We’ll walk you through how to write off uncollectible accounts receivable below. When a specific customer has been identified as an uncollectibleaccount, the following journal entry would occur. However, if estimates such as uncollectible accounts are consistently incorrect, management should reevaluate the method used to make the estimate. If more accounts are written off than previously estimated, the Allowance account will have a temporary debit balance prior to the year-end adjustment. The adjustment will then increase this balance to reflect management’s new estimate of the uncollectible accounts. In order to understand the required journal entries used with the allowance method, assume that during 2019, Delta Corporation’s first year in business, sales totaled $1 million.
The balance sheet aging of receivables method is more complicated than the other two methods, but it tends to produce more accurate results. The balance sheet aging of receivables 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. An account that is 90 days overdue is more likely to be unpaid than an account that is 30 days past due. To compensate for this problem, accountants have developed “allowance methods” to account for uncollectible accounts.
There is no allowance, and only one entry needs to be posted for the entry receivable to be written off. The major problem with the direct write-off is the unpredictability of when the expense may occur. Consider a company that has a single turbotax review for 2021 customer that has a material amount of pending accounts receivable. Under the direct write-off method, 100% of the expense would be recognized not only during a period that can’t be predicted but also not during the period of the sale.
Management may disclose its method of estimating the allowance for doubtful accounts in its notes to the financial statements. 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.
Ways of dealing with uncollectible accounts receivables include sending reminders and dunning letters, negotiating payment plans and discounts with customers, and writing off bad debts as an expense. It will be reported in two separate assets, current assets and non-current assets. This happens because it could eventually become a liability if there were to be a default or it may mature into cash after time passes. The other impact is that they will impact the income statement during the period that they are not collected. The company will have to make a policy decision on whether or not to report an interest expense related to the accounts receivable.
The balance sheet method isanother simple method for calculating bad debt, but it too does notconsider how long a debt has been outstanding and the role thatplays in debt recovery. In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time. In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses.
To illustrate, assume that a company makes sales on account to one hundred different customers late in Year One for $1,000 each. The earning process is substantially complete at the time of sale and the amount of cash to be received can be reasonably estimated. According to the revenue realization principle found within accrual accounting, the company should immediately recognize the $100,000 revenue generated by these transactions2. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’.
The aggregate of all group results is the estimated uncollectible amount. As of January 1, 2018, GAAP requires a change in how health-care entities record bad debt expense. Before this change, these entities would record revenues for billed services, even if they did not expect to collect any payment from the patient. This uncollectible amount would then be reported in Bad Debt Expense. This method aligns better with the matching principle since businesses estimate bad debts in the same accounting period as the sales occur.
When the estimation isrecorded at the end of a period, the following entry occurs. It’s eventually determined that Fancy Foot Store had creditors in line that received all assets as priority lenders, therefore, Barry and Sons Boot Makers will not be receiving the $1 million. The entire amount is written off as bad debt expense on the income statement and the allowance for doubtful accounts is also reduced by $1 million. Using the direct write-off method, uncollectible accounts are written off directly to expense as they become uncollectible. On the other hand, the allowance method accrues an estimate that gets continually revised.
