Writing Off Uncollectable Receivables Cornell University Division of Financial Services

If you’re making a write off entry in SAP, the your software should provide account aging reports that show you how long bills remain unpaid. You might decide to write off accounts after a certain time interval – for example 90 days. The allowance method is the accounting method that provides the provision of overall accounts receivable base on the estimation. They estimate the amount which can be uncollectible and record bad debt expenses and allowance for the doubtful account which is the A/R contra account. When any specific accounts receivable is uncollectible, the company will reverse accounts receivable and the contra account. However, sometimes the company doesn’t have the allowance for doubtful accounts as it follows the direct write off method instead.

The allowance for doubtful accounts will help to reflect the actual value on the accounts receivable that the company have (accounts receivable – allowance for doubtful accounts). After all, the receivables that the customer is not going to pay have no value as they are the assets that have no economic benefits inflow to the company. For example, the company ABC has accounts receivable from 4 customers in which 3 of the customers has overdue their payment for some days already. When the company receives cash for the credit sale on a later date, they will debit cash as it comes in and credit accounts receivable to settle the amount received in cash.

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When the firm makes the bad debts adjusting entry, it does not know which specific accounts will become uncollectible. Thus, the company cannot enter credits in either the Accounts Receivable control account or the customers’ accounts receivable subsidiary ledger accounts. If only one or the other were credited, the Accounts Receivable control account balance would not agree with the total of the balances in the accounts receivable subsidiary ledger.

  • Because customers do not always keep their promises to pay, companies must provide for these uncollectible accounts in their records.
  • It removes the accounts receivable from balance sheet to expenses on the income statement.
  • Likewise, the company makes the journal entry for accounts receivable to recognize the assets that it has a claim as well as to recognize the revenue that it has earned for the period.
  • In the same manner, bad debts or write-offs are considered contra-asset (since it is a loss from the company’s perspective).

After this adjusting entry is made, the Allowance for Bad Debts Account balance is restored back to $1500 on the credit side. It helps the company to reasonably estimate the amount that would be declared as uncollectible from the customers. In accordance with the prudence concept in accounting, accountants are supposed to prepare in advance for any unforeseeable losses.

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Units are expected to include accounts receivable write-offs as part of the internal control initiative and include the unit-specific process and materiality threshold. It is entirely possible that only a portion of the amount recorded on the books for an asset (known as its carrying amount) needs to be written off. For example, the market value of a fixed asset may now be half of its carrying amount, so you may want to write off just half of its carrying amount. However, a customer may have gone out of business, so all of the unpaid accounts receivable for that customer must be completely written off.

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Another way sellers apply the allowance method of recording bad debts expense is by using the percentage of credit sales approach. This approach automatically expenses a percentage of its credit sales based on past history. Direct Method of Writing off Accounts Receivables is mostly used by companies that have a relatively smaller amount of credit sales.

Accounts Receivable Journal Entry

Assuming the estimated losses from bad debt at the year-end of 2020 is USD 3,000, the company will need to make an allowance for doubtful accounts of USD 3,500 (3,000 + 500) in the adjusting entry. This is due to the company need to add the debt balance of USD 500 on to the required balance of USD 3,000. Usually, a write-off will reduce the balance of accounts receivable together with the allowance for doubtful accounts. This is the case in which the company uses the allowance method for an estimate of losses from bad debt. The journal entry above shows that the accounts receivable is directly credited under this approach, and the corresponding amount of bad debt, is written off as an expense in the income statement.

Since Allowance for Doubtful Debts is a contra-asset account, it has a credit balance, by default. At the start of the year, management decides to create a 2% provision for the bad debts. $9,000 shall be reported as an operating expense in his income statement
for the year ended 2019 and accounts receivable on his balance sheet shall be
reduced by this amount.

What is meant by Accounts Receivables Write-Off?

The journal entry is debiting bad debt expenses and credit accounts receivable. So, the company will need to make bad debt expense when writing off accounts receivable under the direct write off method. With the direct write-off method, many accounting periods may come and go before an account is finally determined to be uncollectible and written off. Companies commonly use either credit sales or the age of AR balances as the basis for their allowance estimates. The percentage you use will depend on the specific factors that affect your business, such as financial data from prior years. For example, if $100,000 of annual revenue relates to sales made on credit, the allowance estimate will equal the percentage chosen multiplied by the $100,000.

Does the Write Off of an Uncollectible Account Affect Total Assets?

It would be double counting for Gem to record both an anticipated estimate of a credit loss and the actual credit loss. The allowance method follows GAAP matching principle since we estimate uncollectible accounts at the end of the year. We can calculate this estimates based on Sales (income statement approach) for the year or based on Accounts Receivable balance at the time of the estimate (balance sheet approach). Under the provision method, when you determine that a customer is unlikely to pay, you enter a debit to the provision for bad debt account and a credit to A/R for the written-off amount.

Any such customers might not be able to pay back the debt due to their deteriorating financial position. For example, one of your customers may have faced a huge loss or is maybe facing liquidity issues or may have huge loans to pay off. Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Once the business has been in operation for a considerable time frame, they can reasonably estimate the percentage of collectibles, which might not honor their debt. Make sure to consult your accounting professional before trying any of these options.

Without crediting the Accounts Receivable control account, the allowance account lets the company show that some of its accounts receivable are probably uncollectible. The percentage of credit sales approach focuses on the income statement and the matching principle. Sales revenues of $500,000 are immediately matched with book vs market value $1,500 of bad debts expense. The balance in the account Allowance for Doubtful Accounts is ignored at the time of the weekly entries. However, at some later date, the balance in the allowance account must be reviewed and perhaps further adjusted, so that the balance sheet will report the correct net realizable value.


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