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:
Today we're going to focus on those first two.
Percentage of net credit sales refers to estimating the percent of credit sales made for which payment will not be received.
We can use several methods to make this estimate, such as industry standards, past experience, or any other logical method.
An income statement relationship is emphasized in the percentage of net credit sales method, because we're looking at sales in order to make our estimate to record our bad debts expense.
Again, this helps us achieve matching because we are matching that bad debts expense with the period in which that revenue took place.
Under the percentage of net credit sales method, the existing balance in our allowance account is not considered; we don't need to worry about any balance that is already in our allowance account. Instead, we can focus on our sales and our estimates for bad debt expense.
EXAMPLESuppose Company ABC estimates that 2% of their net credit sales will become uncollectible. We also know that net credit sales for 2012 were $100,000.
This is an illustration of a calculation under the percentage of net credit sales, for recording the allowance.
Percentage of receivables is estimating percent of accounts receivable for which payment will not be collected. So, now we are focusing on the accounts receivable to create our estimate.
Just like with percentage of net credit sales, we use industry standards, past experience, or any other logical method to make our estimate.
In this case, since we're focusing on receivables, the relationship that is emphasized is the balance sheet. We are looking at accounts receivable to help us determine our allowance for uncollectible accounts, which are both balance sheet accounts.
Under the percentage of receivables method, the existing balance in the allowance account is considered. So, when we are performing our calculation, we need to make sure we take into account any balance that is already in the allowance account.
EXAMPLELet's consider the a similar example as above. Company ABC estimates that 2% of their accounts receivable will become uncollectible. We also know that the accounts receivable balance is $100,000.
This represents the slight difference and variation with calculating percentage of receivables.
Source: Adapted from Sophia instructor Evan McLaughlin.