Which of the following is true of the balance sheet presentation of the allowance for bad debts?
Why do businesses make an allowance for impairment of trade receivables?A bad debt can happen to any small business who sells on credit terms. It is when a business has overdue receivables that may result in uncollectible debts, whether it is due to a slow economy or the customer filing bankruptcy. These default payments require Show
Accountants also need to comply with the following accounting principle: To comply with matching principle by ensuring that possible losses incurred due to debts To comply with prudence theory by recording expected losses due to a fall in value of  Recording the Allowance for Impairment on trade/accounts receivablesTwo primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected. 1. Percentage of Sales Method (7086/7087 POA Syllabus)
2. Specific Customer Method (7175/7088 POA Syllabus)
Creating an Allowance for Impairment Loss of Trade ReceivablesIra Company has a total Trade Receivables of $700,000 at the year’s end. The company decided to set up an Allowance for Impairment Loss on Trade Receivables at two percent of the entire Trade Receivables amount each year. The agreed rule is that the actual Impaired Loss on Trade Receivables does not go beyond the reserve. If it does, the firm will have to assess its actual collection performance again and decide on a new rate. Take note that the percentage is used on the Trade Receivables amount after any Impairment Loss on Trade Receivables is written off. So, based on the given data, calculation of net trade receivables is as follows:
The journal entry for setting up the allowance is:
Increasing the Allowance In the second year, the Trade Receivables balance of Ira Company is $750,000. The estimated uncollectable debts at 2% is $15,000. Thus, the increased credit losses is up by $1,000. The double entry is:
Decreasing the Allowance In the third year, the Trade Receivables balance of Ira Company is $650,000. The rate remains at two percent because no actual Impaired Loss on Trade Receivables occurred. There is a need, though, to decrease the reserve balance by $2,000, from $15,000 in year 2 to $13,000 in year 3. The impairment of accounts double entry is:
Based on these cases, the ledger will take up the adjustments for the first two years as an operating expense in the Statement of Financial Performance since the adjustments reduce profit. In the third year, the adjustment reduced the allowance. It is treated as a “negative-expense” and increases profits. The extracts of the financial statements for the three years would look like this: Year 1: Creation of the Allowance for Impairment loss on trade receivable account:Weds.SG Video Equipment
Year 2: Recording the Adjusting Entry to INCREASE the Allowance for Impairment loss on trade receivable account:Weds.SG Video Equipment
Weds.SG Video Equipment
Year 3: Recording the Adjusting Entry for impairment loss to DECREASE the amount of Allowance for Impairment loss on trade receivable account:Weds.SG Video Equipment
Notes on Net Trade Receivables In the 7175/7088 POA syllabus, this term is used in the presentation of trade receivables in the current asset section of the balance sheet to reflect bad debt provisions. This presentation is seen in the statement of financial position at at 31 December 2021 From the
7087/7086 POA syllabus (examinable from 2021), this term is no longer required. You can simply write the net trade receivable figure in the right column as seen in the statement of financial position extract as at 31 December 2022 and 2023. Actual payment behavior of debtorsWhen a credit customer, whose debt that a business thought may be uncollectible in the prior period, makes a partial payment in the current period as full settlement of the debt as the customer has declared bankrupt, the portion of the debt that is not collected is written off to the allowance for impairment as trade receivables account. The double entry for such debtor payment behavior is as follows:
Ways to reduce uncollectible accounts and reduce bad debts expense on outstanding accounts from trade/ accounts receivables:
These Credit Risk Management Practices will increase the probability of payment and improve future cash flows: Check the credit worthiness of potential trade receivables What is allowance for bad debts in balance sheet?An allowance for doubtful accounts is considered a “contra asset,” because it reduces the amount of an asset, in this case the accounts receivable. The allowance, sometimes called a bad debt reserve, represents management's estimate of the amount of accounts receivable that will not be paid by customers.
Which of the following is true about the allowance for doubtful accounts?The correct option is (a) An allowance for doubtful accounts is a contra asset account, and the normal balance is a credit. The management transfers some amount annually to allowance for doubtful accounts based on previous year data and estimates for the future.
How do you account for allowance for bad debts?Bad Debt Allowance Method
Estimate uncollectible receivables. Record the journal entry by debiting bad debt expense and crediting allowance for doubtful accounts. When you decide to write off an account, debit allowance for doubtful accounts and credit the corresponding receivables account.
Is allowance for bad debts subtracted?The allowance for doubtful accounts is a contra asset account and is subtracted from Accounts Receivable to determine the Net Realizable Value of the Accounts Receivable account on the balance sheet.
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