Financial Accounting: An Integrated Statements Approach, 2nd Edition

Chapter 8 Receivables 359

ExTone doesn’t know which customer accounts will be uncollectible. Based upon in-

dustry data, ExTone estimates that $40,000 of its accounts receivable will be uncol-

lectible. Using this estimate, the following adjusting entry is made on December 31:

Dec. 31 Bad Debt Expense 40,000

Allowance for Doubtful Accounts 40,000

Since the $40,000 reduction in accounts receivable is an estimate, specific customer

accounts cannot be reduced or credited. Instead, a contra asset account entitled

Allowance for Doubtful Accountsis credited.

As with all adjustments, the preceding adjusting entry affects the balance sheet

and income statement. First, the adjusting entry records $40,000 of bad debt expense,

which will be matched against the related revenues of the period on the income state-

ment. Second, the adjusting entry reduces the value of the receivables to the amount

of cash expected to be realized in the future. This amount, $960,000 ($1,000,000

$40,000), is called the net realizable value of the receivables. The net realizable value

of the receivables is reported on the balance sheet.

You should note that after the preceding adjusting entry has been recorded,

Accounts Receivable still has a debit balance of $1,000,000. This balance represents the

total amount owed by customers on account and is supported by the individual cus-

tomer accounts in the accounts receivable subsidiary ledger. The accounts receivable

contra account, Allowance for Doubtful Accounts, has a credit balance of $40,000.

Write-Offs to the Allowance Account

When a customer’s account is identified as uncollectible, it is written off against the al-

lowance account. This requires the company to remove the specific accounts receivable

and an equal amount from the allowance account. For example, on January 21, 2008,

John Parker’s account of $6,000 with ExTone Company is written off as follows:

Jan. 21 Allowance for Doubtful Accounts 6,000

Accounts Receivable—John Parker 6,000

At the end of a period, the Allowance for Doubtful Accounts will normally have

a balance. This is because the Allowance for Doubtful Accounts is based upon an esti-

mate. As a result, the total write-offs to the allowance account during the period will

rarely equal the balance of the account at the beginning of the period. The allowance

account will have a credit balance at the end of the period if the write-offs during the

period are less than the beginning balance. It will have a debit balance if the write-offs

exceed the beginning balance.

To illustrate, assume that during 2008 ExTone Company writes off $36,750 of un-

collectible accounts, including the $6,000 account of John Parker recorded on January

21. The Allowance for Doubtful Accounts will have a credit balance of $3,250 ($40,000
    $36,750), as shown below.

Q.If the balance of
accounts receivable is
$380,000 and the
balance of the allowance
for doubtful accounts is
$56,000, what is the net
realizable value of the
receivables?

A.$324,000
($380,000$56,000)

ALLOWANCE FOR DOUBTFUL ACCOUNTS

Jan. 1, 2008 Bal. 40,000

Total accounts

Jan. 21 6,000

written off $36,750

Feb. 2 3,900

Dec. 31, 2008 Unadjusted balance 3,250

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SCF BS IS

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SCF BS IS

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