Allowance Method vs Direct Writeoff Method (Accounts Receivable) - Explained
What is the Allowance Method for Uncollectible Accounts Receivable?
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What is the Allowance Method?
The allowance method matches the estimated expenses or losses from uncollectible accounts receivables against the sales.
We record our accounts receivable on the balance sheet. This amount is often inaccurate, as we will likely not be able to collect all of these.
At the end of the accounting period, a bad debt expense is estimated and recorded in an adjusting entry.
We have to figure out how much we think we're not going to get and reduce our accounts receivables accordingly by recording a bad debt expense.
Example of the Allowance Method
The below video provides an example of the Allowance Method.
What are the Advantages of the Allowance Method?
The advantages of using the allowance method for valuing accounts receivables are:
- It records bad debt expense when the related sales are recorded. So, it matches the expense with the revenue.
- It also records the accounts receivables on the balance sheet and an estimated amount of cash to be collected.
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How to Calculate the Bad Debt
There are three main ways that we can calculate bad debt.
- Percentage of Sales Method - A percentage of what we sell for that year.
- Percentage of Receivables Method - A percentage of whatever our receivables balances,
- Aging Schedule or Aging of Receivables - We itemize those things based upon age of the specific payable.
What is the Percentage of Sales Method?
The below video provides an explanation of the Percentage of Sales Method for creating a bad debt expense account.
Example of the Percentage of Sales Method
The below video provides an example of the Percentage of Sales Method for creating a bad debt expense account.
What is the Percent of Receivables Method?
The below video provides an explanation of the Percentage of Receivables Method for creating a bad debt expense account.