Accounting for Bad Debts

Learning Objective 1 Describing how the Bad Debts Expense account and the Allowance for Doubtful Accounts account are used to record bad debts LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts • Debts that come from credit customers who do not pay their bills • Affects a company’s credit policy • Cannot grant credit to just any company LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts On December 1, 2008, Corey Co. sold merchandise on account for $5,000. On July 1, 2009, Corey Co. determines that the $5,000 will never be collected. 2008 2009 Dec 1 Sales of $5,000 recorded Jul 1 Debt determined to be bad Dec 31 End of fiscal year LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts Bad debts expense should be recognized in the accounting period in which the sales were made. 2008 2009 Dec 1 Sales of $5,000 recorded Dec 31 End of fiscal year Jul 1 Debt determined to be bad LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Bad Debts Solution: Estimate how many of the current sales will be uncollectible Prepare an adjusting entry 2008 2009 Dec 31 End of fiscal year Jul 1 Debt determined to be bad Dec 1 Sales of $5,000 recorded LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Allowance for Doubtful Accounts • Is a contra-asset account • Is subtracted from accounts receivable • Accumulates expected amount of uncollectibles as of a given date LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Adjusting Entry for Bad Debts Dec 31 Bad Debts Expense XXXX Allowance for Doubtful Accounts XXXX Contra-Asset Account LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Balance Sheet Presentation Corbin Company Partial Balance Sheet December 31, 200X Net Realizable Value Gross Amount Estimated to be Uncollectible Current Assets: Cash $ 10,400 Accounts receivable $100,000 Less: Allowance for doubtful accounts 6,000 94,000 Merchandise inventory 300,000 Total current assets $404,400 Total Current Assets LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Net Realizable Value • The amount of Accounts Receivable that is expected to be collected • Calculated by subtracting Allowance for Doubtful Accounts from Accounts Receivable LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Writing off an account Jul 1 Allowance for Doubtful Accounts 5,000 Accounts Receivable-Discello 5,000 LO-1 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Learning Objective 2 Using the income statement approach and the balance sheet approach to estimate the amount of Bad Debts Expense LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Estimating the Amount Dec 31 Bad Debts Expense XXXX Allowance for Doubtful Accounts XXXX How is this amount determined? LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Income Statement Approach Bad Debts Expense = Percentage of net credit sales Focus is on measuring the expense, which is reported on Income Statement. Matching requirement-ignores previous balance of Allowance for Doubtful Accounts when estimating Bad Debts Expense for current period. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Exercise 13-2 Compute Net Sales: Sales $110,000 Sales Returns & Allowances (500) Sales Discounts (9,500) Net Sales $100,000 LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Accounts Receivable Allowance for Doubtful Accounts 5,000 Bal. 30,000 4,000 Adj. $9,000 Bal. Exercise 13-2 Any existing balance in the Allowance account is ignored. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Balance Sheet Approach Adjusting entries are based on bringing the Allowance account to a required amount. • Method is based on the Accounts Receivable amount and the aging process. LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Balance Sheet Approach • Net realizable value - The amount (accounts receivable – Allowance for doubtful accounts) that is expected to be collected. Focus is on determining the net realizable value of Accounts Receivable, which is reported on Balance Sheet LO-2 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Accounts Receivable Allowance for Doubtful Accounts 500 Bal. 30,000 Example Mayfair Co. has the following balances in its accounts at the end of 2008 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Accounts Receivable Allowance for Doubtful Accounts 500 Bal. 30,000 Example 2,179 Desired balance 2,679 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Accounts Receivable Bal. 30,000 What if the Allowance account had a debit balance of $500 before adjustment? Allowance for Doubtful Accounts 500 3,179 Desired balance 2,679 LO-3 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Allowance for Doubtful Accounts • When a company deems an account uncollectible, it is written off and no longer considers it an asset. • When the journal entry is made, allowance for doubtful accounts and accounts receivable are reduced. Example: J. Monaco’s account balance of $500 is deemed uncollectible on June 1, 20X8. LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Recording Recovered Debts using Allowance for Doubtful Accounts Example: Assume J. Monaco paid half of his account balance of $500 on January 3, 20X9. LO-4 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method • Used when a company cannot reasonably estimate bad debt expense • Uncollectible accounts are directly written off to current year’s bad debt expense • The year sale was made does not matter • Allowance for doubtful accounts is not used LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Example: T. DeStadio’s account balance of $400 is deemed to be uncollectible on May 15, 20X7. LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Recording Recovered Debts in same year • Assume T. DeStadio paid $200 of his balance July 3, 20X7. • Reverse the entry made prior by $200 LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Direct Write-Off Method Recording Recovered Debts in different year • A new account- Bad Debts Recovered is used • Assume T. DeStadio paid $200 of his balance on July 3, 20X8. LO-5 © 2010 Prentice Hall Business Publishing, College Accounting: A Practical Approach, 11e by Slater

Accounting for Bad Debts