🔹 Writing Off Receivables
Bad Debts Expense 1,000 Accounts Receivable 1,000
- When using the Direct Write Off Method, you “directly” write off uncollectible amounts into Bad Debts Expense.
- The Allowance for Doubtful Accounts (ADA) is not used in this method; it's applicable only when using the Allowance Method.
- By crediting Accounts Receivable, its balance is reduced, reflecting that the amount is no longer expected to be collected from the customer.
Accounts Receivable 1,000 Bad Debts Expense 1,000
STEP 2: Receive the cash toward the customer’s Accounts Receivable.
Cash 1,000 Accounts Receivable 1,000
Allowance for Doubtful Accounts 1,000 Accounts Receivable 1,000
- When using the Allowance Method, you write off uncollectible amounts from Allowance for Doubtful Accounts (ADA).
- Allowance for Doubtful Accounts (ADA) is a “Contra-Asset” (-/+) that reduces the value of your Accounts Receivable.
- You are debiting ADA here to decrease (i.e. “use”) the available balance in the allowance — from the previous period’s year end adjusting entry to estimate bad debts.
- By crediting Accounts Receivable, its balance is reduced, reflecting that the amount is no longer expected to be collected from the customer.
Accounts Receivable 1,000 Allowance for Doubtful Accounts 1,000
STEP 2: Receive the cash toward the customer’s Accounts Receivable.
Cash 1,000 Accounts Receivable 1,000
🔹 Estimating Bad Debts
Bad Debts Expense ??? Allowance for Doubtful Accounts ???
However, how you’ll get the $ amount does change depending on which method you’re using!
Key Points:
- The specific dollar amount for the entry varies based on the estimation method asked for in your problem.
- The '% of Sales Method' calculates bad debts based on a predetermined percentage of sales.
- This method focuses on the income statement and matches bad debt expense to the sales they are associated with.
For a detailed explanation and example of how to calculate the dollar amount for the adjusting entry, refer to the video below.
Bad Debts Expense ??? Allowance for Doubtful Accounts ???
However, how you’ll get the $ amount does change depending on which method you’re using!
Key Points:
- The specific dollar amount for the entry varies based on the estimation method asked for in your problem.
- The % of A/R method estimates bad debts based on a predetermined percentage applied to the total accounts receivable.
- It is a balance sheet approach, focusing on the expected uncollectibility of the current accounts receivable balance.
For a detailed explanation and example of how to calculate the dollar amount for the adjusting entry, refer to the video below.
Bad Debts Expense ??? Allowance for Doubtful Accounts ???
However, how you’ll get the $ amount does change depending on which method you’re using!
Key Points:
- The specific dollar amount for the entry varies based on the estimation method asked for in your problem.
- The “Aging of A/R Method” involves classifying accounts receivable by their age, and applying different percentages to each category based on historical data to estimate bad debts.
- It provides a more accurate estimate of bad debts by considering the likelihood of receivables turning uncollectible increases with age.
- This approach emphasizes the assessment of each receivable's collectibility, making it a detailed balance sheet method.
For a detailed explanation and example of how to calculate the dollar amount for the adjusting entry, refer to the video below.
Also, here is an example table illustrating the Aging of Accounts Receivable concepts:
Age Category | Total A/R Amount | Estimated Bad Debt Percentage | Estimated Bad Debt Amount |
0-30 Days | $50,000 | 1% | $500 |
31-60 Days | $20,000 | 5% | $1,000 |
61-90 Days | $5,000 | 10% | $500 |
Over 90 Days | $1,000 | 20% | $200 |
In this table, each age category of receivables is associated with a specific percentage that reflects the increasing likelihood of non-collection as receivables get older. The estimated bad debt amount is calculated by applying the corresponding percentage to the total accounts receivable amount in each category. This method allows a company to make a more precise provision for bad debts in its financial statements.
🔹 Notes Receivable Entries
- The journal entry reflects the cash we’ve paid to the borrower and the note receivable the company expects to collect later.
- You will only recognize this for the principal amount, the interest amount will come into play later with the journal entry on the maturity date.
- Start date of the note: January 5th.
- Maturity date calculation:
- January has 31 days; since the note starts on the 5th, count 26 days remaining in January.
- Add 28 days for February.
- 31 days are in March.
- The remaining 5 days carry over into April, making the maturity date April 5th.
- Total days counted: 90.
Knowing the number of days in each month is useful for calculating maturity dates:
- January: 31 days
- February: 28 days (29 in leap years)
- March: 31 days
- April: 30 days
- May: 31 days
- June: 30 days
- July: 31 days
- August: 31 days
- September: 30 days
- October: 31 days
- November: 30 days
- December: 31 days
- Use the formula: Interest = Principal (P) x Rate (R) x Time (T).
- For a $10,000 note at 5% annual interest over 90 days using the 360-day year convention:
- Interest = $10,000 x 0.05 x (90/360).
- Interest = $10,000 x 0.05 x 0.25.
- Interest = $125.
- At maturity, the entry reflects the repayment of the principal and the recognition of interest revenue. Cash is debited for the total amount received.
- Notes Receivable is credited for the principal amount to remove the receivable.
- Interest Revenue is credited for the interest earned over the 90 day period.
- The journal entry records the issuance of a loan (debit to Notes Receivable) and the outflow of cash (credit to Cash).
- The entry recognizes the principal amount; interest will be accounted for when it accrues.
Interest Accrual Over Periods
- If the note spans multiple accounting periods, you must accrue the earned interest at the period's end that has not been paid by the borrower.
- Start date of the note: November 1st.
- Maturity date calculation:
- November has 30 days; since the note starts on the 1st, count 29 days remaining in November.
- Add 31 days for December.
- Add 30 days for January; making the maturity date January 30th.
- Total days counted: 90.
Knowing the number of days in each month is useful for calculating maturity dates:
- January: 31 days
- February: 28 days (29 in leap years)
- March: 31 days
- April: 30 days
- May: 31 days
- June: 30 days
- July: 31 days
- August: 31 days
- September: 30 days
- October: 31 days
- November: 30 days
- December: 31 days
- Use the formula: Interest = Principal (P) x Rate (R) x Time (T).
- For a $10,000 note at 5% annual interest over 90 days using the 360-day year convention:
- Interest = $10,000 x 0.05 x (90/360).
- Interest = $10,000 x 0.05 x 0.25.
- Interest = $125.
- As the accounting period ends, if the note has not yet matured, interest earned to date is recognized.
- Interest Receivable is debited for the amount of interest that has accrued on the note receivable, increasing assets.
- Interest Revenue is credited to record the earned income, reflecting the company's right to this income, which will be received in the future.
Maturity Date Example
- From November 5th:
- November has 25 days remaining after the 5th.
- December adds another 31 days, reaching 56 days in total.
- January contributes 31 more days, resulting in 87 days by the end of January.
- The remaining 3 days carry over into February, making the maturity date February 3rd.
- The cumulative total is 90 days.
Knowing the number of days in each month is useful for calculating maturity dates:
- January: 31 days
- February: 28 days (29 in leap years)
- March: 31 days
- April: 30 days
- May: 31 days
- June: 30 days
- July: 31 days
- August: 31 days
- September: 30 days
- October: 31 days
- November: 30 days
- December: 31 days
- Use the formula: Interest = Principal (P) x Rate (R) x Time (T).
For the 56 days from November 1st to December 31st on a $10,000 note at 5% interest:
- Interest = $10,000 x 0.05 x 56/360
- Interest = $78 (rounded)
- The final maturity entry accounts for the cash received (debit to Cash), the principal amount of the note (credit to Notes Receivable), and all interest accrued.
- The Interest Receivable is credited to clear the receivable, and Interest Revenue is credited for the additional interest accrued from January 1st to January 30th.
- The total interest revenue recognized over the 90 days is $125, with $78 accrued at the end of the previous year and an additional $47 recognized in the new year.
