Chapter 7-2
 
Previous Home Next
Lecture

Lesson

The problem with using the Direct Write-Off Method for writing-off a customer's uncollectible account is that the expense of the transaction may be recorded in a different fiscal period as the transaction to record the revenue. This conflicts with the accounting concept Matching Expenses with Revenues. For this reason, many businesses use the Allowance Method to record the revenue/expense associated with the transaction in the same fiscal period.

Allowance Method of Writing-Off Accounts
There are two methods discussed in this lesson that will estimate the amount a business thinks it cannot collect from customers: 1) the Percentage of Sales Method, and 2) the Percentage of Accounts Receivable Method. Either method estimates a percent that the business thinks will be uncollectible and multiplies it by either Sales or Accounts Receivable. The result of the equation expense to the business. The expense associated with the write-off is debited to the Uncollectible Accounts Expense (the same for either method). Because a business is estimating what it thinks will not be collected, the credit part of the transaction CANNOT be recorded in Accounts Receivable. Only when a customer is identified as being uncollectible, can the Accounts Receivable account be used. Instead, the credit will be recorded in an account called Allowance for Uncollectible Accounts (which is a contra-account to Accounts Receivable).

Allowance for Uncollectible Accounts
Debit Side

Decrease —

Credit Side
Normal Balance
Increase +


 

 

Worksheet Entry

Notice in the adjusting entry above, Allowance for Uncollectible accounts has a previous balance of $25.87 on the Trial Balance. This means $25.87 was the amount remaining from the prior year's estimate. As customer's are identified as uncollectible, the amount is removed from Allowance for Uncollectible Accounts and recorded in Accounts Receivable. If the balance of Allowance for Uncollectible Accounts keeps increasing every year, it means the percentage being used to calculate the estimate is probably too high.

Aging Accounts Receivable
When I previously worked in accounting, the auditors we worked with always asked for an "Aging of Accounts Receivable." This is a detailed list of the customer's who owe you money, categorized by when it was due. It is assumed that the longer an account is past-due, the greater the chance the customer will not pay you back. The first step is to categorize customer's by when the accounts receivable are due ...

Aging AR

Notice each column has a percentage noted as the percent the business thinks it will not be able to collect. The more past-due items are, the higher the percentage. The second step is to take the total of each date column and times it by the percentage estimated to be uncollectible ...

Calculating Uncollectible Estimate

From the example above, the amount thought to be uncollectible is $215.09. With this method, that should be the remaining balance in the Allowance for Uncollectible Accounts account. The $215.09 is NOT your adjustment. The third step is to determine what the current balance is in the Allowance for Uncollectible Accounts account, then create an adjustment that will make the balance of that account $215.09. The adjustment is recorded on the worksheet.

T-Accounts

Writing-Off an Account with the Allowance Method
Once a customer has been identified as uncollectible, the amount is removed from the Accounts Receivable account. With the Allowance Method, Accounts Receivable is debited and the Allowance for Uncollectible Accounts account is credited. By crediting this account, you are removing the estimate because it is no longer an estimate—it is reality. The Uncollectible Accounts Expense account is not used when writing-off an account. This account is only used when creating the adjustment entry to estimate the amount thought to be uncollectible.

January 5
Wrote off Candace Rhode's past due account as uncollectible, $42.80. memorandum No. 71.

Writing Off an Account

Every once in awhile, a customer you have written-off will repay you. Just like the Direct Write-Off Method, two transactions are needed to record the payment: 1) one entry to re-open the account and 2) a second entry to record the payment.

April 5
Received cash in full payment of Candace Rhode's account, previously written off as uncollectible, $42.80. Memorandum No. 92 and Receipt No. 280.

Reopening an Account

The main difference between the Direct Write-Off Method and the Allowance Method is Step 1 (above). In the Allowance Method, the account credited is Allowance for Uncollectible Accounts. The account Collection for Uncollectible Accounts is NOT used with the Allowance Method.

Video Tutorials
Watch the videos below for a demonstration of how to write-off uncollectible accounts using the Allowance Method.

Video Writing Off Uncollectible Accounts: Allowance Method
Percentage of Sales & Aging of Accounts Receivable

Click HERE or on camera to start video
Video Writing Off Uncollectible Accounts: Allowance Method
Application 7-4

Click HERE or on camera to start video
   
Assignments

Application (using Aplia)


  • Work Together 7-2
  • On Your Own 7-2
  • Application 7-4
   
FAQ

Frequently Asked Questions


No questions so far. Check back later.

   
Previous Home Next