When companies make sales on credit, they usually record such sales in an asset account called the accounts receivable. This account records monies that customers owe the business, however, not all customers are able to fulfill their obligation of paying for either goods or services which they had earlier received on credit. Thus when companies make sales on credit, they estimate in advance for sales that may become uncollectible due to the financial constraints of the customer. These uncollectible get recorded in the bad debt account. Allowance for doubtful accounts adjusting entry is a journal entry made at the end of an accounting period to reflect the estimated uncollectible accounts receivable of a company.
This adjusting entry is necessary to reconcile the company’s income and its expenses such that the bad debts are accurately written off and to ensure that transactions that begin in one accounting period and end in a later period are accurately recorded. In this article, we shall discuss the doubtful accounts, its main journal entry as well as adjusting entries.
Read about: Year-end Adjusting Entry: Examples and Types
What is the allowance for doubtful accounts?
The allowance for doubtful accounts is one of the contra-assets accounts in accounting. This account serves to show the real value of a company’s accounts receivable as it records the portion of the accounts receivable which has been deemed uncollectible by the company. This estimation is made to account for a certain amount of debt that may have to be written off within a given period. It is thus, also referred to as the provision for bad debts or provision for doubtful debts, or provision for losses on accounts receivable.
When an allowance for doubtful accounts is made, it can be specific or general. The specific allowance captures specific debts owed by a customer that the company knows has financial challenges and may be unable to fulfill their obligation to pay the debt. The general allowance captures a broader category as it captures a certain percentage of the company’s total accounts receivable that may become uncollectible based on the company’s prior experiences with similar debts. The difference between the bad debt account and the allowance for the doubtful accounts is that the former records debts that are considered uncollectible while the former captures debt that may be repaid or become uncollectible in the future.
The allowance for doubtful accounts is an important part of the accounting records of companies as it aids in presenting a true picture of the companies’ assets. Without this account, businesses may have an inaccurate picture of their accounts receivable which will, in turn, affects their financial statements especially, the statement of financial position where the accounts receivable is recorded as part of the company’s current assets.
Read about: Adjusting entry for accrued salaries
Allowance for doubtful accounts journal entry
When companies make transactions, they record them using journal entries. This is applicable to the allowance for doubtful accounts too. When making a journal entry for the allowance for doubtful accounts, two accounts are involved based on the accounting debit and credit rules where a debit to one account results in an equal but opposite credit to another account. The two accounts involved are the bad debts expense account (an expense account) and the allowance for the doubtful account (contra-asset account). The former account is debited while the latter is credited.
This journal entry is typically made using the allowance method, which estimates the uncollectible portion of accounts receivable based on historical data and other relevant factors. When this journal entry is made, the amount that gets recorded in the allowance for the doubtful accounts does not affect the company’s profit and loss account. The journal entry for allowance for doubtful accounts will be recorded as shown below:
|DD/MM/YYYY||Bad debts expense||$$|
|Allowance for doubtful accounts||$$|
The bad debt expense is debited to recognize the estimated uncollectible accounts receivable as an expense on the income statement, while the allowance for doubtful accounts is credited to increase the contra-asset account on the balance sheet. The amount recorded in the bad debt expense is based on the company management’s estimate of the percentage of accounts receivable that is expected to be uncollectible. This estimate is based on historical data, industry trends, and other relevant factors. The allowance for doubtful accounts is used to offset the accounts receivable on the balance sheet and reflect the net realizable value of accounts receivable.
Read about: How to do adjusting entries with examples
Allowance for doubtful accounts adjusting entry
After the journal entry for the allowance for doubtful accounts has been made, there may be a need to make an adjusting entry in the future. The doubtful accounts adjusting entry is an accounting entry made at the end of an accounting period to reflect the estimated uncollectible accounts receivable. It is also known as the allowance for doubtful accounts or the provision for bad debts. Since the journal entry is made as an estimate, two factors will warrant making an adjusting entry:
- Non-payment of the debt
- Repayment of the debt
Non-payment of the debt
When a customer who has received goods or services from a company on credit is unable to fulfill their obligation, the company will make an adjusting entry to the allowance for the doubtful accounts to reflect the nonpayment of the debt. This adjusting entry will be recorded as a debit to the allowance for doubtful accounts and a credit to the accounts receivable. The adjusting journal entry for this nonpayment will be as shown below:
|DD/MM/YYYY||Allowance for doubtful accounts||$$|
When the above adjusting entry is made, it signifies that the debt has become bad debt since the customer has not fulfilled their obligation to pay up. The debit to the allowance for doubtful accounts indicates a decrease in the account balance and the credit to the accounts receivable also indicates a decrease in the company’s accounts receivable. By this adjusting entry, the company has written off the amount recorded as bad debt since it has become uncollectible.
Repayment of the debt
In an instance where a doubtful account gets paid, an adjusting entry is made to record the payment. This adjusting entry is made by debiting the accounts receivable and crediting the allowance for the doubtful accounts as follows:
|Allowance for doubtful accounts||$$|
The adjusting entry above signifies an increase in both the accounts receivable and the allowance for doubtful accounts which results from the debt repayment. Hence by this adjusting journal entry, the amount that was previously written off due to nonpayment gets reversed.
An additional journal entry is made by debiting the cash account and crediting the accounts receivable as follows:
The above journal entry signifies an increase in the company’s cash and a decrease in its account receivable since the customer has fulfil their obligation by paying off their debt.
Read about: Accrued revenue adjusting entry
What is the adjusting entry for allowance for doubtful accounts?
The adjusting entry for allowance for doubtful accounts is a journal entry made to record either the payment or nonpayment of a debt that had been previously recorded in the allowance for doubtful accounts. If the adjusting entry is for repayment, it will be recorded as a debit to the accounts receivable and a credit to the allowance for doubtful accounts. If the adjusting entry is for nonpayment, it will be a debit to the allowance for doubtful accounts and a credit to the accounts receivable.
Allowance for doubtful accounts adjusting entry examples
Example 1: Allowance for doubtful accounts adjusting entry for nonpayment
Assuming Mr. Ben a clothes retailer purchases clothes worth $30,000 on credit from Calvin Klein on January 20, 2023. If he is expected to pay for the purchase before April 21, 2023, then CalvinKlien will make the following journal entry at the time of the purchase.
But since the purchase was made on credit, it means there is a possibility that Mr. Ben may or may not fulfill his obligation, hence an additional journal entry is made as follows:
|20/1/2023||Bad debts expense||$30,000|
|Allowance for doubtful accounts||$30,000|
If the agreed date passes and Mr. Ben does not pay up what he owes, the company will have to make an adjusting entry to the allowance for doubtful accounts in order to write off the debt. This adjusting journal entry for the doubtful account will be as shown below:
|21/4/2023||Allowance for doubtful accounts||$30,000|
Example 2: Allowance for doubtful accounts adjusting entry for repayment
Continuing the example above, assuming Mr. Ben contacts Calvin Klein by October 5, 2023, and repays what he owed, then the company will need to make another adjusting entry to record the repayment as follows:
|Allowance for doubtful accounts||$30,000|
An additional journal entry will be made to reduce the accounts receivable and increase the cash account as follows:
Read about: Adjusting entry for inventory
Allowance for doubtful accounts adjusting entry is used by companies because it satisfies the Generally Accepted Accounting Principles (GAAP) where the revenue generated in one accounting period must be matched with the expenses accrued within the same period. The allowance for doubtful accounts enables companies to have a better record of their accounts receivable while taking into account the possibility of bad debts in order to avoid reporting misleading information on their balance sheet.
It is important to note that the doubtful accounts adjusting entry is an estimate and may need to be revised in future periods as more information becomes available. Additionally, the specific accounts and amounts involved may vary depending on the accounting policies and practices of a particular company. It is therefore always best to consult with a qualified accountant or financial professional for guidance on making adjusting entries, including those related to doubtful accounts.
Video: Allowance for doubtful debt adjusting entry
- Marxism vs Socialism vs Communism: Differences and Similarities - May 29, 2023
- Forms of Socialism - May 24, 2023
- Reasons why socialism is bad - May 19, 2023