Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

7. Receivables and Investments

Net Accounts Receivable: Aging of Receivables Method

The Aging-of-Receivables Method helps us calculate the ending balance in the Allowance for Doubtful Accounts. We will have to use our BASE formula or T-account to calculate the Bad Debt Expense.



Net Accounts Receivable: Aging of Receivables Method

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Alright now let's use the aging of receivables method for the allowance for doubtful accounts. So different from the percentage of sales method in this method, we estimate the amount of uncollectible accounts in the ending balance of a are based on age. Okay. So what we're gonna see is that we're gonna take the instead of looking at the amount of sales, we're gonna look at how much is owed to us. All right, so a little bit different. This one is called a balance sheet approach because we're gonna be looking at a balance sheet account accounts receivable where the income statement approach for the percentage of sales. We're looking at revenue. Okay? So an example question will typically give you some sort of aging schedule which will see an example below. And we're gonna use this to calculate the ending balance in the allowance. Okay. The ending balance in the allowance for doubtful accounts. Okay. Now they don't always give you an aging schedule. Sometimes you'll have an easier exam question that just tells you the results of the aging schedule. Okay, So instead of actually doing the work of doing the aging schedule, they'll just say this is the ending balance in the allowance. They'll tell you the ending balance in the allowance. Okay, notice that we can again use are based formula just like we did with the percentage of sales method. However, it's a little different this time we still have our same formula beginning balance in the allowance plus bad debt expense minus accounts for on and off equals ending balance. And like I said, we generally you probably won't deal with this in the questions. They usually leave that out but it's good to know that it's there. Um So what's left is our beginning balance which is generally given. And then the ending balance comes from the aging schedule and this is usually given, it's either zero or they'll tell you the amount. Um And then finally bad debt expense. So we have to solve for bad debt expense in this situation. Okay so let's go ahead and do an example and let's see how this all works. A company has gross accounts receivable totaling $100,000. The company estimates the allowance for doubtful accounts based on the following table. If the allowance for doubtful accounts has a credit balance of $1,000. So they have to give you this information in these questions, you have to know the beginning balance because we have to plug in to get the bad debt expense. So this is the beginning balance. If the allowance has a credit balance of 1000, what is the entry to record this year's bad debt expense. Alright so notice what they give us. They give us an age and they tell us the amounts that are within that age group. Okay so this is they told us there was $100,000 in accounts receivable and that's this $100,000 broken up there by age. Okay so what we see is that based on the age there's a percent. That's uncollectible. So the person remember this this schedule. This 100,000 that's all the money that's owed to us right now. So what we're finding is what percentage of that is uncollectable. Well that's the ending balance in the allowance because the ending balance in the allowance should be the amount that's uncollectible. Alright so let's check it out. What we're gonna do is we're gonna multiply across based on the amount times the percent uncollectible. So these current ones, the ones that are from 1 to 30 days notice there's a small chance there uncollectable. times 1%. Well what does that come out to that comes out to $450 right? Four yeah 45,000 times 40.1 is 450. Okay let's do the next one notice as they get older. The percent uncollectable gets bigger. So 25,000 times point oh three that one's 7 750. And that's just multiplying across 25,000 times point oh three let's keep going 20,000 times 30.5 for these older ones. Well 1000 of those are uncollectible. And finally the very old ones, there's 10,000 times 0.2 20% Uncollectable. That comes out to 2000. So we add all of these up and this will be the ending balance in the allowance. So 2000 plus 1000, I don't I don't want to do this in my head right now it's been a long day. 2000 plus 1000 plus 7 50 plus 4 50. That gives us 40 200. Okay, that is the ending balance in the allowance. So knowing that let's set up our T. Account and find out what our bad debt expense is gonna be. So we've got our allowance for doubtful accounts and it started with the beginning balance right? They told us it has a beginning balance of 1000 credit balance. So that's our beginning balance right there as a credit and then there will be some bad debt expense, right? There will be some bad debt expense that increases this account, there will be write offs which in this case we're zero right? There were no write offs. They didn't talk about it in this question at all. So there's no write offs And finally that gets us to our ending balance right? We're gonna have our ending balance down here which we calculated as 40 200. Alright, So what we need to do is we need to find a number that's gonna get us from the beginning balance of 3200. Excuse me of just gave away the answer the beginning balance of 1000 and that will get us to 4200. Okay, so we could just set it up. We would do our 1000 plus the bad debt expense right minus zero equals the ending balance of 4200. Well, we just subtract 1000 from both sides. Right. And it'll tell us that our bad debt expense equals 30 200. Okay, that is our bad debt expense right there. Whoops. Bad debt expense. Okay. And our ending balance in the allowance is 4200. So just to reiterate, just to see so you can see it. I'm gonna make the journal entry over here. The journal entry easy enough. Right. We found out what our bad debt expense is gonna be the 3200. Let me get out of the way. Just make sure you saw all of that. Um So that canceled with that. Right. Um Yeah, so we saw our journal entry for 30 200. Okay. That this is the key here. This is the key to the journal entry is finding what the bad debt expense is going to be. And then we do our journal entry. So we're gonna have bad debt expense for 30 200. An allowance for doubtful accounts for 3200 notice. And that that entry right there. It gets us to the ending balance in the allowance. Right? This number this X becomes 3200 right here. Right? And that brings us up to the ending balance of 4200 that we had previously calculated. Cool. So it's kind of a roundabout, but you can see that the steps are not too complicated. Alright, let's go ahead and move on to the next video. You guys can try a practice.

A company has gross accounts receivable totaling $150,000. The company uses the aging-of-receivables method to estimate the allowance for doubtful accounts. The company estimates that the amount of uncollectible receivables will be $3,600. Currently, the allowance for doubtful accounts has a debit balance of $800. What is the journal entry to record this year’s bad debt expense?

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