9.3 Apply the Allowance Method for Uncollectibles and Estimate Bad Debt Expense based on the percent of sales, percent of receivables and aging of receivables methods PDF

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Professor Lisa Drake...

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9.3 Apply the Allowance Method for Uncollectibles and Estimate Bad Debt Expense Based on the Percent of Sales, Percent of Receivables and Aging of Receivables Methods • Allowance Method: a method of accting for uncollectible receivables in which the co estimates bad debts expense instead of waiting to see which customers the co will not collect from ! • based on the matching principle therefore, accepted by GAAP! • When you sell on credit and then go to write off the bad debt later, what often happens is that the sale is in one period and the expense for the uncollectible account expense is in another period.#The allowance method is based on the matching principle, so that the uncollectible accounts expense is recorded in the same period as the sales revenue.#! Allowance for Bad Debts: a contra asset acct, related to accounts receivables; the business • doesn't wait to see which accounts will become uncollectible, they estimate a bad debt expense based on past experience.#! Recording Bad Debt Expense—Allowance Method:! • • i.e.) Assume as of Dec 31 Company estimates $80 of its $4400 acts receivable are uncollectible! Journal entry: ! Dec 31 Bad Debts Expense 80! $ $ Allowance for Bad Debts 80! Recorded bad debts expense for the period Company Name! • Partial Balance Sheet! Date! Current Assets:! $ Accts Receivable $ xxx! $ Less: Allowance for Bad Debts (xxx) $ xxx (Net Realizable Value: sum of Accts recallow for bad debts exp)! • Net Realizable Value: The net value a company expects to collect from its accounts receivable ! Writing off uncollectible Accts—Allowance Method:! • • i.e.) Jan 10 company determines that it cannot collect a total of $25 from customer Shawn Clark! Journal entry:! Jan 10 Allowance for Bad Debts 25! $ $ Accts Receivable—Clark 25! $ Wrote off an uncollectible account • Recover of Accounts Previously Written off—Allowance Method:! • i.e.) March 4, company unexpectedly receives $25 from Clark! Journal entry: compound ! Mar 4 Accts Receivable—Clark 25! $ Allowance for Bad Debts 25! Reinstated previously written off account

Mar 4 Cash 25! $ $ Accounts Receivable 25! Collected cash on account Estimating and Recording Bad Debts Expense—Allowance Method:! • 1. Percent-of-Sales Method: (Bad Debts Expense = Net Credit Sales X %)a method of estimating uncollectible receivables that calculates bad debts expense based on a percentage of net credit sales ! • Income statement approach because it focus is the expense; we use net credit sales (item from income statement) in order to estimate bad debts expense; try to estimate based on past history of percent of net credit sales that were uncollectible! i.e.: based on past experience, company’s bad debt expense is approx 0.5% of net • credit sales which was $60,000 for the year! Bad Debts Expense = $60,000 X 0.005! Bad Debts Expense = $300!

Journal Entry:! Dec 31 Bad Debts Expense 300! $ Allowance for Bad Debts 300 ! Recorded bad debts expense for the period *WHEN USING ALLOWANCE METHOD, THE ONLY TIME BAD DEBTS EXPENSE IS RECORDED IS AS AN ADJUSTING ENTRY* 2. Percent-of-Receivables Method: a method of estimating uncollectible receivables by determining the balance of the Allowance for Bad Debts account bases on a % of accounts receivable • Balance sheet approach because the estimate comes from the balance sheet—the % of accounts receivable we don’t think were gonna collect on! • Estimate based on past history of % of accounts receivable that was uncollectible ! • Calculating bade debts expense using percent-of-receivables method is a 2 step process! • Step 1: Determine target balance in allowance for bad debts acct (Ending accts receivable balance X % we don’t think were going to collect based on past history = target Balance)! • Step 2: Determining bad debts expense: ! i.e.) Allowance for bad debts! | $200 unadj. Balance! | $700 bad debts expense ($900-$200 = $700)! | $900 target balance (determined in step 1)! *The allowance for bad debts account would have a debit balance if the business wrote off more accounts than expected during the year*!

3. Aging-of-Receivables Method: a method of estimating uncollectible receivables by determining the balance of the allowance for bad debts account based on the age of individual accounts receivable! • a balance sheet approach because it focuses on how old some items in the actual balance sheet are; we’re taking a % of a balance sheet item—accts receivable ! • estimate based on past history! • group individual receivables according to how long they receivable has been outstanding ! • Accounts Receivable Aging Schedule:!

• 3 customers w/ outstanding balance between 1-30 days, company estimates that only 1% ($42) of the total of those 3 accounts ($4,245) will be uncollectible ! • 2 customers w/ outstanding balance between 31-60 days; company estimates that 2% ($17) of the total of these 2 accounts ($830) will be uncollectible! 1 • customer w/ outstanding balance between 61-90 days; company estimates that 3% ($36) of total of the account ($1,200) will be uncollectible ! • 1 customer with balance over 90 days; company estimates that 90% ($90) of the total of the account ($100) will be uncollectible ! • Add all uncollectible accounts ($42+$17+$36+$90) = $185 (target balance for allowance for bad debt)! • Step 1: determine target balance (use again schedule to determine)! • Step 2: determine bad debts expense ! Comparison of accounting for uncollectible:! • • Direct Write-Off Method:! • Allowance account is not used! • bad debts expense only recorded when an account is deemed uncollectible!

• Allowance Method:! • Allowance account is used! • Bad debts expense is estimated and only recorded at the end of the period w/ an adjusting entry...