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An uncollectible account is an accounts receivable that is unpaid and is written off as bad debts expense.
We need to recognize and record these uncollectible accounts and the amounts that are expected not to be collected from credit customers. So, if any customers made purchases on credit and we don't expect to collect on those sales, we need to record those uncollectible accounts.
Now, the allowance method is required for financial reporting. It helps us to achieve matching, so that we can match our bad debts expense with the period in which the uncollectible sale took place.
We can determine uncollectible accounts by using some common methods to help us calculate our uncollectible accounts, or our allowance.
We can use:
Aging receivables refers to estimating percent of accounts receivable for which payment will not be collectible. In other words, we're using our accounts receivable to create our estimate.
This estimate can be made using industry standards, past experience, or any other logical method that management has determined.
The relationship that is emphasized in aging receivables, because we're focusing on accounts receivable, is our balance sheet relationship. Again, we're using accounts receivable to help us determine our allowance for uncollectible accounts, which are both balance sheet accounts.
The existing balance in the allowance account is considered, so we need to take into consideration any existing balance that we already have in our allowance account.
Under the aging receivables method within the allowance method, the accounts receivable are categorized based on the total days outstanding. This means we can categorize our accounts receivable into these time periods:
Let's do a demonstration of calculating aging receivables by performing an example, which will help us to understand how we can use aging receivables to calculate our allowance.
Here is an aging schedule of all of our accounts receivable. An aging schedule is where we summarize all of our accounts receivable for each customer, then we categorize it into the time period in which that accounts receivable is outstanding.
Aging Schedule | ||||||
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Balance | ||||||
Customer | 1-30 days | 31-60 days | 61-90 days | 91-180 days | 180+ days |
Total Balance 12/31/12 |
Customer A | $10,000 | $5,000 | $15,000 | |||
Customer B | $7,000 | $3,000 | $10,000 | |||
Customer C | $1,000 | $2,000 | $3,000 | |||
Customer D | $1,000 | $1,000 | $1,000 | $3,000 | ||
Customer E | $5,000 | $5,000 | $10,000 | |||
Total | $11,000 | $12,000 | $4,000 | $8,000 | $6,000 | $41,000 |
For example, Customer A has a $10,000 balance that is 30 days or less outstanding and a $5,000 balance that is between 31 and 60 days outstanding.
Now we need to look at the percent of those accounts receivable that we estimate to be uncollectible. As you can see below, that percentage grows over time as we extend out to the category of receivables that have been outstanding for over 181 days.
Aging Schedule | ||||||
---|---|---|---|---|---|---|
Balance | ||||||
Customer | 1-30 days | 31-60 days | 61-90 days | 91-180 days | 180+ days |
Total Balance 12/31/12 |
Customer A | $10,000 | $5,000 | $15,000 | |||
Customer B | $7,000 | $3,000 | $10,000 | |||
Customer C | $1,000 | $2,000 | $3,000 | |||
Customer D | $1,000 | $1,000 | $1,000 | $3,000 | ||
Customer E | $5,000 | $5,000 | $10,000 | |||
Total | $11,000 | $12,000 | $4,000 | $8,000 | $6,000 | $41,000 |
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Uncollectible (%) | 2% | 5% | 15% | 35% | 85% |
Next, we take those percentage estimates and we calculate the total uncollectible balance.
Aging Schedule | ||||||
---|---|---|---|---|---|---|
Balance | ||||||
Customer | 1-30 days | 31-60 days | 61-90 days | 91-180 days | 180+ days |
Total Balance 12/31/12 |
Customer A | $10,000 | $5,000 | $15,000 | |||
Customer B | $7,000 | $3,000 | $10,000 | |||
Customer C | $1,000 | $2,000 | $3,000 | |||
Customer D | $1,000 | $1,000 | $1,000 | $3,000 | ||
Customer E | $5,000 | $5,000 | $10,000 | |||
Total | $11,000 | $12,000 | $4,000 | $8,000 | $6,000 | $41,000 |
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Uncollectible (%) | 2% | 5% | 15% | 35% | 85% | |
|
Total Uncollectible Balance | |||||
Uncollectible ($) | $220 | $600 | $600 | $2,800 | $5,100 | $9,320 |
For example, the uncollectible dollar amount of $220 was calculated by taking the $11,000 balance that is 30 days or less outstanding, and multiplying it by the 2% percentage estimate.
We perform the same calculations down the line to arrive at the total estimated uncollectible allowance of $9,320.
Now that we know that our total allowance is $9,320, let's look at a couple different scenarios for recording that entry into our financial system.
EXAMPLE
Scenario 1: First, let's make an assumption that there is no balance in our allowance for uncollectible accounts. If there's no balance in that account, our journal entry looks like this:
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Total Uncollectible Balance | |||||
|
||||||
Uncollectible ($) | $220 | $600 | $600 | $2,800 | $5,100 | $9,320 |
Scenario 1: Assume there is no balance in 'Allowance for Uncollectible Accounts' | ||||||
Journal Entry: | Bad Debt Expense | $9,320 | ||||
Allowance for Uncollectible Accounts | $9,320 |
EXAMPLE
Scenario 2: In this scenario, we will assume there is a $2,000 balance in the allowance for uncollectible accounts. How does this affect our journal entry? We still debit bad debt expense and we credit allowance for uncollectible accounts, but you'll see that the amount of that entry is $7,320.
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Total Uncollectible Balance | |||||
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Uncollectible ($) | $220 | $600 | $600 | $2,800 | $5,100 | $9,320 |
Scenario 2: Assume there is a $2,000 balance in 'Allowance for Uncollectible Accounts' | ||||||
Journal Entry: | Bad Debt Expense | $7,320 | ||||
Allowance for Uncollectible Accounts | $7,320 |
Source: Adapted from Sophia instructor Evan McLaughlin.