Accounting: The Language of Business - Vol. 2 (Intermediate: Part 141)

When IBM released its first large computer in 1952, it was based on the vacuum tube, which was small enough that it made it possible for businesses to buy them and led to accountants being among the first to use them. By 1959, transistors were replacing the tubes and making computers even more accessible. As early as 1961, transistors were being supplanted by microchips, which eventually led to computers for everyone.

Today, technology has brought accounting software such as QuickBooks. These new advancements are much more intuitive, helping accountants do their job quicker, more accurately, and with more ease.

*Investopedia*

 Short-Term Operating Assets: Cash and Receivables (Part F)

by

Charles Lamson

Uncollectible Accounts Estimates

Managers form estimates of the amount expected to be uncollectible using the aging of accounts receivable method.

 

Aging of Accounts Receivable

Under the aging of accounts receivable method, a company estimates the allowance for uncollectible accounts using the following steps:

1. Determine the balance in each aging category by separating the accounts receivable balance based on the age of the receivable (the amount of time that has passed from the original date of sale to the bad debt estimation date).

2. Multiply the balance in each aging category by an estimated percentage of uncollectible accounts for that specific category. .

3. Add the subtotals of each aging category to determine the required balance in the allowance for uncollectible accounts.

4. Record the bad debt expense needed to adjust the allowance for uncollectible accounts to the correct balance. 

Commonly, a company bases the percentage of uncollectible accounts in each age category on experience in collecting its accounts receivable and existing economic conditions. Percentages usually increase with the time the receivables are outstanding because collection becomes less likely for older balances.

The aging of accounts receivable illustrated in Example 9.5 is considered a balance sheet approach because companies calculate the ending balance in the allowance account directly and focus on the proper measurement of accounts receivable at net realizable value (NRV), which describes the estimated amount that a company reasonably expects to collect from its customers and is measured as the gross accounts receivable less an estimated allowance for uncollectible accounts (a contra-asset account).. The resulting bad debt expense (Bad debt expense (BDE) is an accounting entry that estimates how much of a company's receivables it will not be able to collect. It is recorded as an expense on the company's income statement, and is deducted from revenue to calculate net income. BDE reduces receivables on the balance sheet.) and the matching of that expense to sales revenue are ignored.

Using the aging of accounts receivable method, a company directly estimates the ending balance of the allowance account to determine the net realizable value (NRV) of accounts receivable. As a result, the amount for the bad debt expense, which is the change in the allowance account, is “ forced” to be set equal to the adjustment needed in the allowance account. The aging of accounts receivable method focuses on the proper balance sheet valuation of the NRV of accounts receivable. However, it may report a bad debt expense that does not match with current-period net sales. This issue is heightened when there is an existing debit balance in the allowance account [The balance in the allowance account could be a debit due to write-offs (which we discuss in the next part) in excess of amounts previously provided.] Under the aging of accounts receivable method, an existing debit balance would be added to the required allowance to arrive at the necessary journal entry as shown in Example 9.6.

Companies must disclose the method they use to estimate the allowance for doubtful accounts. Exhibit 9.2 presents an example from Levi Strauss & Co. indicating that the company uses an aging of accounts receivable approach combined with other factors.

 EXHIBIT 9.2 Accounts Receivable Disclosure, Levi Strauss & Co. annual report, November 27th, 2016

Source: Levi Strauss and Co. Annual Report, 2016. 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 452-455*

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