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Uncollectible Accounts

Uncollectible accounts / doubtful accounts / bad debts


• Refers to losses sustained because the business is unable to collect all of its
receivables.

Reasons
1. Financial reverses suffered by the customers.
2. Poor credit selection processes
3. Poor or inadequate collection services.

Methods of Recording Uncollectibles


1. Direct Write off
 No entry is made until a specific account has definitely been established as
uncollectible.
 The bad debts are recorded in the year it is determined to be uncollectible.
 Facts, not estimates, are recorded.
 Simple and convenient to apply.
 Does not match costs with revenues.
 Does not state receivables at estimated realizable value.

2. Allowance Method
 An estimate is made of the expected uncollectible accounts every end of the
period.
 Proper matching of expenses and revenues
 Results in proper carrying value of receivables
 Estimates are based from past experiences and market condition
 Considered more appropriate.
 Two estimation methods

a. Percentage of sales or income statement method


• Based on a relationship between charge sales and bad debts.
• Rate of uncollectability is applied to a related income account
• Unaffected by any balance currently existing in the allowance
account
• Bad debts expense is computed as follows:
Bad debts expense = Sales/net sales/credit sales x % of
uncollectible

b. Percentage of receivables or balance sheet method


• Based on a relationship between accounts receivable and bad
debts
• Provides a reasonable accurate estimate of the receivables’
realizable value.
• Affected by the balance in the allowance account.
• Bad debts expense is computed as follows:
1
Accounts receivable Pxxx
Rate of uncollectible %
Required allowance Pxxx
Less: Allowance before adjustment (Cr.) xxx
Bad debts expense Pxxx

• Aging of accounts receivable


- Classifies each receivable according to its age
- The longer an account is past due, the greater the likelihood
that it will not be collected in full.
- Applies a different percentage based on past experience to the
various age categories.

NOTE: Due to revisions in the accounting standards, Income Statement method is no


longer acceptable estimate of bad debts.

Pro-forma Entries

Allowance Method Direct Write-Off Method


Provision Bad debts expense xxx None
for bad Allowance for bad debts xxx
debts

Write-off Allowance for bad debts xxx Bad debts expense xxx
an Accounts receivable xxx Accounts receivable xxx
account

Recovery Accounts receivable xxx Accounts receivable xxx


of an Allowance for bad debts xxx Bad debts expense/
account Miscellaneous income xxx
that was
previously Cash xxx Cash xxx
written off Accounts receivable xxx Accounts receivable xxx

Allowance for bad debts xxx


Bad debts expense/ xxx
Miscellaneous income

OR
Cash xxx
Bad debts expense/ xxx
Miscellaneous income

2
Financial Statements Presentation

Allowance for Bad Debts – reported in the balance sheet as a deduction from
Accounts Receivable

Bad Debts Expense – reported in the income statement, generally as an administrative


expense

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