Adjusting Entries for Uncollectible Accounts

by John Cromwell, Demand Media

Uncollectible accounts receivables require not one, but a series of adjusting entries to ensure that the financial statements properly reflect the current financial condition of a business. There are three considerations when drafting the adjusting entries for an uncollectible receivable. The first is whether the receivable was recognized at all. Next is whether the receivable is uncollectable. The final issue is whether your business has an allowance for uncollectible accounts.

Define Accounts Receivable

Accounts receivable are current assets that represent amounts due from the sale of goods to customers on credit. A current asset is an item that is expected to be converted into cash within a year. Before making a sale on credit, the business needs to ensure that the customer is creditworthy. This provides the business reasonable assurance that if the sale is made on credit, the business can collect what is owed. Once the business is reasonably assured that it can collect, it can complete the sale. The sale is recorded by debiting accounts receivable and crediting sales. Debits increase assets, while credits increase revenues. Therefore, the result of the transaction is an increase in assets and income.

Define Uncollectible Account Process

Before recognizing an account receivable, a business must have a reasonable basis for assuming that it can collect on the outstanding obligation. For an account to become uncollectible, there generally must be a shift in the underlying circumstances of the customer to justify shifting the amount he owes to uncollectible status. Examples of such a shift would include bankruptcy, a souring of the customer-vendor relationship or a failure to pay when the amount is due.

Recording Revenue

U.S. Generally Accepted Accounting Principles require a business to include a contingency on its balance sheet in recognition of future losses that are probable and can be reasonably estimated. One item that many businesses account for is uncollectible receivables. Businesses use historical data to estimate how much to reserve for uncollectible accounts. The reserve is a contra-asset, or an asset listed on the balance sheet with a negative value meant to offset the value of accounts receivable. To record the reserve, you debit uncollectible accounts expense and credit allowance for uncollectible accounts. In addition to creating the reserve, this entry decreases business income for the year.

Recording Uncollectible Accounts

When an account is officially considered noncollectible, the business must make one of two entries. If the business created a reserve account, it must debit the allowance for uncollectible accounts and credit accounts receivable for the amount of the written-off receivable. This entry has no effect on the business income or overall value of assets on the balance sheet, but it adjusts the accounts receivable balance to reflect what is currently collectible. If no reserve was created, you would credit accounts receivable and debit uncollectible accounts expense to write-off an uncollectible account. This causes a decrease in accounts receivable and business income for the year.

Previously Uncollectible

If the business were to recover funds from a receivable it wrote off, you would need to reverse the entries you entered when you wrote off the account. If you have a reserve, you would first debit accounts receivable and credit the allowance for the amount of money you received for the receivable. Then, you debit cash and credit accounts receivable for the amount of cash you received. If you have no reserve, you would credit uncollectible accounts expense and debit accounts receivable for the amount you received and then credit accounts receivable and debit cash for the same amount.

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