BWW estimates that 5% of its overall credit sales will result in bad debt. 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 allowance for doubtful accounts, based on the percentage of sales, 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. As mentioned, some companies that have an insignificant amount of bad debt expense may use the direct write off method to deal with the uncollectable accounts instead.

• The income statement method (also known as the percentage of sales method) estimates bad debt expenses based on the assumption that at the end of the period, a certain percentage of sales during the period will not be collected.
• 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.
• This would split accounts receivable into three past- due categories and assign a percentage to each group.
• This view has been persuasive in the development of the generally accepted accounting principles (GAAP).
• Once a method is selected, it normally must continue to be used in all subsequent periods.
• You are considering switching to the balance sheet aging of receivables method.

The journal entry for the Bad Debt Expense increases (debit) the expense’s balance, and the Allowance for Doubtful Accounts increases (credit) the balance in the Allowance. The allowance for doubtful accounts is a contra asset account and is subtracted from Accounts Receivable to determine the Net Realizable Value of the Accounts Receivable account on the balance sheet. In the case of the allowance for doubtful accounts, it is a contra account that is used to reduce the Controlling account, Accounts Receivable.

Financial Accounting

It also should be noted that this entry is the only one made during the year to the Bad Debt Expense account. That is to say, if other factors can make one prediction better (such as total sales, general economic conditions, or geographic region), we should use them if they are easily included. If the control account was credited, its balance would not equal the sum of the subsidiary account balances.

• It helps the IRS verify the taxpayer’s identity when they file an electronic or paper tax return.
• If management anticipates that similar losses can be expected in 2015 and credit sales for 2015 amount to $300,000, bad debts expense would be estimated as $1,500 ($300,000 x 0.005).
• GAAP requires that businesses extending credit to customers use the allowance method, which means they estimate uncollectible accounts.

Under the income statement method, the $1,500 represents estimated bad debt expense and is recorded as noted below. With the direct write-off method, many accounting periods may come and go before an account is finally determined to be uncollectible and written off. This is different from the last journal entry, where bad debt
was estimated at $58,097. That journal entry assumed a zero balance
in Allowance for Doubtful Accounts from the prior period.

Which of these is most important for your financial advisor to have?

Assume further that the company’s past history and other relevant information indicate to officials that approximately 7 percent of all credit sales will prove to be uncollectible. An expense of $7,000 (7 percent of $100,000) is anticipated because only $93,000 in cash is expected from these receivables rather than the full $100,000. Uncollectible accounts expense is an estimate of the amount of receivables that will not be collected. Bad debt is a specific account that has been determined to be uncollectible.

What are the different types of uncollectible accounts expense?

For another example, assuming we use the direct write-off method to deal with the uncollectible accounts instead. In this case, assuming we decide to write off $5,000 of accounts receivable due to their long overdue and are deemed uncollectible. When a specific customer has been identified as an uncollectible
account, the following journal entry would occur. The first entry reverses the bad debt write-off by increasing
Accounts Receivable (debit) and decreasing Bad Debt Expense
(credit) for the amount recovered.

Review Questions

Uncollectable Accounts Expense is an amount written off as uncollectable. This approach allows the reader to calculate the proportion of the total group that is believed to be collectible or uncollectible. When an uncollectible account is actually written off, there is again no change in working capital. If all or part of a previously written off account is actually collected, several procedures are possible.

This is different from the last journal entry, where bad debt was estimated at $58,097. 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. Direct write-off is the accounting method that directly reduces the accounts receivable balance to bad debt expense on income statement. The company only make journal entry when a specific receivable is considered uncollectable due to a specific reason. The inherent uncertainty as to the amount of cash that will actually be received affects the physical recording process.

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Likewise, we usually need to make the journal entry for uncollectible accounts at the period-end adjusting entry in order to recognize and record the amount of bad debt expense that is estimated to occur during the accounting period. The balance sheet aging of receivables ecommerce accountant method
estimates bad debt expenses based on the balance in accounts
receivable, but it also considers the uncollectible time period for
each account. The longer the time passes with a receivable unpaid,
the lower the probability that it will get collected.