Journal entry for uncollectible accounts

Introduction

Uncollectible accounts are the receivables that we estimate to be uncollectable, due to the customers being unable to pay or the customers are not willing to pay, resulting in the bad debt expense occurring on the income statement. Likewise, we usually need to make the journal entry for uncollectible accounts at the period-end adjusting entry in order to recognize and record the amount of bad debt expense that is estimated to occur during the accounting period.

In accounting, we usually use the allowance method in order to account for the bad debt expense that could occur on the receivables as a result of the uncollectible accounts. This is due to using the allowance method will match the expense that could occur as the result of credit sales to the revenue that we generate from the credit sale. In other words, this method of recording the uncollectible accounts complies with the matching principle of accounting.

Additionally, the allowance method for the uncollectible accounts also makes the accounts receivable on the balance sheet have a better reflection of their net realizable value. This is because the allowance accounts, e.g. allowance for doubtful accounts, are recognized and recorded at the period-end adjusting entry in order to reduce the net book value of the accounts receivable to a more realistic value.

However, we may see some companies the direct write-off method, instead of the allowance method, to account for the uncollectible accounts. The direct write-off method does not try to match the bad debt expense to the revenue that is generated from the uncollectible accounts.

This is because, under the direct write-off method, we only recognize and record the bad debt expense when we need to write off the accounts receivable. And this usually happens in a different period from the period that we make the credit sales.

Hence, the expense does not match the revenue making it a method that goes against the accounting rules. That is why this direct write-off method is usually used by some companies that have a small amount of receivables or its bad debt expense is insignificant or immaterial in the first place.

Journal entry for uncollectible accounts

Allowance method

We can make the journal entry for uncollectible accounts under the allowance method by debiting the bad debt expense account and crediting the allowance for doubtful accounts at the period-end adjusting entry.

The allowance for doubtful accounts is a contra account to the accounts receivable on the balance sheet. Likewise, the normal balance of the allowance for doubtful accounts is on the credit side.

Hence, the journal entry for uncollectible accounts will increase the total expenses on the income statement while decreasing the total assets on the balance sheet.

Though, it may be useful to note that, under the allowance method, we need to estimate the bad debt expense for the period that could happen as a result of the credit sale. The estimation of the bad debt expense can done through the percentage of sales or the percentage of receivables.

Direct write off method

As mentioned, some companies that have an insignificant amount of bad debt expense may use the direct write off method to deal with the uncollectable accounts instead. In this case, there will be no estimation nor there is any recording of the allowance for doubtful accounts at the end of the period.

Specifically, under the direct write-off method, we will only record the bad debt expense when we decide to write off any specific accounts. In other words, once we decide which accounts are uncollectible, we will directly write them off with the debit of bad debt expense account and the credit of the accounts receivable. Hence, the term “direct write off”.

Uncollectible accounts example

For example, on December 31 which is our period-end adjusting entry, we estimate that 3% of the credit sales we made during the year will be uncollectible. This estimation is based on our past experiences and it is in line with the industry average data that is publicly available.

During the year, we have made credit sales of $100,000. Hence, $3,000 ($100,000 x 3%) of the credit sales is estimated to uncollectible. And we use the allowance method to estimate and record the bad debt expense.

In this case, we can make the journal entry for uncollectible accounts at the period-end adjusting entry of December 31, by debiting the $3,000 to the bad debt expense account and crediting the same amount to the allowance for doubtful accounts.

This journal entry for uncollectible accounts will increase the total expenses on the income statement by $3,000 as the result of $3,000 bad debt expense estimation for the period. At the same time, it will decrease the total assets on the balance sheet by the same amount of $3,000 as of December 31.

Example 2:

For another example, assuming we use the direct write-off method to deal with the uncollectible accounts instead. In this case, assuming we decide to write off $5,000 of accounts receivable due to their long overdue and are deemed uncollectible.

In this case, the write off journal entry for the $5,000 accounts receivable that are deemed uncollectible is as below:

This journal entry will charge the $5,000 bad debt expense to the income statement while removing the $5,000 of accounts receivable from the balance sheet.