DEMONSTRATION PROBLEM — Entries for Uncollectible Accounts
Kids-At-Play is a toy store that began operations this year. At the end of its first year
of operations, Kids-At-Play had accounts receivable totaling $50,000. The store's
manager estimates that $1,500 of those receivables will not be collected.
Journal entry to record uncollectible accounts at the end of the year:
Uncollectible Accounts Expense………………
1,500
Allowance for Doubtful Accounts…….
1,500
The year-end balance sheet will report the following balances under the Current
Assets section:
Accounts receivable
$50,000
Less allowance for doubtful accounts
1,500
Net realizable value of accounts receivable
$48,500
Remind your students that $48,500 is the amount of receivables that Kids-At-Play
actually expects to collect.
Assume that early in the second year of operations, Kids-At-Play decides to write off
as uncollectible a $500 receivable owed by Shirley Smith. Emphasize that once an
account has been determined to be uncollectible, it should be written off immediately.
This keeps the subsidiary ledger current for references on the credit standing of
customers.
Journal entry to write off the uncollectible account:
Allowance for Doubtful Accounts…………….
Accounts Receivable — S. Smith……..
500
500
Many students will want to debit Uncollectible Accounts Expense when writing off an
account. Explain that Shirley Smith's $500 account was included in the $1,500
uncollectible accounts expense recorded at the end of last year. Therefore, debiting
the expense account now would record the expense twice.
After writing off the uncollectible account, the T accounts and balance sheet would
appear as follows:
Accounts Receivable
Accounts
Bal. 50,000
1,500
Allowance for Doubtful
Entry to
500
Write-off
Account
Bal.
500
Bal. 49,500
1,000
Balance Sheet Presentation:
Accounts receivable
Bal.
$49,500
Less allowance for doubtful accounts
Net realizable value of accounts receivable
1,000
$48,500
Point out that the net realizable value of accounts receivable did not change. Kids-AtPlay still expects to collect $48,500 of its receivables. All that has changed is that the
company now knows that Shirley Smith, who owes $500, is one credit customer who
will probably not pay. There still is approximately $1,000 in bad debts left to be
discovered.
Ask your students to record the following journal entry in their notes: Kids-At-Play
received notice that another customer, George Jackson, will not be able to pay his
$100 account receivable.
Allowance for Doubtful Accounts……………..
100
Accounts Receivable—G. Jackson…….
100
After demonstrating the write-off of uncollectible accounts under the allowance
method, you will need to address how to record collection of an account that has been
written off. Assume that after Kids-At-Play has written off George Jackson's account,
he does pay the $100 he owes.
Step 1: The account must be reinstated.
Accounts Receivable—G. Jackson……………
Allowance for Doubtful Accounts…….
100
Step 2: The cash received is recorded.
Cash……………………………………………
Accounts Receivable—G. Jackson……
100
100
100
DEMONSTRATION PROBLEM — Estimating Uncollectible Accounts Based on
Sales
When accountants estimate uncollectible accounts based on sales, they determine the
amount of expense to be recorded.
Assume that a business sold $750,000 worth of merchandise on credit. The business
estimates that 2% of all credit sales are uncollectible.
Expense to be recorded = $750,000 x 2% = $15,000
The adjusting entry to record uncollectible accounts is:
Uncollectible Accounts Expense………………
Allowance for Doubtful Accounts………..
15,000
15,000
DEMONSTRATION PROBLEM — Estimating Uncollectible Accounts Based on
Receivables
When accountants estimate uncollectible accounts based on receivables, they
determine what the balance of the allowance for doubtful accounts should be.
Assume that an accountant determines that $2,000 of the current accounts receivable
will probably not be collected. Also assume that the Allowance for Doubtful
Accounts currently shows a $200 credit balance.
Allowance for Doubtful Accounts
200
1,800
Current Balance
Amount that must be
added to the
account to get the correct
balance
2,000
The adjusting entry to record uncollectible accounts is:
Uncollectible Accounts Expense……………….
Allowance for Doubtful Accounts……..
Amount that should be in
the account based on the
estimate of bad debts
1,800
1,800
Assume that the accountant determines that $2,000 of the current accounts receivable
will probably not be collected and that the Allowance for Doubtful Accounts currently
shows a $200 debit balance.
Allowance for Doubtful Accounts
Current Balance
200
2,200
Amount that must be
added to the
account to get the correct
balance
2,000
Amount that should be in
the account based on the
estimate of bad debts
Now, the adjusting entry to record uncollectible accounts is:
Uncollectible Accounts Expense………………
2,200
Allowance for Doubtful Accounts…….
2,200
Your students may question why the Allowance for Doubtful Accounts would have a
debit balance. The following T-account explaining the entries which effect the
Allowance will show that a debit balance occurs when the amount of bad debts are
underestimated and there are more actual write-offs than expected. In the above
example, bad debts from the previous period were underestimated by $200. Since the
allowance came up short, the entry to record bad debts in the current period is
$2,200—the current expense of $2,000 plus an extra $200 to catch-up for the amount
underestimated last accounting period.
Allowance for Doubtful Accounts
Actual Write-Off
of Uncollectible
Accounts
Adjusting Entry to
Record Estimate of
Uncollectible Accounts
A credit balance occurs when the amount of bad debts are overestimated. The
account would have a zero balance if a business perfectly estimated the amount of bad
debts.
Remind students that accountants use an aging analysis to determine the amount of
accounts receivable that will probably not be collected. You may want to review
Exhibits 2 and 3 in the text as an illustration of how to prepare an aging schedule.
Emphasize that the analysis of receivables method emphasizes the accuracy of the
expected net realizable value of the receivables reported on the balance sheet. The
method of estimating uncollectibles based on sales emphasizes the accuracy of the
uncollectible accounts expense reported on the income statement.