Writing Off an Account Under the Allowance Method

As we have shown, the allowance method is based on the accountant’s ability to estimate future uncollectible accounts that result from current year’s sales. Then, you debit cash and credit accounts receivable for the amount of cash you received. If you have no reserve, you would credit uncollectible accounts expense and debit accounts receivable for the amount you received and then credit accounts receivable uncollectible accounts receivable adjusting entry and debit cash for the same amount. Can be considered an investment made by the business that includes both risks and returns. Returns in the form of easily acquiring new customers and risk in the form of non-payments called bad debts. Because of the problems companies have with uncollectible accounts when they offer customers credit, many now allow customers to use bank or external credit cards.

This estimate is accumulated in a provision, which is then used to reduce specific receivable accounts as and when necessary. With this method, the journal entry is a debit to the allowance for bad or doubtful debts account. On the income statement, Rankin would match the uncollectible accounts 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.

Step 1: Definition of bad-debt expense

The amount recorded in the bad debt expense is based on the company management’s estimate of the percentage of accounts receivable that is expected to be uncollectible. This estimate is based on historical data, industry trends, and other relevant factors. The allowance for doubtful accounts is used to offset the accounts receivable on the balance sheet and reflect the net realizable value of accounts receivable. Sales and the ultimate decision that specific accounts receivable will never be collected can happen months apart.

At the end of the first year of operations Mayberry Advertising had accounts receivable of $22.30. Managements of the company estimates that 10% of the accounts will not be collected. Notes receivable are frequently accepted from customers who need to extend the payment of an outstanding account receivable, and they are often required from high-risk customers.

Repayment of the debt

Then all of the category estimates are added together to get one total estimated uncollectible balance for the period. The entry for bad debt would be as follows, if there was no carryover balance from the prior period. To illustrate, let’s continue to use Billie’s Watercraft Warehouse as the example. BWW estimates that 5% of its overall credit sales will result in bad debt. The allowance method is the more widely used method because it satisfies the matching principle.

• At the other extreme, a company can expect 50 percent of all accounts over 90 days past due to be uncollectible.
• For example, if the age of many customer balances has increased to days past due, collection efforts may have to be strengthened.
• The allowance for doubtful accounts is management’s objective estimate of their company’s receivables that are unlikely to be paid by customers.
• After writing off the bad account on August 24, the net realizable value of the accounts receivable is still $230,000 ($238,600 debit balance in Accounts Receivable and $8,600 credit balance in Allowance for Doubtful Accounts).
• One component of the payroll taxes you deposit with the government is FICA tax .

The previous entries demonstrate the entries made to write off an account declared uncollectible and reinstate an account that had previously been written off. In some cases, a customer whose account has been written off will subsequently pay part or all of his or her account. As this entry shows, the debit part of the entry is to the Allowance account. On Abril 14, the Corona Company Informs the Delta Corporation that it is entering bankruptcy proceedings. Because Delta’s management feels that it is unlikely that it will be able to collect the $6,000 balance in Corona’s account, it decides to write off the entire balance. Because this is the first year of the firm’s operations, the balance in the Allowance account equals the amount of the Journal entry.