2. Accounts Receivable and Uncollectible Accounts
Chapter 15
Accounts Receivable and Uncollectible Accounts
Section 1: The Allowance Method Of Accounting For Uncollectible Accounts.
Section Objectives
Chapter 14 discussed development of generally accepted accounting principles and the accounting assumptions and modifying constraints that affect those principles. Chapter 15 focuses on accounts receivable and the accounting adjustments needed for bad debts. In objective 1 of the chapter, we will learn how to record the estimated expense from uncollectible accounts receivable using the allowance method. In objective 2 we will learn how to charge off uncollectible accounts using the allowance method. Finally, in objective 3 we will learn how to record the collection of an account that had been previously written off.
1. Record the estimated expense from uncollectible accounts receivable using the allowance method.
2. Charge off uncollectible accounts using the allowance
method.
3. Record the collection of accounts previously written off
using the allowance method.
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© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

3. Bad Debts
Losses from uncollectible accounts are a normal cost of doing business.
Methods used for writing off accounts that are determined to be uncollectible include the:
In every business, losses from uncollected accounts receivable are considered a normal cost of doing business.
There are two methods of accounting for uncollectible accounts. They are the allowance method and the direct charge-off method. Both methods are generally accepted methods.
Allowance Method
Direct Charge-Off Method

4. What is the allowance method?
QUESTION:
What is the allowance method?
The allowance method is the method of charging uncollectible accounts expense in the period when the sales are recorded.
ANSWER:
What is the allowance method of writing off uncollectible accounts? The allowance method is a technique of charging bad debt expense in the period when sales are recorded.

5. Allowance Method Estimates losses from uncollectible accounts.
Matches uncollectible accounts expense to sales.
Uses a valuation account (Allowance for Doubtful Accounts).
In addition to estimating losses from uncollectible accounts, the allowance method matches bad debt expense to sales, and used a contra-asset account called Allowance for Doubtful Accounts to reduce the overall amount of accounts receivables that will be collected.

6. What is the direct charge-off method?
QUESTION:
What is the direct charge-off method?
The direct charge-off method is the method of recording uncollectible accounts losses as they occur.
It is also the method used for tax purposes as the Allowance Method is not allowed.
ANSWER:
What is the direct charge-off method? The direct charge-off method is not an estimating method of recording bad debt expense. It is a method that only records a bad debt expense when the uncollectibility of a particular account is determined. Also, the direct charge-off method is the only method recognized for income tax reporting purposes.

7. Objective 1
Record the estimated expense from uncollectible accounts receivable using the allowance method.
The first objective of this chapter is to record the estimated expense from uncollectible accounts receivable using the allowance method.

8. Using the Allowance Method
Recording the adjusting entry to record Uncollectible Accounts Expense is based on an estimate of bad debts for the period.
Debit Credit
Dec Uncollectible Accounts Expense
Allowance for Doubtful Accounts
To record estimate of bad debts expected
The allowance method begins by making an adjusting entry to uncollectible accounts expense based upon an estimate of bad debts for the period in question.

9. Allowance for Doubtful Accounts Uncollectible Accounts Expense
Allowance Method of recording bad debts uses two new accounts:
Allowance for Doubtful Accounts
Is a Contra-asset account.
Is reported as a subtraction from the Accounts Receivable account on the Balance Sheet.
Contains the estimate of accounts receivable deemed uncollectible.
Uncollectible Accounts Expense
Is reported on the Income Statement as an expense account.
The allowance method uses two new accounts: allowance for doubtful accounts and uncollectible accounts expense. The uncollectible accounts expense is reported on the income statement as a regular expense account. Allowance for doubtful accounts is a contra-asset account and is reported as a subtraction from accounts receivable on the balance sheet. Both accounts contain an estimate of the accounts receivable deemed to be uncollectible.

10. Balance Sheet (partial)
Carol’s Curtains
Balance Sheet (partial)
December 31, 2010
Current Assets:
Cash $ 9,320
Accounts Receivable $46,400
Less Allowance for Doubtful Accounts ,900 $44,500
Notice how on the balance sheet the balance of the allowance for doubtful accounts total is subtracted from the total accounts receivable balance to yield an amount that is actually expected to be collected from customers. In this particular example, the allowance for doubtful accounts balance of one-thousand nine hundred dollars is subtracted from the total accounts receivable balance of forty-six thousand four hundred dollars to give a net accounts receivable balance of forty-four thousand five hundred dollars.
On the Balance Sheet the balance in the Allowance account is subtracted from the balance in Accounts Receivable.
$44,500 is the amount actually expected to be collected from customers.

11. When using the Allowance Method
There are three ways to estimate uncollectible accounts expense:
Percentage of net credit sales
Aging the accounts receivable
Percentage of total accounts receivable
When using the allowance method, there are three ways to estimate the amount of uncollectible accounts expense. They include the percentage of net credit sales method; the aging of accounts receivable method; and the percentage of total accounts receivable method.

12. Percentage of Net Credit Sales
Multiply net credit sales by a percentage.
Percentage is based on the company’s previous experience.
New businesses base the percentage on the experience of businesses in the same industry.
The percentage of net credit sales method simply multiples the net credit sales of a company by a predetermined uncollectible percentage. The percentage of uncollectible accounts used is normally based on the company’s previous experience with uncollected accounts. If a company is just beginning and has no collection experience from which to base their decision, they normally will use an uncollectible percentage based on experiences of businesses in the same industry.

13. Percentage of Net Credit Sales
Percent estimated to be uncollectible x %
Total amount to write off $ ,500.00
2010
Dec Uncollectible Accounts Expense ,500.00
Allowance for Doubtful Accounts ,500.00
To record estimated uncollectible
accounts based on 0.5 percent
of net credit sales of $500,000
Notice how the amount of uncollectible accounts expense that is recorded as an adjusting entry is calculated by multiplying the net credit sales of five hundred thousand dollars by the predetermined uncollectible percentage of one-half percent.

14. Percentage of Total Accounts Receivable
Multiply the total amount of accounts receivable by a single percentage.
The percentage of total accounts receivable method multiplies the total amount of accounts receivable by a single percentage.

15. Percentage of Total Accounts Receivable
Accounts Uncollectible Date Receivable Accounts
12/31/04 $ 39, $ 2,083.00
12/31/ , ,145.00
12/31/ , ,240.00
Total $130, $ 6,468.00
Average $ 43, $ 2,156.00
To calculate the percentage used to estimate uncollectible accounts, take the average amount of accounts written off and divide that figure by the average accounts receivable. Multiply this percentage by the year end accounts receivable balance to yield the desired ending balance in the allowance for doubtful accounts account.
Average accounts written off
Average accounts receivable
$ 2,156 $43,453 5%
12/31/07 Accounts Receivable Balance = $49,000
Est. Uncollectible Accounts = $49,000 X 0.05 = $2,450

16. What is the amount of the adjustment?
Allowance for Doubtful Accounts is adjusted so that its ending balance is a $2,450 credit.
(Assume the beginning balance on the Allowance account is $118 credit.)
QUESTION:
What is the amount of the adjustment?
$2,450 Credit
118 Credit
Total estimated expense
+ or – beginning balance
The two-thousand four-hundred fifty dollar answer calculated in the previous slide is not the amount used in the adjusting journal entry. It is the desired ending balance in the allowance for doubtful accounts. The amount of the adjusting journal entry must take into consideration the prior balance in the allowance account. If the allowance account had a previous one-hundred eighteen dollar credit balance, the adjusting journal entry amount is two-thousand three-hundred thirty-two dollar. If the allowance account had a debit balance of one-hundred eighteen dollars, the correct adjustment amount would be two-thousand five-hundred sixty-eight dollars.
ANSWER:
$2,332 Credit

17. Third method of estimating your expected uncollectible accounts is by Aging the Accounts Receivable
Classify accounts receivable according to how long they have been outstanding.
The longer an account is past due, the less likely it is to be collected.
The third method of estimating uncollectible accounts is called the aging method. The aging method classifies accounts receivable according to how long they are past due. The major assumption underlying this method is the belief that the longer an account is past due, the great the likelihood the account will not be collected.

18. Aging the Accounts Receivable
CAROL’S CURTAINS
Schedule of Accounts Receivable by Age
December 31, 2010
Past Due - Days
Customer
Balance
Current
1 - 30
Over 60
Andrews, N.
820.00
820.00
Arrington, S.
Barton, S.
Notice how individual account receivable are separated into different time period categories. Those time periods include accounts that are current; those that are one to thirty days late; those that are thirty-one to sixty days late; and finally those accounts more than sixty days late. This slide shows examples of the first three customers, as well as the last customer. There would be other multiple customer accounts listed on a schedule such as this. In addition, schedules would use date intervals that best correspond to their needs.
257.00
37.00
200.00
20.00
Zant, R.
400.00
320.00
80.00
Totals
49,000.00
38,000.00
7,000.00

19. Aging the Accounts Receivable
Over 60 days past due X 2, $ 1,440.00
31–60 days past due X 1,
1–30 days past due X 7,
Current X 38,
Total estimated loss from doubtful accounts $ 2,370.00
Each time period category balance is then multiplied by an estimate of uncollectible percentage to yield a dollar estimate of uncollectible accounts expense. All of the time periods estimates of uncollectible accounts expense are then added together to once again yield the desired allowance for doubtful accounts balance. Notice too how the percentage of uncollectible expense increases with each time category. In the current category, the estimated percentage of uncollectible accounts was only one-half of one percent, while in the over sixty day past due category, the estimated uncollectible percentage was sixty percent. Finally, in this example, the desired ending balance of the allowance for doubt accounts is two-thousand three-hundred seventy dollars.

20. What is the amount of the adjustment?
Allowance for Doubtful Accounts is adjusted so that its ending balance is a $2,370 credit balance.
Assume the beginning balance in the Allowance account is $118 credit.
QUESTION:
What is the amount of the adjustment?
$2,370 Credit
118 Credit
Total estimated expense
+ or – beginning balance
Notice once again that the two-thousand three-hundred seventy dollar amount calculated in the previous slide is not the adjusting journal entry amount. The two-thousand three-hundred seventy dollar amount is the desired ending balance in the allowance for doubtful accounts. The adjusting journal entry amount must take into consideration the previous balance in the allowance account. If the allowance account has a one-hundred eighteen dollar credit balance, the adjusting journal entry amount is two-thousand two-hundred and fifty two dollars.
ANSWER:
$2, Credit

21. Charge-off uncollectible accounts using the allowance method
Objective 2
Charge-off uncollectible accounts using the allowance method
The second objective in this chapter is to charge-off uncollectible accounts using the allowance method.

22. Recall that under the allowance method, an estimate of uncollectible accounts expense was already recorded.
Uncollectible
Accounts Expense
Allowance for
Doubtful Accounts XX XX
Remember that under the allowance method, uncollectible accounts expense and the allowance for doubtful accounts were estimated. No specific accounts were identified as uncollectible at the time the entry was made.
No specific accounts were identified as uncollectible.

23. Recording an Actual Uncollectible Account
Which account is debited?
Which account is credited?
For what amount?
For what amount?
Suppose that the account of James McDonald ($224) is determined to be uncollectible.
Which account is debited, and which account is credited? Also, what is the amount of the journal entry?

24. Recording an Actual Uncollectible Account
Allowance for Doubtful Accounts
Accounts Receivable
224
224
We debit allowance for doubtful accounts for two-hundred twenty-four dollar, the account balance, and credit accounts receivable for the same.

25. Accounts Receivable Subsidiary Ledger
James McDonald’s individual account in the accounts receivable subsidiary ledger is written off.
James McDonald’s individual account balance is written off in the accounts receivable subsidiary ledger.

26. What effect does the write off of a specific account have on the financial statements?
QUESTION:
The write off has no effect on the financial statements because the expense was recorded previously.
ANSWER:
What effect does the write-off of a specific account have on the income statements? The answer is the write-off of a specific account has no effect on financial statements.

27. Income Statement Balance Sheet
Writing Off a Specific Account
Income Statement
Balance Sheet
No effect on net income
Assets
The income statement is not affected because the bad debt expense had been previously recorded. The balance sheet is unaffected because both the account receivable account and the contra asset account allowance for doubtful accounts have been reduced equally.
Contra assets
No effect on net equity

28. Occasionally an account that was written off is later collected.
Collecting an account that was previously written off under the allowance method
Objective 3
Occasionally an account that was written off is later collected.
Two entries are necessary:
1. Reinstate the account receivable.
2. Record the collection of cash.
The third objective of this chapter to show the proper accounting treatment for collecting an account that was previously written off under the allowance method.
If an account that was previously written off as uncollectible is actually paid, two entries are necessary. First, the business must reinstate the account receivable, then it must record the collection of cash.

29. What does it mean to reinstate an account receivable?
QUESTION:
What does it mean to reinstate an account
receivable?
To reinstate an account receivable means to put back or restore an amount that was previously written off.
ANSWER:
What does it mean to reinstate an account receivable? Reinstating an account receivable means to put back or restore an amount that was previously written off.

30. Reinstating an Account Written Off Using the Allowance Method
20--
Feb Accounts Receivable/R. Stream
Allowance for Doubtful Accounts
To reinstate the account
receivable for Richard Stream
that was written off and then
collected in full
Cash
Accounts Receivable/R. Stream
To record the receipt of cash
Richard Stream on account
Notice how the first entry, a debit to accounts receivable and a credit to allow for doubtful accounts reinstates the account receivable balance of one-hundred sixty dollars. The second entry records the cash collection.

31. Accounts Receivable and Uncollectible Accounts
Chapter 15
Accounts Receivable and Uncollectible Accounts
Section 2: Applying the Direct Charge-off Method and Internal Control of Accounts Receivable.
Section two discusses applying the direct charge-off method and internal control of accounts receivable.
Section Objectives
4. Record losses from uncollectible accounts using the direct charge-off method.
5. Record the collection of accounts previously written off using the direct charge-off method.
6. Recognize common internal controls for accounts receivable.
McGraw-Hill
© 2009 The McGraw-Hill Companies, Inc. All rights reserved.

32. Using the Direct Charge-off Method.
Record losses from uncollectible
accounts using the direct charge-off method
Objective 4
Using the Direct Charge-off Method.
This method records Uncollectible Accounts Expense at the time that a specific customer’s account is deemed uncollectible.
Debit Credit
July 5 Uncollectible Accounts Expense
Accounts Receivable/Mike May
(To write-off Mike Mays account
because customer cannot be
located.)
The fourth objective of this chapter is to record losses from uncollectible accounts using the direct charge-off method.
The direct charge-off method only records uncollectible accounts expense at the time a specific customer’s account is deemed uncollectible. There is no estimating of uncollectible accounts expense as calculated under the allowance method.

33. Direct Charge-Off Method
Does not match revenue and expenses (Matching Principle).
Can overstate accounts receivable on the balance sheet.
The only method allowed for income tax purposes.
Two disadvantages of the direct charge-off method include (1) the method does not match revenue with expenses, and (2) the method can overstate accounts receivable on the balance sheet. However, the direct charge-off method is the only approved method for income tax purposes.

34. Objective 5
Record the collection of accounts previously written off using the direct charge-off method
The fifth objective of this chapter is to record the collection of accounts previously written off using the direct charge-off method.

35. Reinstating an Account Written Off Using the Direct Charge-Off Method
(Payment was received in the same period as the write-off. . .)
2010
Oct Accounts Receivable/Mike Mays
Uncollectible Accounts Expense
(To reinstate the account
receivable for Mike May
that was written off and then
collected in full)
Cash
Accounts Receivable/Mike Mays
(To record receipt of cash payment from Mike May on account)
Like the allowance method when payment is received from a person whose account was previously written off, the company must first reinstate the account receivable, then record the collection of cash. If payment is made in the same period as the write-off, a credit entry is made to uncollectible accounts expense.

36. Reinstating an Account Written Off Using the Direct Charge-Off Method
(Payment was received in a period subsequent to that in which account was written off. . .)
2011
Jan Accounts Receivable/Mike Mays
Uncollectible Accounts Recovered
(To reinstate the account
receivable for Mike May
that was written off in the previous
year and paid in full this day.)
Cash
Accounts Receivable/Mike Mays
(To record receipt of cash payment
from Mike May on account)
If payment is made in a period subsequent to the write-off, notice how we credit the uncollectible accounts recovered account. The entry for the collection of cash is the same.

37. Accounting for Other Receivables and Bad Debt Losses
Any company that extends credit is likely to have some type of uncollectible receivable.
As with accounts receivable, notes receivable and other receivables can prove uncollectible.
Losses from uncollectible notes receivable and other receivables can be handled by the direct charge-off method or the allowance method.
If a company has bad debt losses from notes receivable and other receivables, the direct charge-off method or the allowance method can be used.

38. Internal Control of Accounts Receivable
Recognize common internal controls for accounts receivable
Objective 6
Internal Control of Accounts Receivable
Authorization of all credit sales.
Procedures to properly record sales.
Separation of duties.
Invoices and monthly statements.
The sixth objective of this chapter is to review internal controls for accounts receivable.
Proper internal controls for accounts receivable include: 1) authorization of all credit sales; 2) procedures to properly record sales; 3) separation of duties; 4) proper accounting for all invoices and monthly statements.

39. Internal Control of Accounts Receivable
Authorize charge-off of accounts.
Aging of accounts receivable.
Investigation of past due accounts.
Written approval of all write-offs.
Continued efforts to collect written-off accounts.
Further, proper internal controls warrant the: authorization for charge-off accounts; require an aging of accounts receivable; investigation of past due accounts; written approval of all write-offs; and require continued efforts to collect written-off accounts.

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