The balance sheet method is
another simple method for calculating bad debt, but it too does not
consider how long a debt has been outstanding and the role that
plays in debt recovery. Since bills lower stockholders fairness, and stockholders equity decreases with debits, uncollectible accounts expense was debited. The allowance for uncollectible accounts was credited as a result of the corporate’s (resources) decreased. Inasmuch as it usually has a credit stability, versus most belongings with debit balances, the allowance for uncollectible accounts is known as a contra asset account. The sales technique applies a flat share to the entire greenback amount of gross sales for the period.

As mentioned earlier in our article, the amount of receivables that is uncollectible is usually estimated. This is because it is hard, almost impossible, to estimate a specific value of bad debt expense. Sometimes people encounter hardships and are unable to meet their payment obligations, in which case they default. Therefore, there is no guaranteed way to find a specific value of bad debt expense, which is why we estimate it within reasonable parameters. On the income statement, Rankin would match the bad debt expense against sales revenues in the period. We would classify this expense as a selling expense since it is a normal consequence of selling on credit.

2 Accounting for Uncollectible Accounts

This increase, in turn, reduces the net realizable value shown on the balance sheet. 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. With the account reporting a credit balance of $50,000, the balance sheet will report a net amount of $9,950,000 for accounts receivable. This amount is referred to as the net realizable value of the accounts receivable – the amount that is likely to be turned into cash. The debit to bad debts expense would report credit losses of $50,000 on the company’s June income statement.

• The balance sheet aging of receivables method is more complicated than the other two methods, but it tends to produce more accurate results.
• Note that allowance for doubtful accounts reduces the
  overall accounts receivable account, not a specific accounts
  receivable assigned to a customer.
• Bad Debt Expense increases (debit) as does Allowance for
  Doubtful Accounts (credit) for $58,097.

The most prevalent approach — called the “percent of sales method” — uses a pre-determined percentage of total sales assumption to forecast the uncollectible credit sales. The Allowance for Doubtful Accounts is a contra-asset account that estimates the future losses incurred from uncollectible accounts receivable (A/R). Let’s consider a situation where BWW had a $20,000 debit integrate with xero balance
from the previous period. 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.

The entry will contain the working expense account Bad Debts Expense and the contra-asset account Allowance for Doubtful Accounts. Later, when a selected account receivable is definitely written off as uncollectible, the corporate debits Allowance for Doubtful Accounts and credit Accounts Receivable. The percentage of credit score sales approach focuses on the income assertion and the matching principle. Sales revenues of $500,000 are instantly matched with $1,500 of unhealthy money owed expense.

The allowance for doubtful accounts also helps companies more accurately estimate the actual value of their account receivables. 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. You currently use the income statement method to
estimate bad debt at 4.5% of credit sales. You are considering
switching to the balance sheet aging of receivables method.

When customers buy products on credit and then don’t pay their bills, the selling company must write-off the unpaid bill as uncollectible. Allowance for uncollectible accounts is also referred to as allowance for doubtful accounts, and may be expensed as bad debt expense or uncollectible accounts expense. With this method, accounts receivable is organized into categories by length of time outstanding, and an uncollectible percentage is assigned to each category. For example, a category might consist of accounts receivable that is 0–30 days past due and is assigned an uncollectible percentage of 6%. Another category might be 31–60 days past due and is assigned an uncollectible percentage of 15%.

Why does the percentage of net sales method produce a larger amount for bad debt expense than the aging method?

If you use the accrual basis of accounting, you will record doubtful accounts in the same accounting period as the original credit sale. This will help present a more realistic picture of the accounts receivable amounts you expect to collect versus what goes under the allowance for doubtful accounts. The bad debt expense is entered as a debit to increase the expense, whereas the allowance for doubtful accounts is a credit to increase the contra-asset balance. The allowance for doubtful accounts (or the “bad debt” reserve) appears on the balance sheet to anticipate credit sales where the customer cannot fulfill their payment obligations. At the end of an accounting period, the Allowance for Doubtful
Accounts reduces the Accounts Receivable to produce Net Accounts
Receivable. Note that allowance for doubtful accounts reduces the
overall accounts receivable account, not a specific accounts
receivable assigned to a customer.

This provides information which can be used to determine whether any further collection efforts are justified or not. The aging method also makes it easier for management to make changes in credit policies and discounts offered to customers. The method used to estimate the desired balance in the allowance account is called the aging of accounts receivable. The sum of the estimated amounts for all categories yields the total estimated amount uncollectible and is the desired credit balance (the target) in the Allowance for Uncollectible Accounts. The allowance for doubtful accounts is not always a debit or credit account, as it can be both depending on the transactions. When a doubtful account becomes uncollectible, it is a debit balance in the allowance for doubtful accounts.

Balance Sheet Method for Calculating Bad Debt Expenses

However, if the company adopts a more stringent credit policy, it may have to decrease the percentage rate because the company would expect fewer uncollectible accounts. 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. From this information, anyone studying these financial statements for Year One should understand that an expense estimated at $7,000 was incurred this year because the company made sales that will never be collected. In addition, year-end accounts receivable total $100,000 but have an anticipated net realizable value of only $93,000.

Comparison of Percentage of Net Sales Method and Aging Method

And if there are no additions or write-offs, the balance in the account is zero. At the end of 2019, the balance in Accounts Receivable was $200,000, and an aging schedule of the accounts is presented below. Accounts uncollectible are receivables, loans, or other debts that have virtually no chance of being paid. An account may become uncollectible for many reasons, including the debtor’s bankruptcy, an inability to find the debtor, fraud on the part of the debtor, or lack of proper documentation to prove that debt exists. Remember that writing off an account does not necessarily mean giving up on receiving payment.

Using the allowance method, complying with the matching principle, the amount is recorded in the current accounting period with the following percentage of credit sales method journal. Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance for doubtful accounts and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned.

The specific identification method allows a company to pick specific customers that it expects not to pay. In this case, our jewelry store would use its judgment to assess which accounts might go uncollected. While collecting all the money you’re owed is the best-case scenario, small business owners know that things don’t always go as planned.

All categories of estimated uncollectible amounts are summed to get a total estimated uncollectible balance. That total is reported in Bad Debt Expense and Allowance for Doubtful Accounts, if there is no carryover balance from a prior period. If there is a carryover balance, that must be considered before recording Bad Debt Expense. 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 method (also known as the percentage of accounts receivable method) estimates bad debt expenses based on the balance in accounts receivable.

Credit sales all come with some degree of risk that the customer might not hold up their end of the transaction (i.e. when cash payments left unmet). The outstanding balance of $2,000 that Craft did not repay will
remain as bad debt. You could just post the credit to allowance for doubtful accounts, but the proper way to handle this is to re-establish the receivable by reversing the write-off (partially) and then recording the payment against the account. The outstanding balance of $2,000 that Craft did not repay will remain as bad debt. For the taxpayer, this means that if a company sells an item on credit in October 2018 and determines that it is uncollectible in June 2019, it must show the effects of the bad debt when it files its 2019 tax return. This application probably violates the matching principle, but if the IRS did not have this policy, there would typically be a significant amount of manipulation on company tax returns.