BAD DEBTS

Chapter 8p. 407-411

• Bad Debts = a term used to describe amounts that cannot be collected

• The reporting of bad debts is governed by the matching principle

• Expenses from bad debts need to be reported in the same acctg period as the revenues they helped “produce”

The Allowance Method of Accounting for Bad Debts

1) Estimate the total bad debts expected from a period’s sales

2) An allowance is provided for the loss

Advantages

1) Matching principle – expense charged to period of revenue

2) Accounts Receivable are reported on balance sheet at estimated amount of cash to be collected

Example

Sales = $300,000Uncollected from customers = $20,000

Company estimates that $1500 of accounts receivable will be uncollectible

Recording the Estimated Bad Debts Expense

DR Bad Debts ExpenseCR Allowance for Doubtful Accounts

To record the estimated bad debts

This entry will cause the expense to appear on the income statement in the year the sales were made

The reasons why “Allowance for Doubtful Accounts” is credited…

• The account “Allowance for Doubtful Accounts” is a contra account.

A contra account MUST be used because you do not know which customers will not pay at the time of the adjusting entry.

Because it is not possible to identify which customers did not pay, the amounts cannot be removed from the Accounts Receivable Ledger

Bad Debts in the Accounts and in the Financial Statements

The Account called “Allowance for Doubtful Accounts” has the effect of reducing the Accounts Receivable account to something called “REALIZABLE VALUE”

SEE PAGE 409 for how this information is reported in the Balance Sheet

Writing off Bad Debt

DR Bad Debts ExpenseCR Allowance for Doubtful Accounts

This journal entry to write off bad debt does not affect total assets or net income

Bad Debt Recovery

Two journal entries:1) DR Accts Rec. – name of customer CR Allowance for Doubtful Accounts

To reinstate account of customer written off on <date>

• 2)DR CashCr Accounts Receivable – name of customer

Received full payment of <name of customer>

To Do

• Progress Check 8-7 to 8-9• QS 8-4 to 8-5• Exercise 8-5 to 8-7• Problem 8-2 to 8-3