| ASOP: |
Bad Debt can be recorded via the allowance method, or the direct method.
Allowance Method
The allowance for bad debt measures receivables not expected to be collected. Often, it is not known which accounts receivable will be uncollectible, so the allowance account is used instead of accounts receivable. On the balance sheet the allowance is a deduction from accounts receivable and is considered a contra asset.
To estimate the amount of bad debt to accrue into the allowance each period, the following is one acceptable method.
Step 1: Use the actual write-off amount of the previous year and divide it by total credit sales in the same year.
| Example: |
Total write-off for 1993-94 |
= |
$4,679.08 |
|
|
|
Last year's |
|
Volume of charges 1993-94 |
= |
$251,166.98 |
= |
1.86% |
= |
write-off % |
Note: Last year's write-off % becomes the estimated allowance %.
| Step 2: Multiply this percentage by the credit sales in a reporting period to find the amount for the same period's bad debt entry. |
| Example: |
Credit sales in October |
= |
$28,548.71 |
|
Estimated Allowance % |
= |
.0186 |
|
October bad debt expense |
= |
$531.00 |
Integrating the entire example, the correct entry is as follows:
| |
|
Object Code |
Debit |
Credit |
| AVAD |
Bad Debt Expense |
5105 |
$531.00 |
|
| |
Allowance for Bad Debt |
8950 |
|
$531.00 |
|
|
To record the actual write-off, the following method is acceptable. When the write-off in a fiscal year is known, an actual invoice must be eliminated from the detail of accounts receivable. A debit (decrease) to allowance for bad debt and a credit (decrease) to accounts receivable must be made so the receivables balance is decreased appropriately.
Actual write-off entry:
| Example: |
Invoices that have been |
|
C.J. Cox Company |
$3,120.00 |
|
determined to be uncollectible |
= |
Gossic Sales |
$1,453.00 |
|
|
|
Perry Incorporated |
$1,559.00 |
|
|
|
Total |
$6,132.00 |
|
| |
The entry made when the invoices are determined to be uncollectible is: |
| |
|
Object
Code |
Debit |
Credit |
| AVAD |
Allow. for Bad Debt |
8950 |
$6,132.00 |
|
| |
Accounts Receivable |
81XX |
|
$6,132.00 |
| |
In some cases, the Allowance for Bad Debt might be significantly higher or lower than the actual amount of uncollectible invoices. In This case, adjustments must be made to the Allowance account so a fair representation of uncollectibles is shown.
Example: Allowance for Bad Debt $100,000
Estimated future uncollectible invoices $25,000
If $100,000 was in the Allowance for Bad Debt, and only $25,000 of Accounts Receivable was estimated to be uncollectible in the future, the allowance is unfairly representative of your future estimated uncollectible accounts. In this case, a reduction to the allowance for Bad Debt and Bad Debt Expense is necessary.
|
| |
|
Object Code |
Debit |
Credit |
| AVAD |
Allowance for Bad Debt |
8950 |
$75,000.00 |
|
| |
Bad Debt Expense |
5105 |
|
$75,000.00 |
| |
Example: Allowance for Bad Debt $25,000
Estimated future uncollectible invoices $45,000
If $25,000 was in the Allowance for Bade Debt, and $45,000 of Accounts Receivable was estimated to be uncollectible in the future, the allowance is unfairly representative of your future estimated uncollectible accounts. In this case, an increase to the Allowance for Bad Debt and Bad Debt Expense is necessary.
|
| |
|
Object
Code |
Debit |
Credit |
| AVAD |
Bad Debt Expense |
5105 |
$20,000.00 |
|
| |
Allow. for Bad Debt |
8950 |
|
$20,000.00 |
| |
Direct Method
The direct method writes off an invoice directly to Accounts Receivable when it is deemed to be uncollectible. an allowance is not set up to estimate any future uncollectibles that occurred in the month of sale. the direct method does not conform to the matching principle and therefore is not in compliance with GAAP. The direct method should only be used when uncollectible invoices can be estimated to be an immaterial amount.
Example: Unpaid accounts receivable over 2 years old for the amount of $4,679.08.
|
Entry: To write-off an uncollectible invoice
| |
|
Object
Code |
Debit |
Credit |
| AVAD |
Bad Debt Expense |
5105 |
$4,679.08 |
|
| |
Accounts Receivable |
81XX |
|
$4,679.08 |
|
i"The matching principle means that revenues generated and expenses incurred in generating those revenues should be reported in the same income statement. Revenues for an accounting period are recognized in accordance with the realization principle. Then the expenses incurred in generating those revenues are determined in accordance with the matching principle. Thus, expenses are reported in the income statement for the accounting period in which the related revenues are recognized." (Intermediate Accounting, by Chasteen, Flaherty, and O'Conner; 1992; McGraw-Hill, Inc.; p.60).
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