Estimates losses from uncollectible accounts.

Matches uncollectible accounts expense to sales.

Uses a valuation account (Allowance for Doubtful Accounts), a contra asset account which reduces the amount of accounts receivable shown on the balance sheet to its “net realizable value.”

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• The direct charge-off method is the method of recording uncollectible account losses as they occur.

• It is also the method used for tax purposes as the Allowance Method is not allowed since it would result in an estimated expense on the tax return.

ANSWER:

QUESTION:

What is the direct charge-off method?

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2012 Debit Credit

Dec 31 Uncollectible Accounts Expense 1900.00

Allowance for Doubtful Accounts 1900.00

To record estimate of bad debts expected

Recording the adjusting entry to record Uncollectible Accounts Expense is based on an estimate of bad debts for the period

Using the Allowance Method

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Allowance for Doubtful Accounts

Is a Contra-asset account

Is reported as a subtraction from the Accounts Receivable account on the Balance Sheet

Contains the estimate of accounts receivable deemed uncollectible

Uncollectible Accounts Expense

Is reported on the Income Statement as an expense account

Allowance Method of recording bad debts uses two new accounts:

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Current Assets:Cash $ 9,320

Accounts Receivable $46,400

Less Allowance for Doubtful Accounts 1,900 $44,500

•On the Balance Sheet the balance in the Allowance account is subtracted from the balance in Accounts Receivable

•$44,500 is the amount actually expected to be collected from customers

Kathy’s Kitchens

Balance Sheet (partial)

December 31, 2012

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Percentage of net credit sales

Aging the accounts receivable

Percentage of total accounts receivable

There are three ways to estimate uncollectible accounts expense:

When using the Allowance Method

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Third method of estimating your expected uncollectible accounts is by Aging the

Accounts Receivable

Classify accounts receivable according to how long they have been outstanding

The longer an account is past due, the less likely it is to be collected

Aging the Accounts Receivable

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Aging the Accounts Receivable

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Over 60 days past due 0.60 X 2,400.00 $ 1,440.00

Total estimated loss from doubtful accounts $ 2,370.00

Aging the Accounts Receivable

31–60 days past due 0.20 X 1,600.00 320.00

1–30 days past due 0.06 X 7,000.00 420.00

Current 0.005 X 38,000.00 190.00

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Allowance for Doubtful Accounts is adjusted so that its ending balance is a $2,370 credit balance.Assume the beginning balance in the Allowance account is $108 credit.

QUESTION:

What is the amount of the adjustment?

ANSWER:

Total estimated expense + or – beginning balance

$2,370 Credit

- 108 Credit

$2,262.00 Credit

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Income Statement

Balance Sheet

No effect on net income

Assets

Contra assets

No effect on net equity

Writing Off a Specific Account

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1. Reinstate the account receivable.

2. Record the collection of cash.

Occasionally an account that was written off is later collected

Two entries are necessary:

Record the collection of accounts previously written off under the allowance method

Objective 3

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Accounts Receivable and Uncollectible Accounts

Accounts Receivable and Uncollectible Accounts

Section 2: Applying the Direct Charge-off Method and Internal Control of Accounts Receivable.

Chapter

15

Section Objectives

4. Record losses from uncollectible accounts using the direct charge-off method.

5. Record the collection of accounts previously written off using the direct charge-off method.

6. Recognize common internal controls for accounts receivable.

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Direct Charge-Off Method

Does not match revenue and expenses (Matching Principle).

Can overstate accounts receivable on the balance sheet.

The only method allowed for income tax purposes.

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• Any company that extends credit is likely to have some type of uncollectible receivable.

• As with accounts receivable, notes receivable and other receivables can prove uncollectible.

• Losses from uncollectible notes receivable and other receivables can be handled by the direct charge-off method or the allowance method.

Accounting for Other Receivables and Bad Debt Losses

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Authorization of all credit sales.

Procedures to properly record sales.

Separation of duties.

Invoices and monthly statements.

Internal Control of Accounts Receivable

Objective 6Recognize common internal controls for accounts receivable

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Authorize charge-off of accounts.

Aging of accounts receivable.

Internal Control of Accounts Receivable

Investigation of past due accounts.

Written approval of all write-offs.

Continued efforts to collect written-off accounts.