That journal entry assumed a zero balance in Allowance for Doubtful Accounts from the prior period. 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. BWW estimates 15% of its overall accounts receivable will result in bad debt. 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.

On the other hand, the allowance method accrues an estimate that gets continually revised. The allowance for doubtful accounts, based on the percentage of sales, uncollectible accounts expense should be a credit balance of $20,760. Right now, it has a debit balance of $500 because last year we booked $7,500 but the actual write off was $8,000.

Where Is Bad Debt Expense Reported?

Notice, other than the amount and description, this is the same entry we made under the percentage of sales method. The outstanding balance of $2,000 that Craft did not repay will
remain as bad debt. Some companies may classify different types of debt or different types of vendors using risk classifications. For example, a start-up customer may be considered a high risk, while an established, long-tenured customer may be a low risk.

The allowance method is the more widely used method because it
satisfies the matching principle. The allowance
methodestimates bad debt during a period, based on
certain computational approaches. When the estimation is
recorded at the end of a period, the following entry occurs.

Accounting Business and Society

That journal entry assumed a zero balance
in Allowance for Doubtful Accounts from the prior period. 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. BWW estimates 15% of its
overall accounts receivable will result in bad debt. This is different from the last journal entry, where bad debt was estimated at $58,097.

• They rely on the accrual approach, which calls for recognizing revenue when the seller performs.
• That total is reported in Bad Debt Expense and Allowance for Doubtful Accounts, if there is no carryover balance from a prior period.
• So, an allowance for doubtful accounts is established based on an anticipated, estimated figure.
• The estimation is
  typically based on credit sales only, not total sales (which
  include cash sales).
• This increase, in turn, reduces the net realizable value shown on the balance sheet.

As accountants, we help management collect and analyze the information it needs to make these credit decisions, but we also have to account for the bad accounts we won’t collect. We booked the revenue and the receivable, and now the receivable is no good. This is because both the asset account and the contra-asset account are decreasing by the same amount, thereby offsetting one another. But, when compared to industry trends and prior years, they will reveal important signals about how well receivables are being managed.

Overview of Uncollectible Accounts Expense

You are considering
switching to the balance sheet aging of receivables method. This
would split accounts receivable into three past- due categories and
assign a percentage https://accounting-services.net/retail-method-of-inventory-costing/ to each group. 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.

• In effect, we act as if each age group is a different population of receivables with a unique percentage of uncollectible amounts.
• Accounting expediency sometimes permits “incorrect approaches” when the effect is not material.
• This entry assumes a zero balance in Allowance for Doubtful Accounts from the prior period.
• Also, note that when writing off the specific account, no income statement accounts are used.
• It may be obvious intuitively, but, by definition, a
  cash sale cannot become a bad debt, assuming that the cash payment
  did not entail counterfeit currency.

The second entry records the payment in full with Cash increasing (debit) and Accounts Receivable decreasing (credit) for the amount received of $15,000. Accounts uncollectible can provide a significant amount of insight into a company’s lending practices and its customers. For example, if a company notices that its accounts uncollectible are either remaining steady or increasing, it is extending credit to risky customers and therefore should improve its vetting measures.