Regardless of your method, reviewing your allowance periodically and adjusting it accordingly is essential. This will ensure that your financial statements accurately represent the status of your company’s accounts receivable. In this method, businesses can scan through their accounts receivable that form over 80% of the balance, and shortlist the customers that are most likely to default.
The allowance for doubtful accounts is recorded as a contra asset account under the accounts receivable on a company’s balance sheet. If you use the accrual basis of accounting, you will record doubtful accounts in the same accounting period as the original credit sale. This will help present a more realistic picture of the accounts receivable amounts you expect to collect, versus what goes under the allowance for doubtful accounts. The accounts are shown in the balance sheet in the asset section itself, just below the accounts receivables line item. Doubtful accounts are generally considered contra accounts, meaning they will have either zero or credit balances.
Specific identification method
Additionally, the allowance for doubtful accounts in June starts with a balance of zero. The allowance is an estimated reserve for potential bad debts, while bad debt expense is the actual amount recognized as a loss when a specific account is deemed uncollectible. This means that accounts the allowance for doubtful accounts is a contra asset account that equals receivables have a debit balance of $10,000, and the firm credits revenue for $10,000. Contra liability accounts are mainly used by corporations that issue bonds frequently. That is because some of the bonds are issued at a discount, so this reduces the balance of their bonds payable.
You can also evaluate the reasonableness of an allowance for doubtful accounts by comparing it to the total amount of seriously overdue accounts receivable, which are presumably not going to be collected. If the allowance is less than the amount of these overdue receivables, the allowance is probably insufficient. It’s important to note that an allowance for doubtful accounts is simply an informed guess, and your customers’ payment behaviors may not align.
Allowance for Doubtful Accounts Journal Entry
Say it has $10,000 in unpaid invoices that are 90 days past due—its allowance for doubtful accounts for those invoices would be $2,500, or $10,000 x 25%. In effect, the allowance for doubtful accounts leads to the A/R balance recorded on the balance sheet to reflect a value closer to reality. For example, a company has $70,000 of accounts receivable less than 30 days outstanding and $30,000 of accounts receivable more than 30 days outstanding.
This method considers and compares the accounts receivable that are already past due are unlikely to be collected. Although this method doesn’t provide as much information as others, it can still be of great benefit to your business. Consider reevaluating your accounts if the predicted allowance is less than the overdue accounts.
By Industry
Actual results may vary from management’s expectations for accounts receivable collections. When the allowance account is used, the company is anticipating that some accounts will be uncollectible in advance of knowing the specific account. When a specific account is identified as uncollectible, the Allowance for Doubtful Accounts should be debited and Accounts Receivable should be credited. The accounts receivable aging method uses receivables aging reports to keep track of invoices that are past due. Using historical data from an aging schedule can help you predict whether or not an invoice will be paid. An allowance for doubtful accounts is also referred to as a contra asset, because it’s either valued at zero or it has a credit balance.
Contra Accounts serve as a reduction to the balance of their corresponding accounts to find their net values. Assign a risk score to each customer, and assume a higher risk of default for those having a higher risk score. By a miracle, it turns out the company ended up being rewarded a portion of their outstanding receivable balance they’d written off as part of the bankruptcy proceedings. Of the $50,000 balance that was written off, the company is notified that they will receive $35,000. Note that if a company believes it may recover a portion of a balance, it can write off a portion of the account.