For many different reasons, a company may be entitled to receiving money for a credit sale but may never actually receive those funds. Then, the company establishes the allowance by crediting an allowance account often called ‘Allowance for Doubtful Accounts’. Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets. If a company has a history of recording or tracking bad debt, it can use the historical percentage of bad debt if it feels that historical measurement relates to its current debt.

The following table
reflects how the relationship would be reflected in the current
(short-term) section of the company’s Balance Sheet. For the taxpayer, this means that if a company sells an item on
credit in October 2018 and determines that it is uncollectible in
June 2019, it must show the effects of the bad debt when it files
its 2019 tax return. This application probably violates the
matching principle, but if the IRS did not have this policy, there
would typically be a significant amount of manipulation on company
tax returns. For example, if the company wanted the deduction for
the write-off in 2018, it might claim that it was actually
uncollectible in 2018, instead of in 2019. There is one more point about the use of the contra account, Allowance for Doubtful Accounts.

Allowance Method For Uncollectibles

Then, the company will record a debit to cash and credit to accounts receivable when the payment is collected. You’ll notice that because of this, the allowance for doubtful accounts increases. A company can further adjust the balance by following the entry under the “Adjusting the Allowance” section above. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid.

This schedule classifies the receivables on the basis of the length of time they have been outstanding. All approaches involve an analysis of the existing accounts and the application of one or more percentage factors. The reliability of this approach is potentially high because it does not rely on estimates. However, it has the potential for income manipulation by allowing management to determine when to record the expense.

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This estimation is based on our past experiences and it is in line with the industry average data that is publicly available. UNCOLLECTIBLE ACCOUNT EXPENSE, also known as a bad-debt expense, is that expense incurred in the unsuccessful attempt to realize payment of a Account Receivable. Thus, a $75 sale on credit to Mr. A raises the overall accounts receivable total in the general ledger by that amount while also increasing the balance listed for Mr. A in the subsidiary ledger. The matching principle of accounting is another concept to understand concerning uncollectible account expense.

For example, suppose instead that the accountant at Sample Company estimates that the Allowance for Uncollectibles should be $375,000 after it is adjusted. This approach is focused on the balance sheet in that its primary goal is an accurate description of the net collectible amount of receivables. This approach is income statement oriented in that it is designed to match the main expense of extending credit with the revenue produced by that activity. Accountants also have debated the question of the time period in which to recognize the loss on non-collection. Most accounting theorists have endorsed the position that the loss arising from bad debt is an expense. The article also discusses the practical aspects of disclosing the impact of non-collection and the entries that are made for dealing with bad debts.

Recording Uncollectible Accounts Expense and Bad Debts FAQs

Therefore, the direct
write-off method is not used for publicly traded company reporting;
the allowance method is used instead. The first entry reverses the bad debt write-off by increasing
Accounts Receivable (debit) and decreasing Bad Debt Expense
(credit) for the amount recovered. The second entry records the
payment in full with Cash increasing (debit) and Accounts
Receivable uncollectible accounts expense decreasing (credit) for the amount received of
$15,000. Accounts use this method of estimating the allowance to adhere to the matching principle. The matching principle states that revenue and expenses must be recorded in the same period in which they occur. Therefore, the allowance is created mainly so the expense can be recorded in the same period revenue is earned.

• It is a matter of judgment, relating only to the conclusion that the choice among alternatives really has very little bearing on the reported outcomes.
• Whenever a balance sheet is to be produced, these two accounts are netted to arrive at net realizable value, the figure to be reported for this asset.
• The fact that the buyer fails to perform is properly described, they conclude, as an expense.
• If receivables are recorded net of discounts, it may be necessary to establish a supplemental allowance to show the additional amount collectible because the discounts have been missed.
• The company must record an additional expense for this amount to also increase the allowance’s credit balance.

This alternative computes doubtful accounts expense by anticipating the percentage of sales (or credit sales) that will eventually fail to be collected. The percentage of sales method is sometimes referred to as an income statement approach because the only number being estimated (bad debt expense) appears on the income statement. Carefully consider that the allowance methods all result in the recording of estimated bad debts expense during the same time periods as the related credit sales. This journal entry takes into account a debit balance of $2000 and adds the prior period’s balance to the estimated balance of $4608 in the current period, providing for a bad debt of $6608 ($4608+2000).

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Let’s say that on April 8, it was determined that Customer Robert Craft’s account was uncollectible in the amount of $5,000. When a specific customer has been identified as an uncollectible account, the following journal entry would occur. When a customer purchases goods on credit with its vendor, the amount is booked by the vendor under accounts receivable. The payment terms vary, but 30 days to 90 days is normal for most companies.

The accountant for Sample Company may have estimated that 5% of its $7,500,000 of receivables were uncollectible in arriving at the desired balance of $375,000 used in the entry above. While the direct write-off method is simple, it is only acceptable in those cases where bad debts are immaterial in amount. In accounting, an item is deemed material if it is large enough to affect the judgment of an informed financial statement user. Accounting https://accounting-services.net/how-to-figure-out-direct-labor-cost-per-unit/ expediency sometimes permits “incorrect approaches” when the effect is not material. An uncollectible account expense is referred to an expense that occurs when there is a default in the payment by the customer or debtor of the organization. An uncollectible account expense is an expenditure incurred due to the account receivables, loans, or any other debts receivable having no virtual chance of being recoverable in the foreseeable future.

What is the difference between uncollectible accounts expense and bad debt?

If the estimate was too low, the company needs to increase the allowance. This involves debiting or crediting the allowance for doubtful accounts account and the bad debt expense account. For example, if a company has historically had bad debts of 3% of credit sales, it may estimate that 3% of current credit sales will also be uncollectible. This journal entry will charge the $5,000 bad debt expense to the income statement while removing the $5,000 of accounts receivable from the balance sheet. For example, on December 31 which is our period-end adjusting entry, we estimate that 3% of the credit sales we made during the year will be uncollectible.

• The aggregate of all group results is the estimated uncollectible amount.
• UNCOLLECTIBLE ACCOUNT EXPENSE, also known as a bad-debt expense, is that expense incurred in the unsuccessful attempt to realize payment of a Account Receivable.
• Mechanical errors (mathematical problems as well as debit and credit mistakes) tended to abound.
• An uncollectible account expense is an expenditure incurred due to the account receivables, loans, or any other debts receivable having no virtual chance of being recoverable in the foreseeable future.