Writing Project Presentation

Running Head: DEALING WITH BAD DEBT

DEALING WITH UNCOLLECTIBLE ACCOUNTS RECEIVABLES

Alexis Aguirre Leon

Keiser University

Date: 5-14-2020

DEALING WITH BAD DEBT 2

To: Board of directors

From: chief accountant

Date : 5/14/2020

Subject : why the ABC company uses allowance method to manage bad debt

Businesses make purchases and sales on credit and later pays or receives payment from

the customers or the creditors. The risk is usually extended when the business extends payment

terms. While some will pay on the agreed time, other will never pay at all. And that is why the

company incurs bad debts. If any account becomes uncollectable, the management have to

remove the receivable from the accounting books and transfer it to its expenses. It is transferred

to expenses because it is also cost incurred when doing business, it is called bad debt expense. It

this study, two ways of accounting for these uncollectable accounts will be discussed in details.

Direct method.

This method allows business to record bad debts expense only when a given account is

considered uncollectable. The account is transferred to the bad debt expense. It is also common

to find that a customer later sends payment. However, there is nothing to apply the payment

against and if it is applied on the customers account, the balance sheet would not balance. In

order to offset this, the customers balance is first restored in his account and the amount paid can

be debited against customers account. The amount is never considered revenue since the

company is just acknowledged that there is no bad debt any more. The bad debt expense should

DEALING WITH BAD DEBT 3

be reduced. It is extreme easy way of managing bad debt when the uncollectable accounts are

rare in a company. The matching principle is however violated since the revenue has to be

matched with the expenses. When credit is extended to customers, it true that a good number of

them will not be able to pay and the company may take a very long time before exhausting its

effort to collect all the debts.

Allowance method

This method allows the company to create a bad debt expense even before knowing whci

customers will pay and which will not pay. The company uses its history to approximately how

much of its accounts are likely to bad debt. Using that percentage, the company then calculates

how much is likely to be incurred as bad debt. The company is then able to record bad debts.

When this entry is recorded, the account receivable cannot be credited. A holding account

(allowance for doubtful account) is created so that once account is deemed uncollectable, that

part of allowance can be used to reduce the account receivable. The amount is allowance for

doubtful account just settles waiting for any of the account to be identified an uncollectable. In

the event that a customer makes payment later, the balance in the account receivable is restored.

The balance in the allowance account is also restored.

Each of the two methods have their advantages and disadvantages. The internal revenue

regulating bodies ought to specify the method to used to avoid over taxation of under taxation.

Why ABC uses the allowance method

Allowance has been the method that the ABC company has adopted for a very long time

over the direct method. One reason is that account receivables are usually reported on the

DEALING WITH BAD DEBT 4

balance sheet where the amount is likely to be greater that amount that was collected initially.

The second reason is that the uncollectable account is identified much later where it is removed

from the account receivable. In the direct write-off method, the identification and removal of

uncollectable account receivable does not give time for customer to fail to pay. Many internal

revenue services recommend the use of direct write-off method. This is meant to prevent the

people to claim a potential bad debt expenses by just anticipating a potential loss.

Thank you

Chief accounting office

DEALING WITH BAD DEBT 5

References

Warren, C. S. (2011). Survey of accounting. Mason, Ohio: Thomson/South-Western.

Gilbertson, C. B., & Lehman, M. W. (2014). Century 21 accounting.

Hunt, M. F., & Weygandt, J. J. (2013). Problem solving survival guide to accompany Financial

accounting, 7th edition [by] Jerry J. Weygandt, Donald E. Kieso, Paul D. Kimmel.

Hoboken, NJ: Wiley.