Chapter 5

Estimation of Doubtful Accounts

When a loss becomes probable and can be measured reliably, doubtful accounts (bad debt)
expense is recognized.

There are three methods of estimating doubtful accounts, namely;

1. Percentage of Accounts Receivable;

2. Aging of Accounts Receivable; and
3. Percentage of Sales

Percent of Accounts Receivable

To get the required balance of allowance for doubtful accounts, the balance of the accounts
receivable at the end of the period is multiplied by a certain percentage rate.

Illustration:
JPIA Co. has the following information at year end.

Accounts receivable, January 1 P100,000

Net credit sales for the period 300,000
Percentage of Accounts Receivable 5%

The rate applied is determined from the past expenses and careful analysis of the relationship of
bad debts and credit sales. Normally, it is determined by dividing the bad debt expenses net of
recoveries of the prior years by the credit sales of the prior years. However, the debt loss
experience rate may be difficult to obtain and may not be reliable.

To compute the Required allowance for Doubtful Accounts:

Accounts receivable, 1/1 100,000

Net Credit Sales for the period 300,000
Accounts receivable, 12/31 400,000

Accounts receivable, 12/31 400,000

Percentage of accounts receivable 5%
Allowance for doubtful accounts (required allowance) 20,000

The difference between the required balance of allowance for doubtful accounts and the credit
balance of allowance for doubtful accounts is the doubtful account expense for the period.
Illustration: (continuation of the previous illustration)
Suppose the credit balance of allowance for doubtful accounts is P16,000
Required allowance 20,000
 Credit balance of allowance for doubtful accounts 16,000
Doubtful accounts expense 4,000

To record the Doubtful Accounts Expense, the journal entry is as follows;

Doubtful accounts expense 4,000
Allowance for doubtful accounts 4,000

The percentage of accounts receivable favors the statement of financial position because it
presents the accounts receivable at estimated net realizable value. However, it violates the
matching principle because bad debts are recognized based on the ending balance of the accounts
receivable and not on the sales revenue of the period the bad debts are recognized.

Accounts receivable 12/31 400,000

Allowance for doubtful accounts 12/31 20,000
Net realizable value of accounts receivable 12/31 380,000

Aging of Accounts Receivable

To get the required allowance, the rate or percent loss is multiplied by the total accounts
receivable that is classified into not due and past due.

To determine if an account is not due or present due, look into the credit terms. The days past
due is counted right after the maximum credit terms. For example, if the credit terms were 2/10,
n
/30 and the account is 50 days old, then the account is 20 days past due. In the example, if the
account is less than or equal 30 days old, then the account is not due.

Illustration:
JPIA Co. sells their products to these customers on terms of 2/10, n/30. The following data are
summarized at the end of the period;

Age in days Receivable balance

0-30 days 500,000
31-60 days 200,000
61-90 days 100,000
91-120 days 50,000
More than 121 days 20,000

JPIA Co. uses aging of receivable method. The estimated rate of uncollectability are as follows;
1-30 days past due 2%
31-60 days past due 5%
61-90 days past due 10%
More than 90 days past due 20%

The allowance has a balance of P10,000 before adjustments, no write-offs or recoveries were
made during the year.
To compute the required allowance:

Balance (a) uncollectible (b) Required allowance (axb)

1-30 days past due 200,000 2% 4000
31-60 days past due 100,000 5% 5000
61-90days past due 50,000 10% 5000
more than 91 days past due 20,000 20% 4000

The amount computed by aging accounts receivable is the required allowance for doubtful
accounts at the end of the period.

To compute the doubtful account expense for the period is the same computation as the
percentage of receivables method.

Required allowance 18,000

Credit balance of allowance for doubtful accounts 10,000
Doubtful accounts expense 8,000

The journal entry to record the doubtful account expense is:

Doubtful accounts expense 8,000
Allowance for doubtful accounts 8,000
The aging of accounts receivable method favors the statement of financial position because it
presents the accounts receivable at net realizable value. However, it violates the concept of
matching principle because bad debts are recognized based on the balance of receivables and not
the sales revenue during the period.

Accounts receivable 12/31 870,000

Allowance for doubtful accounts 18,000
Net realizable value of accounts receivable 852,000

Percent of Sales

The amount computed by applying the percentage of sales is doubtful account expense, unlike
the percentage of receivables and aging of receivables where the amount computed is the
required allowance.

Doubtful account expense is computed by multiplying the percentage of sale and net credit sales
during the period without considering the beginning balance of the allowance account.

Illustration:
JPIA Co. has the following information on December 31, 2019.

Allowance for doubtful accounts, 1/1/19 12,000

Sales (inclusive of P200,000 cash sales) 500,000
Accounts receivable, 12/31 200,000
Percentage of credit sales 2%
JPIA Co. uses percentage of credit sales method to compute their doubtful accounts.

Total Sales 500,000

Cash sales (200,000)
Credit sales 300,000
Percentage of net credit sales x 2%
Doubtful account expense 6,000

Cash sales are deducted because they are already paid and collected, therefore no allowance is
needed.

The entry to record doubtful account expense is:

Doubtful accounts expense 6,000
Allowance for doubtful accounts 6,000

The allowance for doubtful accounts for the year end is computed as:

Allowance for doubtful accounts, 1/1 12,000

Allowance for doubtful accounts(bad debts for the year) 6,000
Allowance for doubtful accounts, 12/31 18,000

The percentage of sales favors the income statement because it strictly complies with matching
principle where the bad debt loss is directly related to sales reported during the year.

A single estimated percentage is enough. However, when there is a considerable fluctuation in

the proportion of cash and credit sales, the percentage should be reassessed for appropriateness.

Debit Balance in Allowance for Doubtful Accounts

The normal balance or allowance for doubtful accounts is a credit balance. However, there are
instances when allowance for doubtful accounts has a debit balance, such as when the amount
that should be written off during the year is greater than the amount of allowance for doubtful
accounts.

To eliminate the abnormal balance of allowance for doubtful accounts, an adjustment should be
made to eliminate the abnormal balance.

Illustration:
On January , the allowance account before adjustments has a credit balance of P5000 and during
the year, an account of P15,000 is written off and recorded as:

Allowance for doubtful accounts 15,000

Accounts receivable 15,000
Thus, the balance of allowance for doubtful accounts is now on debit side. The necessary year
end adjusting entry to eliminate the abnormal balance would be debit to doubtful account
expense and credit to allowance for doubtful accounts.
Illustration: (continuation)

Suppose the required allowance on December 31 is P30,000, the adjustment entry should be:

Doubtful account expense 40,000

Allowance for doubtful accounts 40,000

Receivables Denominated in Foreign Currency

There are instances when there are transactions arising from foreign countries resulting
receivables denominated in Foreign currency. To initially record the transaction, it is translated
at the exchange rate at the date of transaction.

Subsequently, at the end of the period, the amount of receivables from foreign currency are
translated at the exchange rate at the end of the reporting period and an adjustment should be
made that is recognized in statement of profit or loss as foreign currency gain/loss.
True or False

1. There’s only one method of estimating doubtful accounts, namely “Percentage of

sales”
2. The aging of receivables method violated the matching principle.
3. Credit terms determine if an account is not due or past due.
4. To get the required balance of allowance for doubtful accounts, the balance of the
accounts receivable at the end of the period is multiplied by a certain percentage rate
5. Allowance for doubtful accounts is computed by multiplying the percentage of sale
and net credit sales during the period without considering the beginning balance of
the allowance account.
6. The allowance balance before adjustment is ignored in determining the doubtful
account expense in percent of sale method.
7. The normal balance of allowance for doubtful accounts is credit balance.
8. When the percent of receivables method is used, proper matching of cost revenue
against cost is achieved.
9. The rate is usually determined using future experiences of the entity.
10. The term “past due” refers to the period before the maximum credit term.

Problem 1

Dastu Company provided for doubtful accounts expense monthly at 3% of credit sales. January
1, 2019 balance of the allowance for doubtful accounts was P1,000,000.

Credit sales totaled P20,000,000, interim provisions for doubtful accounts were made at 3% of
credit sales, P200,000 accounts were written off, and recoveries of accounts previously written
off amounted to P50,000 during 2019.

An aging of accounts receivable was made on December 31, 2019.

1 – 60 days 6,000,000 90% collectible
61 – 180 days 2,000,000 80% collectible
181 – 360 days 1,500,000 70% collectible
More than one year 500,000 50% collectible

Based on the review of the “more than one year” category, additional accounts of P100,000 are
to be written off on December 31, 2019.

1. What should be reported as doubtful accounts expense for the current year?
a. 2,250,000
b. 1,650,000
c. 900,000
d. 850,000
2. What is the year end adjustment to the allowance for doubtful accounts on December 31,
2019?
a. 900,000 debit
b. 900,000 credit
c. 300,000 debit
 d. 300,000 credit
3. What is the net realizable value of accounts receivable on December 31, 2019?
a. 9,900,000
b. 8,250,000
c. 7,650,000
d. 8,450,000
Solutions

True or False

1. False
2. True
3. True
4. True
5. False
6. True
7. False
8. False
9. False
10. False

Problem 1

1. C
1 – 60 days (6,000,000x10%) 600,000
61 – 180 days (2,000,000x20%) 400,000
181 – 360 days (1,500,000x30%) 450,000
More than one year (500,000-100,000x50%) 200,000
1,650,000
ADA – January 1, 2019 1,000,000
Recoveries 50,000
DAE 900,000
Total 1,950,000
Accounts written off (300,000)
ADA – December 31, 2019 1,650,000

2. D
Correct DAE 900,000
Recorded DAE (3%x20,000,000) 600,000
Increase in DAE 300,000
3. B
AR – December 31, 2019 9,900,000
AD – December 31, 2019 1,650,000
Net Realizable Value 8,250,000