Uncollectible accounts receivable are the accounts receivable that a company cannot collect. When the conclusion is reached that a receivable is not collectible, that amount is written off, or removed from the company’s books. Since that sale was originally recorded as revenue, this action has the effect of reducing income.
The allowance method of accounting for collectible accounts is also known as the reserve method because it provides in advance for uncollectible receivables. This provision for uncollectibility is made through an adjusting entry performed at the end of a fiscal period and serves two purposes. It reduces the value of receivables to the amount of cash expected to be received and allocates the expected expense associated with this reduction to the current fiscal period.
The amount of provision to be established can be calculated several different ways. One method involves the careful examination of each customer’s account to determine the probability of collection. Those deemed questionable as to collectibility are then totaled and that amount will be used as the provision amount. A simpler method involves a percentage estimate of uncollectible accounts based on outstanding receivables. Many businesses have found that the percentage of uncollectible accounts varies little from year to year and therefore feel comfortable making provisions based on this historical figure.
Once the provision amount is established, that figure will be debited to uncollectible accounts expense or bad debts expense and credited to allowance for doubtful accounts. For example, assume that Company ABC has outstanding accounts receivable totaling $100,000 as of December 31. After examination of the individual accounts, management believes all but $5000 is likely to be collected. The adjusting entry to reflect the provision for uncollectible accounts is shown in diagram.
The debit balance of $100,000 in outstanding accounts receivable represents total claims against customers. The net realizable value of those receivables (the amount expected to be collected) is $95,000. The amount of accounts receivable reported on the financial statement is generally the net realizable value, accompanied by a notation as to the amount of allowance for uncollectible accounts.
Write-offs to the Allowance Account
When an account is determined to be uncollectible, that amount is charged against the allowance for uncollectible accounts. An account which has been written off may later be collected. In such an instance, the account should be reinstated through an entry just the reverse of that used to write off the account.
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