Estimating uncollectible accounts Accountants use two an easy methods to estimate uncollectible accounts because that a period. The very first method—percentage-of-sales method—focuses top top the income statement and also the connection of uncollectible accounts to sales. The second method—percentage-of-receivables method—focuses top top the balance sheet and also the partnership of the allowance for uncollectible accounts to accounts receivable.

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Percentage-of-sales method The percentage-of-sales technique estimates uncollectible account from the credit transaction sales that a given period. In theory, the an approach is based on a percentage of front years’ actual uncollectible account to front years’ credit transaction sales. When cash sales are tiny or comprise a fairly constant percentage of full sales, firms basic the calculation on complete net sales. Due to the fact that at least one the these conditions is usually met, companies frequently use full net sales rather than credit sales. The formula to determine the lot of the finishing estimated negative debts entry is:

Bad Debt expense = net sales (total or credit) x Percentage approximated as uncollectible

To illustrate, assume the Rankin Company’s approximates uncollectible account at 1% of full net sales. Total net sales for the year were $500,000; receivables at year-end were $100,000; and also the pin money for skeptical Accounts had actually a zero balance. Rankin would make the adhering to adjusting entry in ~ year end:

 

Dec.

31

Bad Debt Expense

Debit

5,000

 Credit

  Allowance for Doubtful account  5,000
  To record approximated uncollectible accounts  
  ($500,000 X 1%).  
Rankin reports negative Debt price on the earnings statement. That reports the accounts receivable less the allowance amongst current assets in the balance sheet as follows:

Accounts receivable$100,000
Less: pin money for doubtful accounts(5,000)
Accounts receivable, Net

$95,000

Or the balance sheet could show:
Accounts union (less estimated
uncollectible accounts, $5,000) $95,000
On the earnings statement, Rankin would enhance the bad debt expense against sales profits in the period. We would classify this cost as a selling expense since it is a normal consequence of marketing on credit.

The allowance for Doubtful Accounts account can have one of two people a debit or credit balance prior to the year-end adjustment. Under the percentage-of-sales method, the firm ignores any kind of existing balance in the allowance as soon as calculating the amount of the year-end mediate (except the the allowance account must have actually a credit transaction balance ~ adjustment).

For example, i think Rankin’s pin money account had actually a $300 credit balance prior to adjustment. The adjusting entry would certainly still be for $5,000. However, the balance sheet would show $100,000 accounts receivable much less a $5,300 pin money for doubtful accounts, bring about net receivables of $ 94,700. ~ above the income statement, poor Debt expense would still it is in 1%of complete net sales, or $5,000.

In applying the percentage-of-sales method, companies annually review the portion of uncollectible accounts that resulted native the previous year’s sales. If the portion rate is tho valid, the firm makes no change. However, if the situation has changed significantly, the agency increases or to reduce the percentage rate come reflect the changed condition. For example, in durations of recession and also high unemployment, a for sure may rise the percentage rate come reflect the customers’ decreased capacity to pay. However, if the firm adopts a more stringent credit policy, the may need to decrease the percent rate because the firm would expect fewer uncollectible accounts.

Percentage-of-receivables method The percentage-of-receivables method estimates uncollectible account by identify the desired size the the allowance for Uncollectible Accounts. Rankin would multiply the ending balance in account Receivable through a price (or rates) based upon its uncollectible account experience. In the percentage-of-receivables method, the company may use either an in its entirety rate or a different rate for each age group of receivables.

To calculate the adjusting entrance amount the the entrance for poor debt cost under the percentage-of-receivables method using an overall rate, Rankin would use:

Bad Debt expense = (Accounts receivable ending balance x percentage approximated as uncollectible) – Existing credit transaction balance in allowance for doubtful accounts or + existing debit balance in pin money for doubtful accounts

Using the same info as before, Rankin renders an estimate of uncollectible accounts at the finish of the year. The balance of account receivable is $100,000, and also the allowance account has actually no balance. If Rankin approximates that 6% the the receivables will certainly be uncollectible, the adjusting entry would be:

Dec.

31

Bad Debt Expense

Debit

6,000

 Credit

  Allowance for Doubtful accounts  6,000
  ($ 100,000 x 6%) – 0  
Accounts Receivable would be report on the balance sheet as (notice exactly how the pin money for cynical accounts equates to 6% of account receivable):

Accounts receivable$100,000
Less: allowance for doubtful accounts(6,000)
Accounts receivable, Net

$94,000

Or the balance sheet can show:
Accounts union (less estimated
uncollectible accounts, $6,000) $94,000
If Rankin had a $300 credit transaction balance in the allowance account before adjustment, the entry would be the same, except that the quantity of the entry would certainly be $ 5,700. The distinction in quantities arises due to the fact that management wants the allowance account to contain a credit balance equal to 6% that the superior receivables when presenting the two accounts ~ above the balance sheet. The calculation of the necessary adjustment is <($100,000 x 6%)- $300> = $ 5,700. Thus, under the percentage-of-receivables method, that company consider any type of existing balance in the allowance account when adjusting for uncollectible accounts and also must remove any type of previous quantities in the allowance for doubtful accounts. The year end adjusting entry would certainly be:

Dec.

31

Bad Debt Expense

Debit

5,700

 Credit

  Allowance for Doubtful account  5,700
  ($ 100,000 x 6%) – $300  
Accounts Receivable would certainly be report on the balance sheet as (notice how the allowance for hesitant accounts still equates to 6% of account receivable):

Accounts receivable$100,000
Less: allowance for doubtful accounts(6,000)
Accounts receivable, Net

$94,000

Or the balance sheet can show:
Accounts union (less estimated
uncollectible accounts, $6,000) $94,000
As an additional example, mean that Rankin had actually a $300 debit balance in the pin money account before adjustment. Then, a credit transaction of $6,300 would certainly be essential to poor debt expense to acquire the balance to the required $6,000 credit transaction balance. The calculation of the crucial adjustment is <($ 100,000 x 6%) + $300> = $6,300. The year finish adjusting entry would be:

Dec.

31

Bad Debt Expense

Debit

6,300

 Credit

  Allowance for Doubtful accounts  6,300
  ($ 100,000 x 6%) + $300  
No issue what the pre-adjustment allowance account balance is, once using the percentage-of-receivables method, Rankin adjusts the pin money for Doubtful account so that it has actually an ending credit balance the $ 6,000—equal come 6% of its $100,000 in accounts Receivable. The desired $6,000 finishing credit balance in the allowance for hesitant Accounts serves as a “target” in do the adjustment.

So far, we have used one uncollectibility rate for all accounts receivable, regardless of your age. However, some carriers use a different percentage because that each age group of account receivable. When accountants decision to use a various rate because that each age classification of receivables, castle prepare an aging schedule. An aging schedule classifies accounts receivable follow to just how long they have been outstanding and also uses a various uncollectibility portion rate because that each age category. Providers base these percentages on experience. In exhibition 1, the aging schedule shows that the enlarge the receivable, the much less likely the company is to collect it.

ALLEN COMPANY
Accounts receivable Aging Schedule
CustomerTotalNot however Due Days previous Due
 0 – 30 31 – 6061 – 90Over 90
X $ 5,000 5,000
Y14,000 12,000  2,000
Z 400  200 200
all others808,600 560,000 240,000 2,000 600  6,000
Total account Receivable$ 828,000 $ 560,000 $ 252,000 $ 4,000  $ 800 $ 11,200
x Percent estimated as uncollectible x 1%x 5%x 10%x 25%x 50%
Estimated quantity uncollectible $ 24,400 5,600 12,600 400 200  5,600

Exhibit 1: accounts receivable aging schedule

Classifying account receivable according to age often offers the agency a much better basis for estimating the total amount that uncollectible accounts. Because that example, based on experience, a firm can expect just 1% the the accounts no yet early (sales made less than 30 days before the finish of the bookkeeping period) to be uncollectible. At the various other extreme, a agency can suppose 50% of every accounts end 90 work past as result of be uncollectible. Because that each period category, the certain multiplies the accounts receivable through the percentage approximated as uncollectible to uncover the approximated amount uncollectible.

The sum of the estimated quantities for every categories yields the complete estimated lot uncollectible and also is the wanted credit balance (the target) in the pin money for Uncollectible Accounts.

Since the aging schedule approach is an different under the percentage-of-receivables method, the balance in the pin money account before adjustment influence the year-end adjusting entry amount recorded for uncollectible accounts. For example, the schedule in exhibition 1 shows that $24,400 is necessary as the ending credit balance in the pin money account. If the allowance account has a $5,000 credit balance before adjustment, the adjustment would certainly be because that $19,400 calculated together $24,400 approximated amount uncollectible from exhibit 1 – 5,000 existing credit balance in the allowance account. The entry would be:

Dec.

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31

Bad Debt Expense

Debit

19,400

 Credit

  Allowance for Doubtful accounts  19,400
  ($ 24,400 – 5,000)   
Accounts Receivable would be report on the balance sheet as (notice exactly how the pin money for skeptical accounts equals the approximated amount uncollectible from exhibition 1):

Accounts receivable$828,000
Less: allowance for doubtful accounts(24,400)
Accounts receivable, Net

$803,600

Or the balance sheet could show:
Accounts receivable (less estimated
uncollectible accounts, $24,400) $803,600
The information in one aging schedule additionally is useful to administration for various other purposes. Analysis of repertoire patterns of accounts receivable may suggest the require for changes in credit policies or for included financing. For example, if the period of many customer balances has increased come 61-90 days previous due, collection efforts may need to be strengthened. Or, the company may have to find other resources of cash to pay its debts within the discount period. Ready of an aging schedule may also help identify certain accounts that need to be composed off as uncollectible.