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Accounting: Bad Expense Account

Using the aging method of accounts receivable method, $5,900 of the company’s Accounts Receivable are estimated to be uncollectible. At the end of the year, the balance of Accounts Receivable is $109,000 and the unadjusted credit balance of the Allowance for Doubtful Accounts is $680. Credit sales during the year totaled $168,000. What is the current year’s Bad Debt Expense?

$8,580.
$5,220.
$5,900.
$7,900.

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Christopher B. | Tutor & Coach - Accounting / Career DevelopmentTutor & Coach - Accounting / Career Deve...
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Current year bad debt expense needs to be debited for the difference between the amount determined uncollectible per the aging analysis and the current balance in the Allowance account.
Serge M. | Professor of Accounting, retired. Ph.D., CPAProfessor of Accounting, retired. Ph.D.,...
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The correct answer is $5,220, but you have to understand why.

 

There are two approaches to estimating bad debts expense. With the income statement approach, bad debts expense is estimated as a percentage of credit sales. The journal entry is

 

dr...Bad debts expense . . .
cr.. . . . . . .Allowance for bad debts
The expense is calculated and the allowance account is credited regardless of the balance it already contains.

The balance sheet approach to estimating bad debts is to estimate the amount of receivables that will not be collected. This can be done by an aging method or simply as a percentage of receivables. In this case you are calculating the amount that should be the ending balance in the Allowance for bad debts account.

Consequently, what is already in the account has an effect on the way the journal entry is prepared. I assume you know how to calculate a percentage of a number and add up the results. Let us just assume that you calculate the allowance for bad debts should be $15,000. The Allowance account has a credit balance of $2,000. In that case the entry to record bad debts expense is

dr.. Bad debts expense . . . 13,000
cr. . . . . . .Allowance for bad debts. . .13,000

This is because the allowance account already has a 2,000 credit balance and you want a $15,000 credit balance..

However, if the Allowance account has a debit balance of $2,000, then the entry, given the debit balance assumption is

dr.. Bad debts expense . . . 17.000
cr. . . . . . .Allowance for bad debts. . .17,000

This is because the allowance account has a 2,000 debit balance and you want to end up with a credit balance of $15,000..

How can the allowance account have a debit balance? The allowance is an estimate you make to satisfy the matching principle in accounting. You want to match this period's sales revenue with this period's expense of not being able to collect all that revenue which is locked up in receivables and will be collected only next period. So you record bad debts expense as an estimate.

If your estimate were perfect, as you write off bad accounts receivable against the allowance, you reduce both the A/R balance and the allowance balance, and at the end of the year your allowance account is gone. But your estimates are not perfect. If you write off more receivables than you estimated would be bad, you end up with a debit balance in the allowance account. The entry to write off an account is

dr. Allowance for bad debts.
cr. . . . . . Accounts receivable