Allowance Methods of Accounting for Uncollectible Accounts
The allowance method of accounting for uncollectible accounts is consistent with Generally Accepted Accounting Principles. This method uses historical information to estimate the amount of uncollectible accounts. A percentage of the period’s sales or the period’s accounts receivable balance at year end can be used as the estimate recorded as uncollectible. The estimate is credited to the allowance account, which reduces accounts receivable, with a corresponding debit to bad debt expense, recorded on the income statement.
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Percentage of Sales
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The percentage of sales method is exactly what the name states. A percentage of sales, based on past uncollectible activity, is calculated and recorded as uncollectible. The amount is credited to the “Allowance for uncollectible accounts” account on the balance sheet and a debit is recorded to the “Bad debt expense” account reported on the income statement. The bad debt expense will reduce revenues for the period and the allowance will reduce accounts receivable.
Example of Percentage of Sales
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The Square Pants Company’s sales for the period are $1 million. Past experience with uncollectible accounts has shown that 5 percent of sales are uncollectible. The estimated uncollectible amount equals $50,000 or, $1 million multiplied by 0.05. The allowance account is credited for $50,000 and bad debt expense is debited for $50,000.
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Percentage of Accounts Receivable at Year End
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Uncollectible accounts can also be estimated by taking a percentage of the accounts receivable balance at the end of the year. The calculated amount is the allowance account’s ending balance for the period and disclosed on the balance sheet. The journal entry recorded should adjust the prior year’s balance to equal the new balance for the allowance for uncollectible accounts. The adjustment recorded is the amount of bad debt expense for the period.
Example of Percentage of Accounts Receivable at Year End
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The Square Pants Company’s ending balance of accounts receivable for the current period is $500,000. Past experience has shown that 10 percent of the ending balance of accounts receivable is uncollectible. The ending balance of the allowance account should be $50,000 for the current period, or $500,000 multiplied by 0.10. A review of the beginning balance of the allowance account shows a balance of $45,000. Record a journal entry that debits “Bad debt expense” for $5,000 and credits “Allowance for uncollectible accounts” for $5,000. This entry adjusts the balance in the allowance account to $50,000 to reflect current period activity.
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References
- “Financial: CPA Exam Review”; DeVry/Becker Educational Development Corp.; 2009
- Accounting Coach: What is the Allowance for Doubtful for Accounts?
