Uncollectible Accounts Are…
Uncollectible accounts are receivables for which the company cannot collect the full amount owed from the customer.
Reconciliation of Bad Debts
Matching bad debts to the sales of the period that gave rise to the bad debts is the fundamental accounting difficulty when it comes to accounting for uncollectible accounts.
In other words, the bad-debt charge should be recorded when the transaction was made and the receivable was created, and not after management decided the customer would not or could not pay.
Management may not find out that a sale made in the current year would not be recoverable until the following year, which creates an accounting dilemma.
If the bad debt charge is not recorded until the year after the sale, this goes against the matching norm. The allowance approach is employed in order to produce the most suitable pairing.
The allowance technique compares the period’s sales to the uncollectible account charge.
To do so, you must forecast the cost of bad debt during the selling time.
Since it’s hard to predict with precision which accounts still outstanding at year’s end will become uncollectible in the next year, an estimate is necessary.
An adjustment journal entry is often made at the conclusion of the fiscal year to reflect this estimate.
Accountants agree that the matching convention is worth implementing despite the risks associated with using estimates.
Allowance-Based Method of Accounting for Bad Debt
First, we’ll go over the necessary journal entries for applying the allowance method, and then we’ll look at the various approaches to making the necessary estimates.
Assume that in 2019, Delta Corporation’s first year of business, sales reached $1 million. This will help illustrate the necessary journal entries employed with the allowance technique.
The sum of all cash collected on account and sales made on credit came to $750,000. Management analyzed the $250,000 in Accounts Receivable at the conclusion of the period and determined that $12,500 would become uncollectible.
Recording the Initial Guess in a Journal
Sales, cash receipts, and $12,500 in uncollectible accounts necessitate the following summary journal entries:
The first two are standard practice for keeping track of credit sales and cash receipts.
The adjusting entry for the expected uncollectible accounts on December 31, 2019, however, requires some clarification.
The Uncollectible Accounts Expense account receives the debit portion of the adjusting entry.
This item, which is also known as “bad debt expense” and “closed to income summary,” appears as a “selling expense” on the income statement and goes by the name “bad debt” in other contexts.
Some businesses, however, report that amount is subtracted from gross sales to determine net sales. The Allowance for Uncollectible Accounts account receives the credit portion of the entry.
Since the company can only make a total dollar estimate of uncollectible accounts and cannot be sure which individual account will prove uncollectible, this account is credited instead of Accounts Receivable.
A company should have already written off an uncollectible account if they are aware of this fact.
Since it has a positive balance, the Allowance for Uncollectible Accounts is considered a contra-asset account.
This account is also known as an Allowance for Debts or an Allowance for Doubtful Accounts.
The Allowance account balance is offset by the Gross Accounts Receivable balance while compiling a balance statement.
Management has determined that this net amount accurately reflects the receivables’ net realizable value.
After the adjusting entry has been completed, the December 31, 2019 presentation of current assets for Delta Corporation is provided below.
The Journal entry’s amount is equal to the Allowance account balance because this is the first year of business. This might change in the years to come, though.
Let’s say the following for the sake of this Illustration occur in 2020:
The Corona Company notified the Delta Corporation of its intent to file for bankruptcy on April 14. Delta’s management has determined that it is not worth the effort to attempt to collect the $6,000 remaining in Corona’s account, and therefore has decided to write off the whole sum.
On November 29th, the Bankruptcy Court officially settles Corona’s account with Delta for $400.