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VISUAL # 7-1
METHODS OF ACCOUNTING FOR BAD DEBTS
DIRECT WRITE-OFF METHOD
Accounts for bad debts from an uncollectible account
receivable at the time account is determined to be
uncollectible.
ALLOWANCE METHOD
At the end of each accounting period,
bad debts expense is
estimated and recorded.
Year-end No adjusting entry
Adjusting entry required:
Bad Debt Expense XXX
Allowance for Uncollectible Accounts XXX
(The amount is an estimate based on a percentage of sales or a
percentage of outstanding accounts receivable. If the estimate is based
on sales, the full estimate is used in the adjusting entry. If the estimate
is based on accounts receivable the allowance account balance is
brought to the amount of the estimate.)
When an account is
determined to be
uncollectible
Write-off entry required:
Bad Debts Expense XXX
Accounts Receivable/Customer XXX
(The amount is the balance of the uncollectible account.)
Write-off entry required:
Allowance for Uncollectible Accounts XXX
Accounts Receivable/Customer XXX
(The amount is the balance of the uncollectible account.)
When an account
previously written
off is recovered
1. Reinstate account by reversing write-off:
Accounts Receivable/Customer XXX
Bad Debts Expense XXX
(The amount is the account balance that was written off.)
2. Record collection on account normally:
Cash XXX
Accounts Receivable/Customer XXX
(The amount is the amount collected.)
1. Reinstate account by reversing write-off:
Accounts Receivable/Customer XXX
Allowance for Uncollectible Accounts XXX
(The amount is the account balance that was written off.)
2. Record collection on account normally:
Cash XXX
Accounts Receivable/Customer XXX
(The amount is the amount collected.)
Advantages: Does not require adjusting entry.
Does not require year-end estimating of
uncollectibles.
Matches expense against related revenues.
Reports the net realizable accounts receivable on the balance
sheet (a more accurate reporting of assets).
Disadvantages: Violates matching (expense recognition) principle,
therefore only allowed if qualified under
materiality principle. (Permitted if a business
anticipates an immaterial amount of uncollectibles.)
Requires adjusting entry.
Requires year-end estimating of uncollectibles.
7-8
7-9
VISUAL #7-2
PROMISSORY NOTE
(6) $2,000.00 April 15, 2011 (1)
Amount Date
For value received, I promise to pay to the order of
Plexi-Plus Supply Co. (2)
Tobay, New York
(7)
Two thousand and no/100 -------------------Dollars
on June 14, 2011 (3)
plus interest at the annual rate of 9 percent.
(4)
Scott Cooke (5)
for Tobay Surfer Inc.
7-10
Alternate Demonstration Problem
Chapter 7
At the end of the year, the M. I. Wright Company showed the following
selected account balances:
Sales (all on credit)............................................................................$300,000
Accounts Receivable......................................................................... 800,000
Allowance for Doubtful Accounts..................................................... 38,000
Required:
1. Assume the company estimates that 1% of all credit sales will not be
collected.
a. Prepare the proper journal entry to recognize the expense
involved.
b. Present the balances in Accounts Receivable and Allowance for
Doubtful Accounts as they would appear on the balance sheet.
Also show the net realizable Accounts Receivable.
2. Assume the company estimates that 5% of its accounts receivable
will never be collected.
a. Prepare the proper journal entry to recognize the expense
involved.
b. Present the balances in Accounts Receivable and Allowance for
Doubtful Accounts as they would appear on the balance sheet.
Also show the net realizable Accounts Receivable.
3. Under assumptions 1 and 2 above, give the proper journal entries for
the following events.
June 3 John Shifty, who owes us $500, informs us that
he is broke and cannot pay. We believe him.
Nov. 9 We learned that John Shifty has won the lottery and
is willing to pay off all his old debts.
Solution: Alternate Demonstration Problem
Chapter 7
1a. Bad Debts Expense.......................................... 3,000
Allowance for Doubtful Accounts.............. 3,000
($ 300,000 X 1 %)
($ 800,000 X 5 % less $38,000)
2b. Accounts Receivable.......................................$800,000
Less: Allowance for Doubtful Accounts........ 40,000
Estimated Realizable A/R...............................$760,000
3. Both assumptions 1 and 2 above represent the allowance method of
accounting for uncollectibles. The only difference is in the approach
Note: There would be a closing entry for the Bad Debts Expense
since it is an expense account just like any other expense account.
There would be no closing entry for the Allowance for Doubtful
Accounts since it is not a temporary account. It is a contra-asset
account, contra to Accounts Receivable.
