Overview

This topic covers how businesses account for amounts owed by customers (receivables), including how to recognize, value, and write off bad debts. Understanding how to estimate uncollectible accounts is essential to maintaining accurate financial records.

Key Concepts and Methods

• Accounts Receivable: Amounts due from customers for credit sales; reported as a current asset.
• Notes Receivable: Formal, written promises to pay a fixed amount with interest by a specific date.
• Bad Debts: Customer balances that are no longer expected to be collected.
• Direct Write-Off Method: Recognize bad debts only when they become uncollectible (not GAAP-compliant for large companies).
• Allowance Method: Estimate uncollectible amounts in the same period as the sale; required by GAAP.
• Allowance for Doubtful Accounts: Contra-asset account used to reduce accounts receivable to net realizable value.
• Net Realizable Value (NRV): Accounts Receivable - Allowance for Doubtful Accounts
• Estimating Bad Debts:
  • Percentage of Sales Method
  • Aging of Receivables Method

Step-by-Step Example

Problem: A company has $50,000 in accounts receivable. It estimates that 4% will be uncollectible. What is the adjusting entry?

Step 1: Calculate the estimated bad debts:
$50,000 × 4% = $2,000

Step 2: Record the adjusting entry:

  Date        Account                        Debit     Credit
  Dec 31      Bad Debt Expense               2,000
              Allowance for Doubtful Accts             2,000
      

Result: Net realizable value = $50,000 - $2,000 = $48,000

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