A percentage of accounts receivable will become uncollectible for a myriad of reasons, requiring a periodic write-off of receivables. Whether the allowance for doubtful accounts or the direct write off method are used, an uncollectible accounts expense must be recorded to remain compliant with U.S. GAAP. Below are details regarding this expense, and how it impacts the balance sheet and income statement.
Businesses often make 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 because a customer cannot or will not pay. When using the allowance for doubtful accounts method, a expense entry is recognized on the income statement, at regular intervals. Bad debt write-offs are recorded using the direct write-off method.
Calculating Uncollectible Accounts Expense
When using the allowance for doubtful accounts method, an estimate is calculated to record uncollectible accounts expense. 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 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.
Differences Between Uncollectible & Bad Debt Expense
Bad debt expense and uncollectible accounts expense are often used interchangeably. They refer to the recognition of an expense, when accounts receivable or notes receivable become uncollectible. The allowance for bad debt is a contra asset account listed on the balance sheet. While these expenses are listed on the income statement, accurate presentation of uncollectible accounts expense is critical for analysis of financial statements.
When accounting for uncollectible accounts and recording the expense entry, it’s critical to follow established write-off procedures and to save supporting documentation. Following established accounting best practices will prevent misstatement of the balance sheet. Inevitably some accounts will be uncollectible and knowing how to record write-offs is a necessity.