University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

378

Pages:

2
Author:

stud_ice13

The allowance method for accounts receivable is a way to account for potential losses from uncollectible accounts by estimating bad debts in the same period as the related sales. This approach allows companies to reflect a more accurate financial picture, as it recognizes potential losses earlier rather than waiting until specific debts are deemed uncollectible. Key Points of the Allowance Method: 1. Estimation of Bad Debts: At each period's end, companies estimate the expected uncollectible amount based on the sales generated in that period, which helps align bad debts expense with revenue. This estimated bad debts expense is recorded with an adjusting entry, ensuring that accounts receivable on the balance sheet reflect a realistic amount expected to be collected. 2. Advantages Over Direct Write-Off Method: o It matches bad debts expense with the period's sales, reflecting expenses more accurately in the income statement. o It reports accounts receivable at their net realizable value on the balance sheet, which is the expected collectible amount. 3. Recording Bad Debts Expense: o For instance, if TechCom has $300,000 in credit sales and anticipates $1,500 as uncollectible, it makes an adjusting entry to record this estimated bad debt. This entry reduces the Allowance for Doubtful Accounts (a contra asset account), which in turn reduces the reported value of accounts receivable. o In the example, even though customers owe TechCom $20,000, the balance sheet shows only $18,500 as the realizable value, accounting for the estimated uncollectible amount. 4. Writing Off Specific Accounts: When a specific account (e.g., J. Kent’s $520) is deemed uncollectible, it’s removed from Accounts Receivable and written off against the Allowance for Doubtful Accounts. This action does not impact total assets or net income because the bad debts expense was already recorded in the period the sales occurred. 5. Recovery of Written-Off Accounts: If a previously written-off account is later paid, two entries are made: o The first reverses the write-off and reinstates the customer’s account. o The second records the payment received. 6. Use of Data Analytics: Financial institutions often employ data analytics (e.g., credit scores, income data, and payment history) to predict credit risks more effectively, guiding decisions around extending or limiting credit. Example Transactions: • • • Estimate for Bad Debts: If a retailer expects $3,000 of accounts receivable to be uncollectible by year-end, it records an adjusting entry to reflect this estimate. Writing Off an Account: If $400 from a customer named ZZZ Company is uncollectible, it’s written off against the Allowance for Doubtful Accounts. Recovery of Bad Debt: If ZZZ Company later pays its debt, the retailer reinstates the account and records the payment. This method ensures that accounts receivable and bad debts expense align with the revenue and financial position at any period’s end, thereby offering a clearer view of anticipated receivables and financial health.