Accounting for Bad DebtsAccounting for Bad Debts

Allowance MethodAccounts Receivable

Approach

Accounts Receivable ReviewAccounts Receivable Review

Current Asset

Due 30 – 45 DaysInformal Credit

Balance Sheet Account

Inc with a DrNormal Dr Balance

Allowance for Doubtful AccountsAllowance for Doubtful Accounts

Inc with a Cr

Normal Cr Balance

Contra Asset

Estimated Uncollectible Amount

Balance Sheet Account

Balance Sheet PresentationBalance Sheet Presentation

ABC CorporationBalance Sheet

12/31/X0

Current Assets

Accounts Receivable

Net Realizable Value

Allowance for Doubtful Accounts

$500,000

(30,000)

$470,000

Why Use the Allowance Method?Why Use the Allowance Method?

Required by GAAP

Complies with matching principle

Match bad debt expense to the period of revenue

WHY?

WHAT IS THAT?

THAT’S RIGHT!

Estimate Uncollectible AmountEstimate Uncollectible Amount

Management estimates the uncollectible amount

Use past experience adjustedfor expected changes

Estimate Uncollectible AmountEstimate Uncollectible Amount

Actual uncollectible accounts are not known on the last day of the accountingperiod

Why must an estimate be used?

ExampleExample

During X1During X1

Sales on account - $800,000

800,000

800,000

During X1During X1

Collections on account - $700,000

700,000

700,000

During X1During X1

Accounts written off - $25,000

25,000

25,000

12/31/X1 Balances12/31/X1 Balances

Before Adjusting Entry for Bad Debts

12/31/X1 balance575,000

X1 sales on account

X1 write offs

X1 collections

12/31/X1 Balances12/31/X1 Balances

Before Adjusting Entry for Bad Debts

X1 write offs

12/31/X1 balance 5,000

This account has a $5,000 credit balancebefore the adjustment for bad debts.

SummarySummary

• Before the adjustment for bad debts–Accounts Receivable has a debit balance of

$575,000–Allowance for Doubtful Accounts has a

credit balance of $5,000

Bad Debt AdjustmentBad Debt Adjustment

Accounts Receivable Approach 2 Step Process

Step 1Step 1

Allowance for Doubtful Accounts

Determine the ending balance

Based on management’s estimate

Step 1Step 1

12/31/X1 Accounts Receivable Balance $575,000

Management estimates 3% of AccountsReceivable will not be collected

$575,000 X .03 = $17,250

This is the 12/31/X1 ending balance of Allowance for Doubtful Accounts (desired ending balance)

Step 2Step 2

Compare the desired ending balance of Allowance for Doubtful Accounts

$17,250

to

Its balance before adjustment

$5,000 cr balance

ResultResult

The difference is the amount of the adjusting entry

Record the entry on the last day of the accounting period

Balance After AdjustmentBalance After Adjustment

AdjustingEntry

X1 Write offs

Balance Sheet PresentationBalance Sheet Presentation

ABC CorporationBalance Sheet

12/31/X1

Current Assets

Accounts Receivable

Net Realizable Value

Allowance for Doubtful Accounts

$575,000

(17,250)

$557,750

575,000 X .97 = 557,750