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When companies sell products to customers on credit, the customer receives the product and agrees to pay later. The customer’s obligation to pay later is recorded in accounts receivable on the
balance sheet of the selling company. However, sometimes customers simply don’t pay their bills. When customers don’t pay their bills, the
selling company has to write-off the amount as bad debt or uncollectible accounts. Direct Charge-Off Method: MeaningOne way to record the affects of uncollectible accounts is the direct charge-off method. This method is simple. But it violates the matching principle and does not conform to GAAP standards and procedures. Thus, it cannot be used to record the write-offs of uncollectible accounts in
financial statements prepared for the public in accordance with FASB and GAAP regulations. Allowance MethodAnother way to record bad
debt expense or uncollectible accounts in the financial statements is by using the allowance method. This method adheres to the matching principle and the procedural standards of GAAP.  [box]Strategic CFO Lab Member Extra Access your Cash Flow Tune-Up Tool Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow. Click here to access your Execution Plan. Not a Lab Member? An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management’s estimate of the amount of accounts receivable that will not be paid by customers. If actual experience differs, then management adjusts its estimation methodology to bring the reserve more into alignment with actual results. In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time. In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. Units should consider using an allowance for doubtful accounts when they are regularly providing goods or services “on credit” and have experience with the collectability of those accounts. The following entry should be done in accordance with your revenue and reporting cycles (recording the expense in the same reporting period as the revenue is earned), but at a minimum, annually. DR Bad Debt Expense CR Allowance for Doubtful Accounts
When it is determined that an account cannot be collected, the receivable balance should be written off. When the unit maintains an allowance for doubtful accounts, the write-off reduces the outstanding accounts receivable, and is charged against the allowance – do not record bad debt expense again! DR Allowance for Doubtful Accounts CR Accounts Receivable For detailed expectations and guidelines related to write offs, see Writing Off Uncollectable Receivables. What is the allowance method for uncollectible accounts?The allowance for uncollectible accounts is calculated by multiplying the receivable balance in the various aging categories (see table below) by a reserve rate. A higher reserve rate is applied to older receivables because those receivables are less likely to be collected.
What are the two methods of estimating the allowance for uncollectible receivables?The percentage of sales method and the accounts receivable aging method are the two most common ways to estimate uncollectible accounts.
What is the accounting method for uncollectible receivables?¨ Two methods are used in accounting for uncollectible accounts: (1) the Direct Write-off Method and (2) the Allowance Method. § When a specific account is determined to be uncollectible, the loss is charged to Bad Debt Expense.
What is the allowance method for reporting accounts receivable?What is the Allowance Method? The allowance method matches the estimated expenses or losses from uncollectible accounts receivables against the sales. We record our accounts receivable on the balance sheet. This amount is often inaccurate, as we will likely not be able to collect all of these.
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