Chapter 15 - Accounts Receivable & Uncollectible Accounts

Direct Charge-off Method

A method of recording uncollectible account losses as they occur

2) Charge off uncollectible accounts using the allowance method.

Under the allowance method, an account that proves uncollectible is written off by a debit to Allowance for Uncollectible Accounts and a credit to both Accounts Receivable and the customer's account in the subsidiary ledger.

Allowance Method

A method of recording uncollectible accounts that estimates losses from uncollectible accounts and charges them to expense in the period when the sales are recorded

Valuation Account

An account, such as allowance for doubtful accounts, whose balance is revalued or reappraised in light of reasonable expectations

Aging the Accounts Receivable

Classifying accounts receivable balances according to how long they have been outstanding

1) Record the estimated expense from uncollectible accounts receivable using the allowance method.

The allowance method matches bad debt losses for a period against revenue received in the same period. It is consistent with generally accepted accounting principles and is the preferred method for recognizing uncollectible accounts. -The estimate of losses from uncollectible accounts can be based on a percentage (determined by experience) of credit sales. The estimated amount is debited to Uncollectible Accounts Expense and credited to Allowance for Doubtful Accounts. -The estimate can be based on a single rate of expected noncollectibility of all accounts receivable. On the basis of past experience, the rate is applied to the balance of Accounts Receivable to determine the anticipated losses from the accounts. The balance in Allowance for Doubtful Accounts is adjusted to this estimated loss amount. -The estimate of uncollectible accounts can also be based on the age of accounts receivable. A different percentage for credit losses is applied to each age group, and the resulting amounts are added together. Then Allowance for Doubtful Accounts is adjusted to the proper balance and the same amount is charged to Allowance for Doubtful Accounts.

3) Record the collection of accounts previously written off using the allowance method.

Under the allowance method, if all or part of an account previously written off as uncollectible is subsequently paid, the amount being paid is reinstated by a debit to Accounts Receivable and a credit to Allowance for Doubtful Accounts and to the customer's account in the subsidiary ledger. Any cash paid at that time is recorded by debiting Cash and crediting Accounts Receivable and the customer's account in the subsidiary ledger.

4) Record losses from uncollectible accounts using the direct charge-off method.

Under the direct charge-off method of recording uncollectible accounts, Uncollectible Accounts Expense is debited at the time specific accounts receivable are deemed to be uncollectible. Because the expense resulting from uncollectible accounts may not be matched in the same accounting period with the revenue that gave rise to the receivable, this method is not generally acceptable. It does not conform to the matching principle. However, many small businesses, and even some larger ones with relatively small amounts of receivables, use the method. It is required to be used for federal income tax purposes.

5) Record the collection of accounts previously written off using the direct charge-off method.

Under the direct charge-off method, if an account previously charged off as uncollectible is subsequently collected in the same accounting period, the original entry to charge off the account (to the extent it is collected) is reversed. The reversing entry is a debit to Accounts Receivable and the customer's account in the subsidiary ledger, and a credit to Uncollectible Accounts Expense. At the same time, an entry is made in the cash receipts journal debiting Cash and crediting Accounts Receivable and the customer's subsidiary ledger account. If the collection is made in a year subsequent to the year in which the write-off was recorded, the entry to record the reinstatement is a debit to Accounts Receivable and the customer's subsidiary account and a credit to Uncollectible Accounts Recovered.

6) Recognize common internal controls for accounts receivable.

t is very important that management establish formal procedures for approving and granting credit, for keeping close watch on customers' accounts to assure they are paid promptly, and for properly assigning duties related to accounts receivable. A key element in internal control is to avoid giving any one person responsibility for a large number of the functions related to receivables. These functions include granting credit, recording accounts receivable transactions, preparing bills for customers, mailing the bills and statements, processing payments from customers, approving write-offs, and trying to collect past-due accounts.