Accounting Basics Part Ten - The Provision for Uncollectible Accounts Okay, today we’re going to look at providing for doubtful accounts. What is a doubtful account? Well, if you remember earlier, we’re recording our revenues when we earn them, and many times we’re doing business on account. And I’ve heard people say, well, I can’t, small business people say, “well, I can’t count that as a revenue, because I haven’t collected the money, you know what if I don’t collect the money?”, and really if you’re working your business correctly, in many businesses they’re generating more business by offering credit, but they may, depending on what their credit policy is in the business, they usually have a percentage that’s not collectible, and in order to follow the matching principle, we want to match the expense in the period that we’ve been generating revenue. So, when we come to the end of the period and we’ve done business on credit, we know that a certain part of it may not be collectible. We don’t know which accounts. We don’t know how much. If we knew who they were we wouldn’t have extended credit. So the way that it’s handled is providing for doubtful accounts in an account called allowance for doubtful accounts. Now how do we know how much to have in this allowance? How much is going to be uncollectible? Well, there’s a couple of different ways to do this, and the first one here The analysis of receivables method. This has to do with looking at your receivables, looking at each one of them, each one of the groups, and seeing, that the ones that are older are less likely going to be collected. After you have some experience with receivables in your business you can get a feel for what the percentages are. This is very important in a business, that they are able to collect this money. Remember we report it back there in current assets, and we’re hoping to get it in very soon. So, there’s no rule on what you have to use for a percentage. It’s going to depend on your business, your credit policy, your collection policy. But then, when you use this method you analyze your receivables, you look at the age, okay? For this business they have $400,000 that were not past due, and they, from past experience they found that 1% of their sales that are in this category are not going to be collectible. So, what we want to do is just multiply that out and see well, what would be uncollectible, thats $4,000. All right, and then in the 1-30 day category, there’s $50,000, that was 50,00 that was uncollectible, and they found that 2% that was normally not collectible in that category, so if we multiply that out we get $1,000.00. Okay, 31-60 days past due, see how the percentage is jumping up to 6%, so my $30,000, 6% of $30,000 would be $1,800., and again I’m having smaller amounts because the older they are the greater chance either that they’ve been paid or we’ve given up some way or another. All right, so then $20,000 they have listed here as being 61-90 days past due and they’ve found that 15% of those were not collectible, so we’re going to take the $20,000 times 15% which gives us $3,000.00. Okay, if we add that up we’re getting a very specific amount that is not collectible. Now remember that this is only an estimate; it’s only an estimate, but if we’re using the analysis of receivables method it gives us, we end up with a very specific number that should be in our uncollectible accounts. Just to tell you a little bit about uncollectible accounts, when we actually record this on our books, we’ll be recording $9,800.00 in that debt expense and the other, the off set to that, so that’s an increase, is an account called allowance for doubtful accounts; that is another contra asset account. It’s an offset to accounts receivable. As a matter of fact, when we take accounts receivable and we subtract out our allowance for doubtful accounts that

gives us what is called net realizable value. Any time you see the word net you know something’s been taken out, and actually that can be kind of easy to remember, because everybody seems to know the difference between gross pay and net pay, so, gross receivables will be a full amount of receivables, net would be after we take out our allowance for doubtful accounts. Now this first question here says to estimate the proper balance in allowance for doubtful accounts, so, we did that $9,800.00, but if you go down to part A it says, assume the allowance before adjustments has a positive balance of $3,000.00. Determine the amount needed to adjust the allowance for doubtful accounts to provide for doubtful accounts. Right, if we were doing that we’d take the $9,800, and it says we already have $3,000.00 in there. What’s that telling us? We have $3,000 left over from the last period, so we estimated too much last time so we just go ahead and take that $9,800.00 and subtract the $3,000.00 to give us $6,800.00. Okay, the next scenario says here, assume the allowance for doubtful accounts has a negative balance of $3,200.00. What does it mean to have a negative balance? It means that last period we wrote off more accounts than we had provided for in our allowance account, so we ended up with a negative number, so if we had a negative number, which they said was $3,200.00, we’d add the $9,800.00 plus the $3,200 which would give us $13,000.00. So again, using this method, the analysis of receivables method we come up with a very precise number, and look at what’s already in our account to make our adjustments. There’s another method that’s perfectly acceptable and it’s called the net sales method. It’s completely different. You actually look at your net credit sales. How many sales did I make on credit? And you have a percentage that you’ve estimated to be uncollectible. Now this would be based on past experience. What percentage do you find of your net credit sales to be uncollectible? And that’s pretty much it. You just multiply the net sales by your estimate, what’s estimated to be uncollectible, and whatever you come up for your answer is what you should record as your bad debt expense for that period, and the offset to that is the increase to the allowance account. So again, you’re setting that allowance away for sales you made in this period that you estimate will be collectible. Now, often I find when we’re looking at these two different methods, people get so used to this method where you’ve got to subtract to get the precise amount, come down here this one’s just too easy, but that’s just all there is to the net sales method. So, if you look at your problem here number two it says the DEF Company provides for their uncollectible accounts using the percent of sales method. Net sales for the year total $1,000,000.00. Bad debts are estimated at one half of one percent of net sales. The allowance account before adjustment it says has a negative of $5,000. Determine the amount needed to adjust for the allowance for doubtful accounts for the year. All right, so let’s look down here. What are our net sales? What did it say? $1,000,000.00? All right, and what was the percent estimated to be uncollectible? It said one half of one percent, so we’re going to take one half of one percent, and that should be $5,000.00. If you are uncomfortable with that half you can just get 1% and divide it by 2, and it would be $5,000.00. They gave us in this problem the balance in the allowance for doubtful accounts, telling us what it, that it had a negative balance, but guess what, we don’t do anything with that; all we do is record this. We don’t look at a balance. We don’t make any subtractions or additions. We just use the actual number that we got, and it can be over time, if this number is not giving us what we need and we’re ending up with

negative amounts we can increase the percent, because obviously we’re not on target with what our percent should be. And we’ll cover more in the next series.