Advanced Accounting
Chapter 7: Accounting for Uncollectible Accounts
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Many business transactions are completed on account
(charged) instead of in cash
Offer credit to: attract new customers, increase sales to
current customers, encourage customer loyalty
BUT before offer credit should investigate creditworthiness –
run a credit report
Some customers won’t pay when account due – uncollectible
accounts or bad debts
The amount owed remains recorded in the Account
Receivable asset account until it is paid or specifically known
to be uncollectible
When a customer account is believed to by uncollectible, it is
no longer as asset
An uncollectible account should be cancelled and removed
from the assets of the business – writing off an account
Sometimes a written off account is collected, so the balance
is restored and the receipt of cash is recorded
Section 1: Direct Write-off method of Recording
Uncollectible Accounts
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An amount owed by a specific customer is part of the
accounts receivable account balance until it is paid or written
off as uncollectible
An uncollectible account is closed by transferring the balance
to a general ledger account – Uncollectible Accounts
Expense
Direct Write-off Method of recording losses from
uncollectible accounts: recording uncollectible accounts
expense only when an amount is actually known to be
uncollectible
o In General Journal, debit Uncollectible Accounts
Expense, and credit both Accounts Receivable and the
individual customer account.
o When posting, need to post to both AR and the
customer account, in the customer account need to
put the words “written off” in the description area
Sometimes a person who has been written-off will pay later
– so the amount is recorded as Other Revenue
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Collecting a written-off account using the direct write-off
method
o Record an entry in the general journal to debit
Accounts Receivable/customer name and credit
Collection of Uncollectible Accounts for the amount of
the receipt
o Record an entry on the cash receipts journal to debit
Cash and credit Accounts Receivable for the amount
of the receipt.
The account Collection of Uncollectible Accounts is closed to
Income Summary at eh end of the fiscal period and is
reported on an income statement as part of Other Revenue
Section 2: Allowance Method of Recording Uncollectible
Accounts Expense
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Problem with direct write-off method is that an expense may
be recorded in a fiscal period different from the fiscal period
of the sale
Uncollectible accounts expense should be recorded in the
same fiscal period in which the ales revenue is recorded
But, until an account is known to be bad, don’t really know
how many are going to go bad
As a result will use an estimation based on previous years
experience with uncollectible accounts
Two methods: percentage of sales method or percentage of
accounts receivable method
Percentage of sales method assumes that a percentage of
each sales dollar will become an uncollectible account
Percentage of accounts receivable method assumes that a
percentage of accounts receivable at the end of the fiscal
period will become uncollectible
Either way, the amount calculated is charged to Uncollectible
Accounts Expense
Estimating Uncollectible Accounts Expense by using the
Percentage of Sales method
o Compute the estimated uncollectible accounts
expense by multiplying net sales by the percentage
estimate
o Record an adjustment on the work sheet, recording a
debit to Uncollectible Accounts Expense and a credit
to Allowance for Uncollectible Accounts
Percentage of Accounts Receivable Method utilizes a concept
called aging accounts receivable
The older the account the less likely it will be
collected
o Each time period used is given a percentage of
unlikelihood of collection and each must be calculated
separately then added together to determine the
amount deemed uncollectible
Estimating the balance of uncollectible accounts expense
using the percentage of accounts receivable method
o Compute the estimate for each age group. Multiply
the amount of each age group by the percentage
estimate
o Compute the total of the uncollectible estimates
o Subtract the current balance from the total estimate
to determine the addition to the allowance account.
(If the allowance account has a debit balance, add
the current balance to the total estimate)
Procedures for writing off an account are the same
regardless of the allowance method used
When a specific customer account is thought to be
uncollectible, the account balance is written off by:
o In the General Journal: debit Allowance for
Uncollectible Accounts and credit both Accounts
Receivable and the Customer Account
The balance is no longer estimated to be uncollectible it is
actually determined to be uncollectible
Uncollectible Accounts Expense is not affected when a
business writes off an account using the allowance method.
Journalizing the collection of a written-off account –
allowance method
o Reopen the account by debiting Accounts Receivable
and Customer account and credit Allowance for
Uncollectible Accounts
o Record an entry in the cash receipts journal to debit
cash and credit Accounts Receivable and the
customer account for the amount of the receipt
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Section 3: Accounts Receivable Turnover Ratio
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If a business does not collect amounts due from customers
promptly, too large a share of the assets are tied up in
Accounts Receivable and not usable
Accounts Receivable Turnover Ratio: the number of times
the average amount of accounts receivable is collected
during a specified period
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Book value of accounts receivable: the difference between
the balance of Accounts Receivable and its contra account,
Allowance for Uncollectible Accounts
Average days required to pay: 365/accounts turnover ratio
Calculating the accounts receivable turnover ratio and
average number of days for payment
o Compute the beginning and ending book value of
accounts receivable
o Compute the average book value of accounts
receivable by adding the beginning book value to the
ending book value and dividing the total by 2
o Compute the accounts receivable turnover ratio by
dividing net sales on account by the average book
value of accounts receivable
o Computer the average number of days for payment
by dividing 365 days by the accounts receivable
turnover ratio
Steps to take to create a more favorable accounts receivable
turnover ratio
o Send statements out more often, with requests from
prompt payment
o Not sell on account to anyone who has an account
more than 30 days past due
o Encourage more cash sales and fewer sales on
account
o Conduct more rigorous credit checks on new
customers
Sometimes the demand for quicker payment can result in
the loss of customers, so need to balance service with
payment demands