Accounting for Bad Debts Allowance Method Accounts Receivable Approach Allowance Method Accounts Receivable Approach

Accounts Receivable Review Current Asset Due 30 – 45 Days Informal Credit Balance Sheet Account Inc with a Dr Normal Dr Balance

Allowance for Doubtful Accounts Inc with a Cr Normal Cr Balance Contra Asset Estimated Uncollectible Amount Balance Sheet Account

Balance Sheet Presentation ABC Corporation Balance Sheet 12/31/X0 ABC Corporation Balance Sheet 12/31/X0 Current Assets Accounts Receivable Net Realizable Value Allowance for Doubtful Accounts $500,000 (30,000) $470,000

Why Use the Allowance Method? Required by GAAP Complies with matching principle Complies with matching principle Match bad debt expense to the period of revenue Match bad debt expense to the period of revenue WHY? WHAT IS THAT? THATS RIGHT!

Estimate Uncollectible Amount Management estimates the uncollectible amount Management estimates the uncollectible amount Use past experience adjusted for expected changes Use past experience adjusted for expected changes

Estimate Uncollectible Amount Actual uncollectible accounts are not known on the last day of the accounting period Actual uncollectible accounts are not known on the last day of the accounting period Why must an estimate be used?

Example

During X1 Sales on account - $800, ,000

During X1 Collections on account - $700, ,000

During X1 Accounts written off - $25,000 25,000

12/31/X1 Balances Before Adjusting Entry for Bad Debts 12/31/X1 balance 575,000 X1 sales on account X1 write offs X1 collections

12/31/X1 Balances Before Adjusting Entry for Bad Debts X1 write offs 12/31/X1 balance 5,000 This account has a $5,000 credit balance before the adjustment for bad debts.

Summary Before the adjustment for bad debts – Accounts Receivable has a debit balance of $575,000 – Allowance for Doubtful Accounts has a credit balance of $5,000

Bad Debt Adjustment Accounts Receivable Approach 2 Step Process Accounts Receivable Approach 2 Step Process

Step 1 Allowance for Doubtful Accounts Determine the ending balance Based on managements estimate

Step 1 12/31/X1 Accounts Receivable Balance $575,000 12/31/X1 Accounts Receivable Balance $575,000 Management estimates 3% of Accounts Receivable will not be collected Management estimates 3% of Accounts Receivable will not be collected $575,000 X.03 = $17,250 This is the 12/31/X1 ending balance of Allowance for Doubtful Accounts (desired ending balance) This is the 12/31/X1 ending balance of Allowance for Doubtful Accounts (desired ending balance)

Step 2 Compare the desired ending balance of Allowance for Doubtful Accounts Compare the desired ending balance of Allowance for Doubtful Accounts $17,250 to Its balance before adjustment $5,000 cr balance

Result The difference is the amount of the adjusting entry Record the entry on the last day of the accounting period

Balance After Adjustment Adjusting Entry X1 Write offs

Balance Sheet Presentation ABC Corporation Balance Sheet 12/31/X1 ABC Corporation Balance Sheet 12/31/X1 Current Assets Accounts Receivable Net Realizable Value Allowance for Doubtful Accounts $575,000 (17,250) $557, ,000 X.97 = 557,750