Effective Allowance Method for Uncollectible Accounts

1. LESSON 14-4 Planning and Recording an Allowance for Uncollectible Accounts Adjustment

2. ALLOWANCE METHOD OF RECORDING LOSSES FROM UNCOLLECTIBLE ACCOUNTS • With each sale on account, a business takes a risk that customers will not pay their accounts • Accounts receivable that cannot be collected are called uncollectible accounts • At the end of a fiscal year, a business does not know which customer accounts will become uncollectible • To solve this problem, a business can calculate & record an estimated amount of uncollectible accounts expense. • Estimating uncollectible accounts expense accomplishes 2 objectives: • It reports a balance sheet amount for Accounts Receivable that reflects the amount the business expects to collect in the future. • It recognizes the expense of uncollectible accounts in the same period in which the related revenue is recorded LESSON 14-4

3. ALLOWANCE METHOD OF RECORDING LOSSES FROM UNCOLLECTIBLE ACCOUNTS • To record estimated uncollectible accounts, an adjusting entry is made affecting 2 accounts: • The estimated amount of uncollectible accounts is debited to Uncollectible Accounts Expense and credited to an account titled Allowance for Uncollectible accounts. • Allowance for Uncollectible Accounts is a contra account to its related asset account, Accounts Receivable • Crediting the estimated value of uncollectible accounts to a contra account is called the allowance method of recording losses from uncollectible account. • The difference between an asset’s account balance & its related contra account balance is called book value LESSON 14-4

4. ALLOWANCE METHOD OF RECORDING LOSSES FROM UNCOLLECTIBLE ACCOUNTS page 419 LESSON 14-4

5. Total Saleson Account × Percentage = EstimatedUncollectibleAccounts Expense ESTIMATING UNCOLLECTIBLE ACCOUNTS EXPENSE page 420 • Businesses use a percentage of total sales on account to estimate uncollectible accounts expense • Each sale on account represents a risk of loss from an uncollectible account. A review of Hobby Shack’s previous experience in collecting sales on account shows that actual uncollectible accounts expense has been about 1% of total sales on account. The company’s total sales on account for the year is $124,500.00 $124,500.00 × 1% = $1,245.00 LESSON 14-4

6. ESTIMATING UNCOLLECTIBLE ACCOUNTS EXPENSE page 420 • At the end of a fiscal period, an adjustment for uncollectible accounts expense is planned on a worksheet. • The allowance for Uncollectible Accounts balance in the Trial Balance Credit column, $127.52 is the allowance estimate from the previous fiscal period that has not yet been identified as uncollectible. LESSON 14-4

7. 3. Label the two parts with a small letter e in parentheses. 3 3 ANALYZING AND RECORDING AN ADJUSTMENT FOR UNCOLLECTIBLE ACCOUNTS EXPENSE page 421 1 2 1. Enter the estimated uncollectible amount. 2. Enter the same amount in the Adjustments Debit column. LESSON 14-4

8. Accounts Receivable - Balance of Allowance for Uncollectible Accounts = Book Value of Accounts Receivable ALLOWANCE METHOD OF RECORDING LOSSES FROM UNCOLLECTIBLE ACCOUNTS • The book value of the Accounts Receivable is the difference between the Accounts Receivable and the Allowance for Uncollectible Accounts $14,698.40 - $1,372.52 = $13,325.88 • Hobby Shack estimates that it will collect $13,325.88 from its outstanding accounts receivable LESSON 14-4

9. TERMS REVIEW page 422 • uncollectible accounts • allowance method of recording losses from uncollectible accounts • book value • book value of accounts receivable LESSON 14-4