Accounts Receivable

Estimation of Doubtful Accounts

Methods of Estimating Doubtful Accounts

• Statement of financial position approach

1. Percent of accounts receivable
2. Aging the accounts receivable
• Income statement approach
1. Percent of sales
A Comparison
Percent of Sales

• The amount of sales for a year is multiplied by a certain

rate to get the doubtful accounts expense.
• The rate may be applied on credit sales or total sales.
• Rate to be used is computed by dividing the bad debt
losses in prior years by the charge sales (or total sales) of
prior years.
• There is proper matching of cost against revenue (direct
relation to sales).
• An income statement approach.
Percent of Sales

• Disadvantage
– AR may not be shown at estimated realizable value because
the allowance for doubtful accounts may prove excessive or
inadequate.
Percent of Sales (an Example)

Gonzales Company elects to use the percentage-of-sales

basis. It concludes that 1 percent of net credit sales will
become uncollectible. If net credit sales for 2017 are
$800,000, the estimated bad debts expense is $8,000 (1%
× $800,000). The adjusting entry is:
Percent of Accounts Receivable

• A certain rate is multiplied by the open accounts at the

end of the period in order to get the required allowance
balance.
• The rate used is usually determined from past experience
of the entity.
• Advantages:
– Presents the AR at estimated net realizable value.
– Simple to apply.
Percent of Accounts Receivable

• Disadvantages:
– Violates the matching principle.
– The loss application rate may be difficult to obtain and may not
be reliable.
• A statement of financial position approach.
Percent of Accounts Receivable (an Example)

The balance of AR is P2,000,000 and the credit balance in

the allowance for doubtful accounts is P10,000. Doubtful
accounts are estimated at 3% of AR.

Required allowance (3% × 2,000,000) 60,000

Less: Credit balance in allowance 10,000
Doubtful accounts expense 50,000

Journal entry
Doubtful accounts 50,000
Allowance for doubtful accounts 50,000
Aging of Accounts Receivable

• involves an analysis where the accounts are classified

into not due or past due (beyond the maximum credit
term).
• the allowance is determined by multiplying the total of
each classification by the rate of loss experienced by the
entity for each category.
• more accurate than the percent of AR method.
• VIOLATES the mathing process and can be time
consuming.
Aging of Accounts Receivable (an Example)
Correction of Allowance for Doubtful Accounts

• When percent of sales method is being used AND aging

the accounts may prove the allowance to be inadequate
or excessive.
• Any correction is to be reported as an adjustment to
doubtful accounts expense (and allowance for doubtful
accounts).
• Any correction shall NOT result to doubtful accounts
expense having a credit balance. In cases where the
correction exceed the debit balance of doubtful accounts
expense, the difference shall be credited to miscellaneous
income.