Valuing Accounts Receivable
• Some receivables will become uncollectible
– Not reported as assets if no future benefit
– Net realizable value: the collectible amount
• Receivables are written down to their collectible
amount
– By recording bad debt expense
– In the same period as related revenues are
recorded: matching of revenues and expenses
The Allowance Method
Three features of allowance method:
1. Amount of uncollectible receivables is estimated
and recorded at end of period
2. Specific amounts determined uncollectible are
written off against the allowance
3. Specific amounts that are recovered are reversed
out of allowance and the collection recorded
1. Recording Estimated Uncollectibles
Assume that $24 000 of receivables are assumed to be uncollectible.
The journal entry is as follows:
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
To record estimate of bad debts expense
24,000
24,000
Allowance for Doubtful Accounts
• Deducted from Accounts Receivable in the current assets
section of balance sheet – contra asset account
• Net Realizable value = Accounts Receivable less
Allowance for Doubtful Accounts
• Look at p.415 for presentation in financial statements
Two Methods for Estimating the Allowance:
A. Percentage of Sales
• Calculates bad debt expense as a percentage of net credit sales
– Based on past experience and company’s credit policy
– Example: 2% of credit sales of $1,200,000 = $24,000
– The adjusting entry would be:
Bad Debts Expense
24 000
Allowance for Doubtful Accounts
24 000
• Better matches revenues and expenses
• When calculating the adjusting entry the existing balance in the Allowance
for Doubtful Accounts is ignored
• The amount should be compared to what is actually written off, if it is
significantly different than a different percentage should be used.
• Also called the income statement method
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B. Percentage of Receivables
Calculates the percentage of receivables that are estimated to be
uncollectible
• Based on past experience and credit policy
Can be applied to total receivables balance or amounts grouped by age
• Requires an aging schedule to be prepared – this is easy to do in a
computerized system
Better estimate of net realizable value – therefore the one usually used
See page 416 for an example of an aging schedule
The balance in the allowance for doubtful accounts must be taken into
account.
For example, if a company has a balance of $5 000 and needs an allowance
of $20 000, an adjusting entry of $15 000 (20 000 – 5 000) would be made
Bad debts expense
15 000
Allowance for Doubtful Accounts 15 000
Also called the balance sheet method
Comparison of Approaches
Percentage of Sales
Percentage of Receivables
Matching
Sales
Net Realizable Value
Bad Debts
Expense
Income Statement
Approach
Accounts
Receivable
Allowance for
Doubtful
Accounts
Balance Sheet Approach
2. Recording Write-Off of an Uncollectible
Account
• When collection has been tried and it appears impossible, the receivable
needs to be written off
• To keep good internal control write-offs should be approved by
management
• Assume that the accounts receivable from Kids Online of $4500 has been
deemed uncollectible, the journal entry for the write-off would be as
follows:
Mar. 1 Allowance for Doubtful Accounts
Accounts Receivable - Kids Online
Write-off of uncollectible account
4,500
• Only Balance Sheet accounts are affected for a write-off – the Net
Realizable Value is not affected.
4,500
3. Recovery of an Uncollectible Account
• If a company ends up collecting cash from a customer that had
previously been written off, two entries need to be made.
• The entry to write off the account needs to be reversed to restore
the customer’s account
• The collection is recorded in the normal way
• Assume the Kids Online account was subsequently collected, the journal
entries would be as follows.
July 1 Accounts Receivable - Kids Online
Allowance for Doubtful Accounts
To reverse write-off of Kids Online account
4,500
July 1 Cash
Accounts Receivable - Kids Online
To record collection from Kids Online
4,500
4,500
4,500
Homework
• BE8-5,6,7,8,9