Principles of Financial Accounting: Receivables - Writing Off, Uncollectible Accounts Impact on Balance Sheet No Impact on Income Statement

What It Is

Writing off uncollectible accounts is a process of estimating and recording the amount of accounts receivable that a company does not expect to collect. This is done to match the expenses with the revenues in the same period, as per the matching principle. For example, if a company has accounts receivable of $100,000 and estimates that $5,000 will not be collected, it will write off the uncollectible amount.

Key Concepts & Formulas

• Allowance for Doubtful Accounts (ADA): A contra-asset account that represents the estimated amount of accounts receivable that will not be collected. ADA = Estimated Uncollectible Accounts
• Bad Debt Expense: An expense account that represents the estimated amount of accounts receivable that will not be collected. Bad Debt Expense = Estimated Uncollectible Accounts
• Percentage of Sales Method: A method used to estimate the uncollectible accounts by applying a percentage of sales to the total accounts receivable. Estimated Uncollectible Accounts = (Percentage of Sales x Total Accounts Receivable)
• Direct Write-Off Method: A method used to write off uncollectible accounts directly to Bad Debt Expense. Bad Debt Expense = Uncollectible Account
• Matching Principle: The principle that states that expenses should be matched with the revenues they help to generate. Matching Principle = Expenses = Revenues
• GAAP (Generally Accepted Accounting Principles): The set of rules and guidelines that accountants follow to prepare financial statements. GAAP = Standardized Accounting Rules

Journal Entry Examples

1. Direct Write-Off Method Dr. Bad Debt Expense $5,000 Cr. Accounts Receivable $5,000

Explanation: The company is writing off the uncollectible account directly to Bad Debt Expense.

1. Allowance for Doubtful Accounts Method Dr. Bad Debt Expense $5,000 Cr. Allowance for Doubtful Accounts $5,000

Explanation: The company is increasing the Bad Debt Expense and decreasing the Allowance for Doubtful Accounts.

Common Mistakes

1. Mistake: Confusing debits and credits for expense accounts. Correction: Remember that debits increase assets and expenses, while credits decrease assets and increase expenses. Use the mnemonic "ADE" (Assets, Drawings, Expenses).

2. Mistake: Not considering the matching principle when writing off uncollectible accounts. Correction: Remember that the matching principle requires expenses to be matched with the revenues they help to generate.

3. Mistake: Not using the Allowance for Doubtful Accounts method. Correction: The Allowance for Doubtful Accounts method is a more accurate method of estimating uncollectible accounts.

Exam Tips

1. Tip: Remember that the Allowance for Doubtful Accounts method is a more accurate method of estimating uncollectible accounts.
2. Tip: Use the percentage of sales method to estimate uncollectible accounts.
3. Tip: Remember that the matching principle requires expenses to be matched with the revenues they help to generate.

Quick Practice

1. Problem: A company has accounts receivable of $100,000 and estimates that 5% will not be collected. What is the adjusting entry for the allowance for doubtful accounts? Answer: Dr. Bad Debt Expense $5,000, Cr. Allowance for Doubtful Accounts $5,000 Explanation: The company is increasing the Bad Debt Expense and decreasing the Allowance for Doubtful Accounts.

2. Problem: A company has accounts receivable of $50,000 and estimates that $5,000 will not be collected. What is the adjusting entry for the direct write-off method? Answer: Dr. Bad Debt Expense $5,000, Cr. Accounts Receivable $5,000 Explanation: The company is writing off the uncollectible account directly to Bad Debt Expense.

Last-Minute Cram Sheet

1. Allowance for Doubtful Accounts (ADA): A contra-asset account that represents the estimated amount of accounts receivable that will not be collected.
2. Bad Debt Expense: An expense account that represents the estimated amount of accounts receivable that will not be collected.
3. Percentage of Sales Method: A method used to estimate the uncollectible accounts by applying a percentage of sales to the total accounts receivable.
4. Direct Write-Off Method: A method used to write off uncollectible accounts directly to Bad Debt Expense.
5. Matching Principle: The principle that states that expenses should be matched with the revenues they help to generate.
6. GAAP (Generally Accepted Accounting Principles): The set of rules and guidelines that accountants follow to prepare financial statements.
7. Dividends are NOT an expense – they go directly to retained earnings.
8. The Allowance for Doubtful Accounts method is a more accurate method of estimating uncollectible accounts.
9. The matching principle requires expenses to be matched with the revenues they help to generate.
10. Debits increase assets and expenses, while credits decrease assets and increase expenses.