Allowance for Doubtful Accounts and Aging of Accounts Receivable

GAAP permits two methods for estimating the bad debt expense and the allowance for doubtful accounts:

1. a percentage of credit sales and
2. the method discussed in this section, a percentage of ending accounts receivable.

Whereas the percentage of credit sales emphasizes matching the bad debt estimate with the same credit sales for the period, the percentage of ending accounts receivable emphasizes reporting accounts receivable at the net realizable value.

For example, if Sunny estimates that 3% of his ending accounts receivable balance of $21,900 is uncollectible, the ending balance in the allowance account should be 21,900 x 3% = 657. Note that this balance is maintained from year to year. Since this is Sunny’s first year in business, the entry is for the full amount:

To record estimated bad debt expense for the year:

Date	Account and Explanation	Reference	Debits	Credits
Dec. 31	Bad Debt Expense	525	$657	–
Dec. 31	Allowance for Doubtful Accounts	111	–	$657

If, on the other hand, the balance in the allowance account was already $500 from previous years, the additional amount to increase the allowance account to match the percentage of accounts receivable would be:

To record estimated bad debt expense for the year:

Date	Account and Explanation	Reference	Debits	Credits
Dec. 31	Bad Debt Expense	525	$157	–
Dec. 31	Allowance for Doubtful Accounts	111	–	$157

Note that the percentage of sales journal entry is for the full amount of the percentage of credit sales from year to year, while the percentage of accounts receivable journal entry is made to adjust the balance to the new required balance as determined by the percentage of ending accounts receivable.

Aging of Accounts Receivable

Similar to the percentage of accounts receivable, aging of accounts receivable estimates the amount of uncollectible accounts based on the accounts receivable ending balance.  Aging considers that the longer an account is outstanding, the more likely it is that it will not be collected. Aging of accounts receivable therefore prepares an estimate based on the length of time each account is outstanding. The following table demonstrates aging of accounts receivable:

Aging of Accounts Receivable

Age (Days)	Amount	Percent Estimated Uncollectible	Required Ending Balance in Allowance Account
Less than 30	12,045	1%	$120
30-90	7,884	3%	$237
Over 90 days	1,971	15%	$296
Total	$21,900		$653

Sunny would make the following entry to estimate the bad debt based on the aging of accounts receivable:

To record estimated bad debt expense for the year:

Date	Account and Explanation	Reference	Debits	Credits
Dec. 31	Bad Debt Expense	525	$653	–
Dec. 31	Allowance for Doubtful Accounts	111	–	$653

The $653 is the amount required in the allowance account. Since this was Sunny’s first year in business, the full amount is entered. However, similar to the percentage of ending accounts receivable, had a balance already existed in the allowance account, the amount required would be an adjustment to arrive at the final balance of $653. Assuming a debit balance of $500 in the allowance account, the entry would then be as follows:

To record estimated bad debt expense for the year:

Date	Account and Explanation	Reference	Debits	Credits
Dec. 31	Bad Debt Expense	525	$1,153	–
Dec. 31	Allowance for Doubtful Accounts	111	–	$1,153

Writing off Accounts Receivable

When Sunny knows the accounts receivable balance will not be paid by a customer, he debits allowance for doubtful accounts and credits accounts receivable.  The estimate was already carried on the income statement in bad debt expense to match the sales with the estimated bad debt. For example, if a customer goes bankrupt and does not pay $500, Sunny would make the following entry.

To write off accounts receivable balance:

Date	Account and Explanation	Reference	Debits	Credits
Jan. 5	Allowance for Doubtful Accounts	111	$500
Jan. 5	Accounts Receivable	110	–	$500

The net realizable value of accounts receivable is not affected since allowance for doubtful accounts carried the estimate for bad debt as a contra account to accounts receivable on the balance sheet.

Restoring Accounts Receivable Previously Written Off

If the customer previously written off under accounts receivable sends in a check for $500, the entry to restore the account is similar to restore the accounts and record the cash received.
To restore accounts receivable and record payment:

Date	Account and Explanation	Reference	Debits	Credits
Feb. 15	Accounts Receivable	110	$500	–
Feb. 15	Allowance for Doubtful Accounts	111	–	$500
Feb. 20	Cash	100	$500	–
Feb. 20	Accounts Receivable	110	–	$500

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