Accounting for Bad Debt

CH. 8 Question 3:

What are the essential features of the allowance method of accounting for bad debts?

The allowance method of accounting for bad debts is a process that allows for estimating the uncollectable accounts at the end of each period. Doing so provides a better matching of expenses with revenues on the income statement. It also guarantees that receivables are reflected at their cash (net) realizable value on the balance sheet. For financial reporting purposes companies must use the allowance method when bad debts are material in amount. The three essential features of this method are:

• Companies estimate uncollectable accounts receivable and match them against revenues in the same accounting period in which the revenues are recorded.

• Companies record estimated uncollectibles as an increase (a debit) to Bad Debts Expense and an increase (a credit) to Allowance for Doubtful Accounts (a contra asset account) through an adjusting entry at the end of each period.

• Companies debit actual uncollectibles to Allowance for Doubtful Accounts and credit them to Accounts Receivables at the time the specific account is written off as uncollectible.

CH. 8 Question 4:

Lauren Anderson cannot understand why the cash realizable value does not decrease when an uncollectable account is written off under the allowance method. Clarify this point for Lauren.

A write-off only affects balance sheet accounts and does not affect the net realizable value of accounts receivable. Only accounts receivable and allowance for uncollectible accounts would be affected and reduced based on the amount of the uncollectible account. The calculation made to adjust the net realizable amount is done before the account is written off. This method allows for predicting the amount that will become bad debt, and accounts for it immediately. Because it was already adjusted or accounted for this would be the reason why the realizable value wouldn’t change....