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Sample Bad Debts Expense

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					                             Accounting for Bad Debts
The two methods for accounting for bad debts are the Direct Write-off method and the
Allowance method.

Direct write-off does not properly match, nor does it conform to conservatism, hence the
method is not GAAP. It is, however, the method that must be used for income tax
reporting.

The Allowance method (is GAAP) does properly match expenses with revenues and is
in conformity with conservatism and can be applied in two different, yet similar ways:
        Income statement method—relies on an estimate based on a percentage of net
credit sales. The balance in the allowance account at the end of the period is not taken
into consideration. The percentage of net credit sales is debited to Bad debt expense and
credited to the Allowance for bad debts accounts, no matter the balance in the allowance
account. (The Kimmel, et al. text does not present this method)

        Balance sheet method—relies on an estimate of uncollectible accounts made
during an analysis of the Accounts receivable account. The balance in the Allowance
account is taken into consideration and the adjusting entry brings the Allowance account
up to the desired amount. If the allowance account has a debit balance, it is “overdrawn”.
In other words, there have been more write-offs than planned. If the allowance account
has a credit balance, it has a positive balance and has not been utilized as fully as was
expected.
Accounting for bad debts expense is done only at the end of the accounting period and is
done as an adjusting entry. The Bad debt expense account is not used at the time
individual accounts are written off. The adjusting entry looks identical under either the
Income Statement method or the Balance Sheet method (since Direct Write-off is not
GAAP, we won’t do the journal entries related to the method). The adjusting journal
entry replenishes the allowance account, which is a contra-asset account and is in effect a
reserve for uncollectible accounts, in order to provide for the write-offs that will surely
occur as a result of past credit sales. The only difference between the income statement
method and the balance sheet method would be the amount in question:

12/31       Bad debt expense                                       X,XXX
              Allowance for bad debts                                            X,XXX


Net realizable value:

Since we know that we probably won’t be able to collect the entire amount of our
receivables, we must present the amount that we reasonably believe that we can collect
on the balance sheet (remember that conservatism tells us to avoid overstating our assets).
This net amount is often referred to as the net realizable value (NRV) of accounts
receivable. This amount is the difference between the amount in accounts receivable and
the amount in the allowance account.
Writing off an account:

When a reasonable effort has been made to collect from a customer and it has become
evident that our efforts are to be unsuccessful, it is time to write off the account. This is
accomplished by the following entry:

Date         Allowance for bad debts                                  X,XXX
                Accounts receivable—Deadbeat customer                               X,XXX


Recovery of an account:

On rare occasions customers can return from apparent oblivion and pay us for a debt that
seemed hopelessly uncollectible. If we have written them off, we must reinstate their
account and journalize the receipt of their payment. This is usually done with two journal
entries:

Date         Accounts receivable—Deadbeat customer                    X,XXX
               Allowance for bad debts                                              X,XXX

             Cash                                                     X,XXX
               Accounts receivable—Deadbeat customer                                X,XXX

Notice that the first entry is the reverse of the entry to write off the account and the
second is the standard entry to record the receipt of cash on account.

				
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