UNCOLLECTIBLEDOUBTFUL ACCOUNTSBAD DEBTS

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					UNCOLLECTIBLE/DOUBTFUL ACCOUNTS/BAD DEBTS

Companies that make sales on credit want to sell to customers that will pay. Regardless of how
efficient its credit control system is the company will always have some customers that will not
pay. The accounts owed by such customers are collected uncollectible or doubtful accounts.

The allowance method of accounting argues that in accordance with the matching rule, it is
assumed that losses from uncollectible accounts occur at the moment of sale. The Allowance for
Uncollectible Accounts is used because the company doesn’t know until after the sale that the
company will not pay. The allowance for uncollectible accounts appears in the statement of
financial position. It reduces the amount of accounts receivable to the amount that is expected to
be realized or collected in cash.

Because it is impossible to know which accounts will be uncollectible at the time financial
statements are prepared, it is necessary to give an estimate of the expense for the year that will
cover the expected losses.

Two methods are available for estimating uncollectible accounts expense for the accounting
period:

   1. The percentage of net sales method;

   2. The accounts receivable aging method.

The percentage of net sales method represents an income statement view point. It is based on
the proposition that of each dollar of sales a certain proportion will not be collected, and this is
expense for the year.

Example: At the end of the year 20x1, Marine Enterprises estimates the uncollectible accounts
expense to be 0.7% of net sales of $10 000000.
0.007*$10 000000 = $70 000
20x1 (current year): At the end of the year the company makes an allowance for doubtful
accounts for the amount of $ 70 000:

Debit Uncollectible accounts expense (Income statement) 70 000

Credit Allowance for uncollectible accounts 70 000

This allowance will be used next year in order to cover actual losses.

20x2 (next year): Suppose that one of the customers is not able to pay. Accounts receivable of
the customer amounts to $20 000. The company uses the allowance for uncollectible accounts to
write off uncollectible accounts/bad debts:

Debit Allowance for uncollectible accounts 20 000

Credit Accounts receivable 20 000
At the end of the year 20x2 the company makes new estimation for uncollectible accounts.
Suppose that net sales for the year 20x2 are of $ 10 500 000 and estimated percentage of
uncollectible accounts is 1%.

At the end of the year the company makes an allowance for doubtful accounts for the amount of
$ 105 000:

Debit Uncollectible accounts expense      105 000

Credit Allowance for uncollectible accounts 105 000

At the end of the year 20x3 the balance of the Allowance account equals to the amount of
$155000 (70 000 – 20 000 + 105 000).



The accounts receivable aging method represents balance sheet view point. This method asks
question, how much of the year-end balance of the Accounts receivable will not be collected.
The answer determines the amount that the allowance for uncollectible account is supposed to be
at the end of the year. The difference between this amount and actual balance of the Allowance
account is the expense for the year.

Example: The general ledger controlling account for accounts receivable of Parker Company
shows a debit balance of $104 000 at the end of the year. An aging method analysis of the
individual accounts indicates estimated uncollectible accounts to be 6% of the amount of
Accounts Receivable (0.06*$104 000 = $6 240).
   1) Suppose that The Allowance for Uncollectible Accounts has actual credit balance $800.
       According to our estimates the balance should be $ 6 240. At the end of the period the
       company makes the following record:
Debit Uncollectible Accounts Expense 5 440 (6 240 – 800)
Credit Allowance for uncollectible accounts 5 440
   2) The Allowance for Uncollectible Accounts has a debit balance $800 (it means that actual
       amount of uncollectible accounts for the year has exceeded previously estimated
       amount).
       According to our current estimates we should have the credit balance of $ 6 240. At the
       end of the period the company makes the following record:
Debit Uncollectible Accounts Expense 7 400 (6 240+ 800)
Credit Allowance for uncollectible accounts 7 400 (6240+800)