Accounts Receivable and Uncollectable Accounts

  • The Allowance Method
      - Definition: Estimating uncollectable accounts at the end of the period to match the bad debt expense with the revenue generated.
      - Allowance for Doubtful Accounts (AFDA): A contra-asset account (negative balance) that reduces Accounts Receivable to its Net Realizable Value.
      - Net Realizable Value (NRV): The amount the business expects to actually collect in cash. NRV=Accounts Receivable−AFDA\text{NRV} = \text{Accounts Receivable} - \text{AFDA}
      - Bad Debt Expense: The cost of selling on credit, recorded in the same period as the revenue.

  • Estimating the Allowance
      - Overall Percentage Method: A flat rate applied to the total ending Accounts Receivable balance.
      - Aging of Accounts Receivable Method: Grouping invoices by how long they are overdue (Current, 1-30 days, etc.) and applying higher uncollectable percentages to older categories. This is considered more accurate.

  • Write-Offs and Recoveries
      - Write-Off: When a specific customer is known to be unable to pay (e.g., bankruptcy), their balance is removed from A/R and set against AFDA. This does not affect the income statement.
      - Recovery: If a customer pays after being written off, the write-off is reversed (reinstated) for the amount received, and the cash payment is recorded.