Allowance for Doubtful Accounts Calculation & Journal Entry

The two main methods of estimating Uncollectible Accounts Receivable are the percentage-of-net-sales method and the aging method. The percentage-of-net-sales method is the simpler of the two and involves calculating an allowance based on a percentage of net sales. The aging method is more complex and requires analyzing customer accounts to determine their collectibility. This method is usually superior as it takes into account factors such as past-due payments and the payment habits of customers. Consider why the direct write-off method is not to be used in those cases where bad debts are material; what is “wrong” with the method?

• Finally, an entry, that debits Cash and credits an Allowance account cannot arise from normal external transactions.
• The calculated amount of the invoice, including all expenses and taxes, was $10000, to be paid on or before Jan 31, 2019.
• Under the allowance method, an adjustment is made at the end of each accounting period to estimate bad debts based on the business activity from that accounting period.
• In some cases, a customer whose account has been written off will subsequently pay part or all of his or her account.
• As you’ve learned, the delayed recognition of bad debt violates GAAP, specifically the matching principle.

In some cases, a customer whose account has been written off will subsequently pay part or all of his or her account. As this entry shows, the debit part of the entry is to the Allowance account. On Abril 14, the Corona Company Informs the Delta Corporation that it is entering bankruptcy proceedings. Because Delta’s management feels that it is unlikely that it will be able to collect the $6,000 balance in Corona’s account, it decides to write off the entire balance. Because this is the first year of the firm’s operations, the balance in the Allowance account equals the amount of the Journal entry.

How to Estimate Accounts Receivables

The first method—percentage-of-sales method—focuses on the income statement and the relationship of uncollectible accounts to sales. The second method—percentage-of-receivables method—focuses on the balance sheet and the relationship of the allowance for uncollectible accounts to accounts receivable. This approach looks at the balance of accounts receivable at the end of the period and assumes that a certain amount uncollectible accounts receivable journal entry will not be collected. Accounts receivable is reported on the balance sheet; thus, it is also known as the balance sheet approach. The final point relates to businesses with very little exposure to the possibility of bad debts, typically, entities that rarely offer credit to its customers. Assuming that credit is not a significant component of its sales, these sellers can also use the direct write-off method.

Accounts receivable aging is a more precise method to calculate the allowance for doubtful accounts. Here a business takes into account both payment dues and the time it has been due for. It is critical to have an allowance for doubtful accounts as it indicates the bad debt expense a company expects to incur. Use the percentage of bad debts you had in the previous accounting period to help determine your bad debt reserve. A reserve for doubtful debts can not only help offset the loss you incur from bad debts, but it also can give you valuable insight over time. For example, your ADA could show you how effectively your company is managing credit it extends to customers.

How to Calculate Bad Debt Expense

The note receivable is recorded at its face value, the value shown on the face of the note. The payee may be specifically identified by name or may be designated simply as the bearer of the note. In a promissory note, the party making the promise to pay is called the maker. A schedule is prepared in which customer balances are classified by the length of time they have been unpaid. The entry made in writing off the account is reversed to reinstate the customer’s account.

Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. If receivables are recorded net of discounts, it may be necessary to establish a supplemental allowance to show the additional amount collectible because the discounts have been missed. This approach allows the reader to calculate the proportion of the total group that is believed to be collectible or uncollectible.