Allowance for Doubtful Accounts and Bad Debt Expenses Cornell University Division of Financial Services
How you determine your AFDA may also depend on what’s considered typical payment behavior for your industry. Customers might short pay their invoices, raise disputes that delay payments, declare bankruptcy, etc. The Statement of Financial Position (a.k.a Balance Sheet using Canadian ASPE accounting standards) presents the company’s total assets, liabilities and the netted amount – called shareholder’s equity. With this method no provision is made, and the uncollectible amount is written off directly as an expense.
The allowance method estimates bad debt during a period, based on certain computational approaches. When the estimation is recorded at the end of a period, allowance for doubtful accounts balance sheet the following entry occurs. The direct write-off method delays recognition of bad debt until the specific customer accounts receivable is identified.
How to Record the Allowance for Doubtful Accounts Journal Entry
BWW estimates 15% of its overall accounts receivable will result in bad debt. The journal entry for the Bad Debt Expense increases (debit) the expense’s balance, and the Allowance for Doubtful Accounts increases (credit) the balance in the Allowance. The allowance for doubtful accounts is a contra asset account and is subtracted from Accounts Receivable to determine the Net Realizable Value of the Accounts Receivable account on the balance sheet. In the case of the allowance for doubtful accounts, it is a contra account that is used to reduce the Controlling account, Accounts Receivable. It’s a contra-asset that offsets accounts receivable, reflecting potential losses. The allowance for bad debt always reflects the current balance of loans that are expected to default, and the balance is adjusted over time to show that balance.
It indicates how much bad debt the company actually incurred during the current accounting period. Let’s assume that a company has a debit balance in Accounts Receivable of $120,500 as a result of having sold goods on credit. Through the use of the aging method, the company sees that $18,000 of the receivables are 100 days past due.
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Adjusting the allowance for doubtful accounts is important in maintaining accurate financial statements and assessing financial risk. Accounts use this method of estimating the allowance to adhere to the matching principle. The matching principle states that revenue and expenses must be recorded in the same period in which they occur.
However, without doubtful accounts having first accounted for this potential loss on the balance sheet, a bad debt amount could have come as a surprise to a company’s management. Especially since the debt is now being reported in an accounting period later than the revenue it was meant to offset. For example, say a company lists 100 customers who purchase on credit and the total amount owed is $1,000,000. The purpose of the allowance for doubtful accounts is to estimate how many customers out of the 100 will not pay the full amount they owe. Rather than waiting to see exactly how payments work out, the company will debit a bad debt expense and credit allowance for doubtful accounts. The accounts are shown in the balance sheet in the asset section itself, just below the accounts receivables line item.