Most businesses usually extend some form of credit to attract customers. It may be a retail store offering to sell their goods on credit cards or a vendor who allows payment for goods sometime after they are delivered. With offering goods on credit comes the inevitable- not all customers will repay the full amount of their debt.
The Generally Accepted Accounting Principles (GAAP) require that a business reports only receivables on which it expects to receive payment. Therefore, the uncollectible accounts must be provided for in some other way in the accounting ledger.
Accounting for Uncollectible Receivables
- Direct Write-Off Method
This is the simplest method but not always the most accurate. The uncollectible account is written off and the expense recognized in the period in which the receivable becomes worthless. Although it is a straightforward way of handling an uncollectible account, it is not recognized as GAAP. The only time it would be considered appropriate i,
- Allowance Method
Because the direct write-off method contains some discrepances, accountants have developed the allowance method. It is an estimation of uncollectible accounts at the end of each accounting period. When the amount has been determined, the Uncollectible Accounts Expense is debited while the account Allowance for Uncollectible Accounts is credited.
An accountant can use either two methods to determine the estimation of uncollectible accounts expense: the percentage-of-sales method and the accounts receivable aging method.
- The Percentage-of-Sales Method functions by deciding the total sales for the period based on the income statement. Then, an estimation is made as to how much of these sales will be uncollectible. It isn’t necessary to determine exactly which accounts will fall into this category.
- The Accounts Receivable Aging Method not only estimates but pays attention to how long the account has been outstanding. It sets up an aging schedule. From there, it can be determined just how much of each age’s balance will not be collectible.