How to Calculate Uncollectible Accounts Expense

(Last Updated On: March 27, 2021)

A percentage of accounts receivable will become an uncollectible amount of cash for many reasons, requiring a periodic write-off of receivables at the end of the year. Whether the allowance method or allowance account, such as the allowance for doubtful accounts or the direct write-off method, are used, the expense of an uncollectible account must be recorded as an adjustment to remain compliant with U.S. GAAP and follows the matching principle. Below are details regarding the amount of money of this expense and how it impacts the balance sheet, general ledger, and income statement.

Definition

Businesses often make a transaction of credit sales to customers and collect payment after the initial sale. Under accrual accounting, an accounts receivable is recorded on the balance sheet, and revenue is booked on the income statement. However, receivables often become uncollectible to the lender because a customer or maker, the person promising to pay, cannot or will not pay. When using the allowance for doubtful accounts method, an expense entry is recognized on the income statement at regular intervals. The direct write-off method records the amount of the bad debt. The bad debt may lead to an interest receivable account as well.

Calculating Uncollectible Accounts Expense

When using the allowance for doubtful accounts method, an estimate is calculated using an aging schedule that considers the number of days as time passes or the receivables method to record uncollectible accounts expense. Hopefully, most clients will pay within a 90-day time frame. The maturity date is usually determined in days. As far as the formula, historical data typically forms the basis for the estimate. However, industry averages can form the basis if the business doesn’t have a history of uncollectible accounts. For example, if a company averages five percent uncollectible accounts for the past two years, it is reasonable to book that percentage as uncollectible over the course of the current year.

The direct write-off method, however, calls for recognition of bad debts expense as accounts become uncollectible. This process requires adherence to internal accounting policies and U.S. GAAP to remain consistent over time. The journal entry to record bad debt expense involves reducing accounts receivable, or the allowance for doubtful accounts, on the balance sheet and recording an expense on the income statement. The entry should debit the bad debt amount and enter a credit balance for the allowance for doubtful accounts.

Differences Between Uncollectible & Bad Debt Expense

Bad debt expense and uncollectible accounts expense are often used interchangeably. They refer to recognizing an expense when the balance of accounts receivable or notes receivable becomes uncollectible. The allowance for bad debt is an adjusting entry known as a contra asset account listed on the balance sheet that reduces the accounts receivable to the net realizable value or realizable value of accounts. While these expenses are listed on the income statement, accurate presentation of uncollectible accounts expense is critical for the financial statements’ sales method analysis.

When accounting for uncollectible accounts receivable and recording the expense entry, it’s critical to follow established write-off procedures and save supporting documentation. Following established accounting best practices will prevent misstatement of the balance sheet. Inevitably some accounts will be uncollectible. Knowing how to record write-offs as part of financial reporting is necessary at the end of the accounting period, which may run from January to December or any other time period.