What are the two methods used to estimate uncollectible accounts receivable?
The amount of uncollectible accounts receivable must be estimated in order to create an allowance for doubtful accounts. This estimate can be derived from the aged accounts receivable report, or by using a percentage of sales. Both approaches are described next. This estimate is used in an accrual-basis business where reserves are set up in contra accounts to be paired with and offset various asset accounts. Show
Derivation from an Aging AnalysisA common estimation method is based on the aged accounts receivable report. This report categorizes unpaid customer invoices by time bucket. Each time bucket is usually in 30-day increments, so the 31-60 day bucket, the 61-90 day bucket, and the 90+ day bucket show those invoices with increasing probabilities of nonpayment. The accountant assigns a larger percentage of assumed nonpayment probability to each of these time buckets, such as 5% to the balance in the 31-60 day bucket, 20% to the 61-90 day bucket, and 40% to the 90+ day bucket. These percentages are based on the historical experience of the firm in obtaining payments from each of these classifications. The totals of estimated unpaid amounts for each time bucket are then added together to arrive at the total amount of estimated uncollectible receivables. This approach works best when receivables include a small number of relatively large invoices. Derivation from Total SalesA simpler approach is to assume that a percentage of total credit sales will not be collected. This percentage, which is based on historical experience, is multiplied by total credit sales. Thus, if the historical experience is a 0.5% bad debt rate, then this amount is applied to total credit sales. This approach is not as refined as a derivation from the aged receivables report, but can be adequate when sales are comprised of many small invoices. Accounting for Uncollectible ReceivablesNo matter which method is used, the resulting estimate is added to the allowance for doubtful accounts by debiting the bad debt expense account and crediting the allowance for doubtful accounts. When a company sells goods and/or provides services on account (on credit) using the accrual basis or method of accounting, the amount of the sales or service revenues is reported on the income statement and the related accounts receivable is reported on the balance sheet (until the receivables are collected). Unfortunately, some customers may not pay the amount owed to the company. In order to not overstate the company's profits and current assets, the following is required:
Examples of Estimating Uncollectible Accounts ReceivableTwo common ways of estimating the amount of uncollectible receivables are:
What are the 2 most common methods of estimating uncollectible receivables?Two common ways of estimating the amount of uncollectible receivables are:. Preparing an aging of accounts receivable to identify the potentially uncollectible accounts. ... . Estimating the amount of uncollectible accounts by simply recording a percentage of the credit sales that occur in each accounting period.. Which method is used to estimate uncollectible accounts receivable?Under U.S. GAAP, only the allowance method is an allowable method to estimate uncollectible accounts receivable. The allowance method recognizes bad debt expense when the company believes there is a high likelihood the receivable will not be collected, which follows the matching principle.
What are the two methods under the allowance method to estimate uncollectible accounts?The two basic methods for estimating uncollectible accounts under the allowance method are the percentage of credit sales method and the percentage of receivables. The percentage of sales method estimates uncollectible accounts based on a percentage of credit sales for the period.
Which of the two methods of estimating uncollectible accounts would normally be more accurate why?The aging of receivables is the most accurate when estimating the amount of receivables that may become uncollectable in the future. This approach applies a lower percentage to accounts with newer balances and a higher percentage to accounts that are past due.
|