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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 Objectives1. 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.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

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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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The allowance method is the method of charging uncollectible accounts expense in the period when the sales are recorded.

ANSWER:

QUESTION:

What is the allowance method?

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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).

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

• It is also the method used for tax purposes as the Allowance Method is not allowed.

ANSWER:

QUESTION:

What is the direct charge-off method?

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

Objective 1

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20-- 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.

Carol’s Curtains

Balance Sheet (partial)

December 31, 2010

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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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Percentage of Net Credit Sales

Multiply net credit sales by a percentage.

Percentage is based on the company’s previous experience.

New businesses base the percentage on the experience of businesses in the same industry.

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2010

Dec. 31 Uncollectible Accounts Expense 2,500.00

Allowance for Doubtful Accounts 2,500.00

To record estimated uncollectible

accounts based on 0.5 percent

of net credit sales of $500,000

Net Credit Sales $500,000.00

Percent estimated to be uncollectible x 0.5%

Total amount to write off $ 2,500.00

Percentage of Net Credit Sales

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Percentage of Total Accounts Receivable

Multiply the total amount of accounts receivable by a single percentage.

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Average accounts written offAverage accounts receivable

$ 2,156 $43,453

0.04962 5%

12/31/07 Accounts Receivable Balance = $49,000

Accounts Uncollectible Date Receivable Accounts12/31/04 $ 39,600.00 $ 2,083.0012/31/05 44,360.00 2,145.0012/31/06 46,400.00 2,240.00Total $130,360.00 $ 6,468.00

Average $ 43,453.00 $ 2,156.00

Est. Uncollectible Accounts = $49,000 X 0.05 = $2,450

Percentage of Total Accounts Receivable

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Allowance for Doubtful Accounts is adjusted so that its ending balance is a $2,450 credit.(Assume the beginning balance on the Allowance account is $118 credit.)

QUESTION:

What is the amount of the adjustment?

ANSWER:

Total estimated expense + or – beginning balance

$2,450 Credit

- 118 Credit

$2,332 Credit

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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.

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Customer Balance Current 1 - 30 31 - 60 Over 60

Andrews, N. 820.00 820.00

Arrington, S. 1200.00 1200.00

Barton, S. 257.00 37.00

Zant, R. 400.00 320.00 80.00

Totals 49,000.00 38,000.00 7,000.00 1600.00 2400.00

Past Due - Days

CAROL’S CURTAINS

Schedule of Accounts Receivable by Age

December 31, 2010

Aging the Accounts Receivable

200.00 20.00

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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 $118 credit.

QUESTION:

What is the amount of the adjustment?

ANSWER:

Total estimated expense + or – beginning balance

$2,370 Credit

- 118 Credit

$2,252.00 Credit

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Charge-off uncollectible accounts using the allowance method

Objective 2

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Uncollectible Accounts Expense

XX

Allowance for Doubtful Accounts

XX

Recall that under the allowance method, an estimate of uncollectible accounts expense was already recorded.

No specific accounts were identified as uncollectible.

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Recording an Actual Uncollectible Account

Which account is debited?

For what amount?

Which account is credited?

For what amount?

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Allowance for Doubtful Accounts

224

Accounts Receivable

224

Recording an Actual Uncollectible Account

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James McDonald’s individual account in the accounts receivable subsidiary ledger is written off.

Accounts Receivable Subsidiary Ledger

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What effect does the write off of a specific account have on the financial statements?

QUESTION:

The write off has no effect on the financial statements because the expense was recorded previously.

ANSWER:

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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:

Collecting an account that was previously written off under the allowance method

Objective 3

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To reinstate an account receivable means to put back or restore an amount that was previously written off.

ANSWER:

QUESTION:

What does it mean to reinstate an account receivable?

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20--Feb. 9 Accounts Receivable/R. Stream 160.00

Allowance for Doubtful Accounts 160.00 To reinstate the account

receivable for Richard Stream that was written off and then collected in full

9 Cash 160.00 Accounts Receivable/R. Stream 160.00 To record the receipt of cash Richard Stream on account

Reinstating an Account Written Off Using the Allowance Method

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 Objectives4. 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.

McGraw-Hill © 2009 The McGraw-Hill Companies, Inc. All rights reserved.

15-32

2010 Debit CreditJuly 5 Uncollectible Accounts Expense 400.00

Accounts Receivable/Mike May 400.00 (To write-off Mike Mays account

because customer cannot be located.)

This method records Uncollectible Accounts Expense at the time that a specific customer’s account is deemed uncollectible.

Using the Direct Charge-off Method.

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

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

Objective 5

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Reinstating an Account Written Off Using the Direct Charge-Off Method

2010Oct.19 Accounts Receivable/Mike Mays 400.00

Uncollectible Accounts Expense 400.00 (To reinstate the account

receivable for Mike May that was written off and then collected in full)

19 Cash 400.00 Accounts Receivable/Mike Mays 400.00 (To record receipt of cash

payment from Mike May on account)

(Payment was received in the same period as the write-off. . .)

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Reinstating an Account Written Off Using the Direct Charge-Off Method

2011Jan. 9 Accounts Receivable/Mike Mays 400.00

Uncollectible Accounts Recovered 400.00 (To reinstate the account

receivable for Mike May that was written off in the previous year and paid in full this day.)

9 Cash 400.00 Accounts Receivable/Mike Mays 400.00 (To record receipt of cash payment from Mike May on account)

(Payment was received in a period subsequent to that in which account was written off. . .)

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Accounting for Other Receivables and Bad Debt Losses

• 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.

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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 6 Recognize 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.

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Thank Youfor using

College Accounting, 12th Edition

Price • Haddock • Farina