Accounting for Bad Debts

1. Accounting for Bad Debts Allowance Method Accounts Receivable Approach

2. Accounts Receivable Review Inc with a Dr Normal Dr Balance Current Asset Informal Credit Due 30 – 45 Days Balance Sheet Account

3. Allowance for Doubtful Accounts Inc with a Cr Normal Cr Balance Contra Asset Estimated Uncollectible Amount Balance Sheet Account

4. Balance Sheet Presentation ABC Corporation Balance Sheet 12/31/X0 Current Assets Accounts Receivable $500,000 (30,000) Allowance for Doubtful Accounts $470,000 Net Realizable Value

5. Why Use the Allowance Method? Required by GAAP WHY? Complies with matching principle WHAT IS THAT? Match bad debt expense to the period of revenue THAT’S RIGHT!

6. Estimate Uncollectible Amount Management estimates the uncollectible amount Use past experience adjusted for expected changes

7. Estimate Uncollectible Amount Why must an estimate be used? Actual uncollectible accounts are not known on the last day of the accounting period

8. Example

9. During X1 Sales on account - $800,000 800,000 800,000

10. During X1 Collections on account - $700,000 700,000 700,000

11. During X1 Accounts written off - $25,000 25,000 25,000

12. 12/31/X1 Balances Before Adjusting Entry for Bad Debts X1 sales on account X1 collections X1 write offs 12/31/X1 balance 575,000

13. 12/31/X1 Balances Before Adjusting Entry for Bad Debts X1 write offs 12/31/X1 balance 5,000 This account has a $5,000 credit balance before the adjustment for bad debts.

14. Summary • Before the adjustment for bad debts • Accounts Receivable has a debit balance of $575,000 • Allowance for Doubtful Accounts has a credit balance of $5,000

15. Bad Debt Adjustment Accounts Receivable Approach 2 Step Process Step 2 Step 1

16. Step 1 Allowance for Doubtful Accounts Determine the ending balance Based on management’s estimate

17. Step 1 12/31/X1 Accounts Receivable Balance $575,000 Management estimates 3% of Accounts Receivable will not be collected $575,000 X .03 = $17,250 This is the 12/31/X1 ending balance of Allowance for Doubtful Accounts (desired ending balance)

18. Step 2 Compare the desired ending balance of Allowance for Doubtful Accounts $17,250 to Its balance before adjustment $5,000 cr balance

19. Result The difference is the amount of the adjusting entry Record the entry on the last day of the accounting period

20. Balance After Adjustment X1 Write offs Adjusting Entry

21. Balance Sheet Presentation ABC Corporation Balance Sheet 12/31/X1 Current Assets Accounts Receivable $575,000 (17,250) Allowance for Doubtful Accounts $557,750 Net Realizable Value 575,000 X .97 = 557,750