How to Estimate Uncollectible Accounts

This account serves to show the real value of a company’s accounts receivable as it records the portion of the accounts receivable which has been deemed uncollectible by the company. This estimation is made to account for a certain amount of debt that may have to be written off within a given period. It is thus, also referred to as the provision for bad debts or provision for doubtful debts, or provision for losses on accounts receivable. You estimated that $1,000 worth of accounts from 2017 sales would be uncollectible in 2018. During 2018, $900 worth of accounts proved uncollectible, leaving you with a credit balance of $100 in the allowance for doubtful accounts ledger account.

This variance in treatment addresses taxpayers’ potential to manipulate when a bad debt is recognised. If the account has an existing credit balance of $400, the adjusting entry includes a $4,600 debit to bad debts expense and a $4,600 credit to allowance for bad debts. Allowance for doubtful accountsBad journal entry for estimated uncollectible accounts debt expenseAllowance for doubtful accounts or allowance for uncollectible accounts is an estimation of the AR that a business expects to go unpaid. It is deducted from the total AR of a company even before a customer defaults. Customers who don’t pay on time are categorized as doubtful accounts.

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This application probably violates the matching principle, but if the ATO did not have this policy, there would typically be a significant amount of manipulation on company tax returns. For example, if the business wanted the deduction for the write-off in 2021, it might claim that it was actually uncollectible in 2021, instead of in 2022. This method also does not provide the best estimate of how accounts receivable affect expected cash inflow for the business. So, when a company estimates it will have $15,000 in bad debt, they debit bad debt expense on the balance sheet and credit the allowance for doubtful accounts. This provides the business reasonable assurance that if the sale is made on credit, the business can collect what is owed.

If the balance in the Allowance for Uncollectible Accounts is presently a credit balance of $1,500, the entry needed is a $4,500 credit to Allowance for Uncollectible Accounts, and a $4,500 debit to Uncollectible Accounts Expense. Companies that use the percentage of credit sales method base the adjusting entry solely on total credit sales and ignore any existing balance in the allowance for bad debts account. If estimates fail to match actual bad debts, the percentage rate used to estimate bad debts is adjusted on future estimates.

How can HighRadius help reduce the number of doubtful accounts?

It is critical to have an allowance for doubtful accounts as it indicates the bad debt expense a company expects to incur. The estimated bad debts represent the existing customer claims expected to become uncollectible in the future. After the accounts are arranged by age, the expected bad debt losses are determined by applying percentages, based on past experience, to the totals of each category. Uncollectible accounts receivable are estimated and matched against sales in the same accounting period in which the sales occurred. The allowance method is required for financial reporting purposes when bad debts are material. Assume further that the company’s past history and other relevant information indicate to officials that approximately 7 percent of all credit sales will prove to be uncollectible.

The two main methods of estimating Uncollectible Accounts Receivable are the percentage-of-net-sales method and the aging method. The percentage-of-net-sales method is the simpler of the two and involves calculating an allowance based on a percentage of net sales. The aging method is more complex and requires analyzing customer accounts to determine their collectibility.

Allowance Method for Bad Debt Example

The Allowance for Doubtful Accounts account can have either a debit or credit balance before the year-end adjustment. Under the percentage-of-sales method, the company ignores any existing balance in the allowance when calculating the amount of the year-end adjustment . Mechanically, the underestimation still exists in the accounting records in Year Two. It creates the $3,000 debit in the allowance for doubtful accounts before the expense adjustment.