1. Accounts Receivables PAST DUE
No matter how thorough a business checks a customer’s credit, there will be some customers who cannot or will not pay what they owe. These AR that cannot be collected are called Uncollectible Accounts or Bad Debts.
Up to this point in the course, it’s been unrealistically assumed that all of the Accounts Receivable will be collected. In reality, payment will not be received for some Accounts Receivable.
Companies must account for the fact that some customers may not be able to pay the amounts they owe.
PAST DUE

2. Methods of Accounting for Uncollectibles
Allowance Method
Direct Write-off
PAST DUE

3. When you use the Direct Write-off Method, you write off the account when it is determined to be uncollectible
What? They went bankrupt!!!
But, this method does not follow the matching principle
Therefore, businesses with many Account Receivables will use the Allowance method that matches revenue with expenses

4. Uncollectible Accounts—the Allowance Method
At the end of each period, record an estimate of the uncollectible accounts.
At the end of the period, a company estimates how much of its accounts receivable will not be collected. This estimate is based on past collection history and current economic information. Remember that when this estimate is made, it’s not known specifically WHO will not pay. If that was known, they would never have been sold to on credit in the first place, right?
The entry requires a debit to Uncollectible Accounts Expense and a credit to Allowance for Doubtful Accounts for the estimated amount. Why isn’t Accounts Receivable credited in this entry? Remember, this recording is an estimate of uncollectible accounts, and it’s not known specifically WHO will not pay. If Accounts Receivable was credited, which customer’s account would be used? Because of this unknown, the Allowance for Doubtful Accounts account is credited.
Uncollectible Accounts Expense is classified as a selling expense on the Income Statement. Allowance for Doubtful Accounts is a contra-asset account and has a normal credit balance. It is reported on the balance sheet as a subtraction from the Accounts Receivable balance to arrive at the amount of accounts receivable that is likely to be collected.
Selling expense
Contra-asset account

5. Writing Off an Uncollectible Account Receivable
When an account is determined to be uncollectible, it no longer qualifies as an asset and should be written off.
Now, let’s see what happens when it’s been determined that a specific customer will not be able to pay the amount owed.
When using the allowance method, write off an uncollectible account to Allowance for Doubtful Accounts.
The company debits Allowance for Doubtful Accounts and credits Accounts Receivable. Now that the specific customer involved is known, the customer is noted in the transaction so the proper entry in the Accounts Receivable ledger can be made.

6. The Allowance for Doubtful Accounts
The net realizable value is the amount of accounts receivable that the business expects to collect.
On the balance sheet, the Allowance for Doubtful Accounts is subtracted from the Accounts Receivable balance. The reported value is called net realizable value and is the amount of Accounts Receivable that will likely be collected.

7. Example: Writing Off an Uncollectible Account Receivable
Assume that on January 5, K-Max determined that Jason Clark would not pay the $500 he owes.
K-Max would make the following entry.
Assume that K-Max determines that Jason Clark’s five hundred dollar account receivable is uncollectible. What entry would K-Max make?
K-Max would debit Allowance for Doubtful Accounts and credit Accounts Receivable for five hundred dollars.

8. Monthly Estimates of Credit Losses
At the end of each month, management should estimate the probable amount of uncollectible accounts and adjust the Allowance for Doubtful Accounts to this new estimate.
There are two methods to estimate uncollectible accounts. One method is the Balance Sheet Approach and the other is the Income Statement Approach. Let’s look at the Balance Sheet Approach first.
Two Approaches to Estimating Credit Losses:
Balance Sheet Approach
Income Statement Approach

9. Estimating Credit Losses — The Balance Sheet Approach
Year-end Accounts Receivable is broken down into age classifications.
Each age grouping has a different likelihood of being uncollectible.
When using the Balance Sheet Approach, first classify the Accounts Receivable by age. Second, for each age group determine the likelihood of being uncollectible. Third, for each age group calculate a separate allowance amount. Finally, add up all the allowance amounts to get the balance in the Allowance for Doubtful Accounts.
Let’s see an example of how the aging of accounts receivable works.
Compute a separate allowance for each age grouping.

10. Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
First, EastCo’s accounts receivable have been broken up into aged categories such as current, 1 to 30 days past due, 31 to 60 days past due, and so on.

11. Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
Then, for each of these age groups, it was determined how much would be uncollectible. For the current age group, one percent is expected to be uncollectible. For the 1 to 30 days past due age group, three percent is expected to be uncollectible, and so on. Notice that the older the age group the higher the uncollectible percentage.

12. Estimating Credit Losses — The Balance Sheet Approach
At December 31, the receivables for EastCo, Inc. were categorized as follows:
Next, the balance of each age group is multiplied by its uncollectible percentage. Then, all of the uncollectible amounts are added up to one thousand three hundred fifty dollars, and this should be the balance in the Allowance for Doubtful Accounts.

13. Estimating Credit Losses — The Balance Sheet Approach
EastCo’s unadjusted balance in the allowance account is $500.
Per the previous computation, the desired balance is $1,350.
Assume EastCo already had a five hundred dollar balance in Allowance for Doubtful Accounts.
Since the balance should be one thousand three hundred fifty dollars, the account will need to be credited for eight hundred fifty dollars.
The entry would be to debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for eight hundred fifty dollars.

14. Let’s look at another way to estimate credit losses!
Now, let’s look at the Income Statement Approach to estimate credit losses.

15. Estimating Credit Losses — The Income Statement Approach
Uncollectible accounts’ percentage is based on actual uncollectible accounts from prior years’ credit sales.
Focus is on determining the amount to record on the income statement as Uncollectible Accounts Expense.
When using the Income Statement Approach, the estimate at the end of the period is determined by taking current period sales and multiplying by an established bad debt percentage. The bad debt percentage is determined based on past history of the company and current economic trends. The sales transactions included in this computation are typically only the credit sales. There are not any collection issues to consider for cash sales transactions.

16. Estimating Credit Losses — The Income Statement Approach
The credit loss estimate is calculated as net credit sales times the estimated uncollectible percentage.

17. Estimating Credit Losses — The Income Statement Approach
In 2010, EastCo had credit sales of $60,000.
Historically, 1% of EastCo’s credit sales has been uncollectible.
For 2010, the estimate of uncollectible accounts expense is $600.
($60,000 × .01 = $600)
Now, prepare the adjusting entry for December 31,
EastCo has credit sales of sixty thousand dollars in Management estimates that one percent of credit sales will eventually prove to be uncollectible. What is East Company’s adjusting entry for uncollectible accounts in 2007?

18. Estimating Credit Losses — The Income Statement Approach
EastCo would debit Uncollectible Accounts Expense and credit Allowance for Doubtful Accounts for six hundred dollars, which is one percent of sixty thousand dollars in credit sales.

19. Recovery of an Account Receivable Previously Written Off
Occasionally a customer who was previously written off will pay you!
In order to record recovery of a previous bad debt, you must first reinstate the account (Put it back on the accounting books):
Ex: Discount Dan sends you a check for payment in full, $4,000. His account was previously written off.
First, reinstate the account:
Debit: A/R Discount Dan $4,000
Credit: Allowance for Doubtful Accounts $4,000

20. Now the entry to record the payment should be:
Debit: Cash $4,000
Credit: A/R Discount Dan $4,000