Unit 2: accounting for receivables introduction

(C) Recovery of Uncollectable Accounts

Occasionally, a company collects from a customer after has been written off as uncollectable. Two entries are required to record the recovery of bad debts:

1. 
   The entry made in writing off the account is reversed to reinstate the customer’s account.
   
2. 
   The collection is journalized in the usually manner.
   

To illustration, assume that on July 1, Gemechu co. pays the br 500 amounts that had been written off on March 1. The entries are:

July Accounts receivable- Gemechu co 500

Allowance for doubtful accounts 500
(To reverse write-off of Gemechu Co accounts)

July1 Cash 500

Account receivable- Gemechu Co 500
Note that the recovery of bad debt, like the writer off of bad debt, affects only balance sheet accounts. The net effect of the two entries above is a debit to Cash and credit to Allowance for Doubtful Accounts for Br 500. Accounts Receivable is debited and the Allowance to Doubtful Accounts is credit for two reasons: First, the company made an error in judgment when it wrote off the account receivable. Second, Gemechu Co did pay, and therefore the Accounts Receivable account should show this collection for possible future credit purposes.

Estimating Bad Debts Expense

How does a company estimate bad debts expense?

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To simplify the preceding explanation, the amount of the expected uncollectible was given. However, in “real life” companies must estimate the amount if they use the allowance method. Two bases are used to determine this amount.

(a) Percentage of sales and

(b) Percentage of receivables.

Both bases are generally accepted in accounting. The choice is a management decision. It depends on the relative emphasis that management wishes to give to expense and revenues on one hand or to cash realizable value of the accounts receivable on the other. The choice is whether to emphasize income statement or balance sheet relationship.

The percentage of sales basis results in a better matching of expenses with revenues- an income statement viewpoint. In contrast, the percentage of receivables basis produces the better estimate of cash realizable value – a balance sheet viewpoint. Under both bases, it is necessary to determine the company’s past experience with bad debt losses.