Unit 2: accounting for receivables introduction

1.4.1 Allowance Method

The allowance method is required for financial reporting purpose when bad debts are material in amounts. Its essential features are:

1. Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred.

2. Estimated uncollectible are debited to Bad Debts Expense and credited to allowance for doubtful accounts through an adjusting entry at the end of each period.

3- Actual uncollectible are debited to allowance for doubtful accounts and credited to accounts receivable at the time the specific account is written off.

Recording Uncollectible Under Allowance Method

1. 
   Recording Estimated Uncollectible
   

To illustrate the allowance method, Assume that ABC Company has credit sales of Br. 1, 200, 000 in 1996, of which Br. 200,000 remain uncollected at December 31; The credit manager estimates that Br. 12,000 of these sales will prove uncollectible. The adjusting entry to record the estimated uncollectible is:

Dec. 31 Bad Debts expense - - - - - - - - - 12,000

Allowance for Doubtful Accounts - - - 12, 000
(To record estimate of uncollectible accounts)

Bad Debts expense is reported in the income statement as an operating expense (usually as selling expense). Thus, the estimated uncollectible are matched with sales in 1996 because expense is recorded in the same year the sales are made.

Allowance for doubtful accounts is a contra asset account that shows the claims of customers that are expected to become uncollectible in the future. A contra account is used instead of a direct credit to accounts receivable because we do not know which customers will not pay. The credit balance in this account will absorb the specific write-offs when they occur. Allowance for doubtful accounts is not closed at the end of the fiscal year. It is deducted from accounts receivable in the current asset section of he balance sheet as follows:

Current assets:
Cash __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ __ Br. 14,800