Business, Legal & Accounting Glossary
“Allowance for Doubtful Accounts” is a method for recognizing that some Accounts receivable items will not be collected in full. The allowance method focuses on recognizing bad debts as a percentage of receivables rather than on an item-by-item basis. At the end of each accounting cycle, the balance in the contra asset account of Allowance for Doubtful Accounts should be adjusted so that the balance equals the agreed-upon percentage of Accounts Receivable.
For example, if the balance in AR is $1,000,000 and the accepted percentage is 10%, then the ending balance in the ADA account needs to be $100,000. The journal entry that will produce the desired result is
Bad Debt Expense 100,000
Allowance for DA 100,000.
The Bad Debt Expense will flow through to the Income Statement. The ADA will appear on the Balance Sheet as a contra asset. Example:
Accounts Receivable 1,000,000
Less: ADA 100,000
Net Accounts Receivable 900,000.
If certain accounts were written off in the next cycle, the journal entry would be
Allowance for AD 50,000
Accounts Receivable 50,000.
The Balance Sheet figure for Net Accounts Receivable would be unaffected by this entry.
If net credit sales for the cycle were $750,000, the new balance for AR would be $1,700,000. The balance for ADA, however, would only be $50,000. To get the ADA balance to 10% of AR, the following journal entry should be made
Bad Debt Expense 120,000
Now the balance in ADA is $170,000 and the balance sheet figure for Net Accounts Receivable is 90% of the figure for Accounts Receivable.
If an account previously written off subsequently were paid in full, the journal entries should read
Accounts Receivable 45,000
Accounts Receivable 45,000.
The net effect of these journal entries is to increase the balance in Cash and reduce the balance in Accounts Receivable.
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This glossary post was last updated: 18th April, 2020 | 1 Views.