July 15, 2023

Estimation of Doubtful
Accounts

Christopher Neil C. Pastrana

MBA 602-1 - Financial Accounting
Learning
Objectives

• Identify the method of estimating doubtful accounts.

• Compute the doubtful accounts expense and allowance for
doubtful accounts under different methods.
Table of Page
Contents
I Methods of Estimating Doubtful Accounts 4

II Aging of Accounts Receivable 5

III Percent of Accounts Receivable 9

IV Percent of Sales 11

V Correction in Allowance for Doubtful Accounts 16

VI Debit balance in allowance account 18

VII References 20
I Methods of Estimating Doubtful Accounts

There are three methods of estimating doubtful

accounts, namely:

• Aging the accounts receivable or "statement of

financial position approach"
• Percent of accounts receivable or also statement of
financial position approach
• Percent of sales or "income statement approach"

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II aging of accounts receivable

Aging of accounts receivable

The aging of accounts receivable involves an analysis where the accounts are
classified into not due or past due.

When is an account past due?

The credit terms will determine whether an account is a. Not due
past due. For example, if the credit terms were 2/10, n/30 b. 1 to 30 days past due
and the account is 45 days old, it is considered to be 15 c. 31 to 60 days past due
days past due. d. 61 to 90 days past due
Therefore, the phrase "past due" refers to the period e. 91 to 120 days past due
beyond the maximum credit term. In the example, the f. 121 to 180 days past due
credit term is 30 days. g. 181 to 365 days past due
h. More than 1 year past due
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II aging of accounts receivable

Aging of accounts receivable

The allowance is then determined by multiplying the total of each

classification by the rate or percent of loss experienced by the entity for each
category.
The major argument for the use of this method is the more accurate and
scientific computation of the allowance for doubtful accounts.

• This method has the advantage of presenting fairly the accounts

receivable in the statement.
• The objection to the aging method is that it violates the matching process.
• Moreover, this method could become prohibitively time consuming if a
large number of accounts are involved.

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II aging of accounts receivable

Aging of accounts receivable

Illustration:
The following data are summarized in aging the accounts receivable at the end of the period:

(a) (b) (a x b)

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II aging of accounts receivable

Aging of accounts receivable

The amount computed by aging of accounts receivable represents the required allowance for the end of the period.
Thus, if the allowance for doubtful accounts has a credit balance of P10,000 before adjustment, the doubtful accounts
expense is determined as follows:

The journal entry to record the doubtful accounts expense is:

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III percent of accounts receivable

Percent of accounts receivable

A certain rate is multiplied by the open accounts at the end of
the period in order to get the required allowance balance.
The rate used is usually determined from past experience of the
entity.
This procedure has the advantage of presenting the accounts
receivable at estimated net realizable value.
However, the application of this approach violates the principle
of matching bad debt loss against the sales revenue.
Moreover, the loss experience rate may be difficult to obtain and
may not be reliable.

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III percent of accounts receivable

Percent of accounts receivable

Illustration:
The balance of accounts receivable is P2,000,000 and the credit balance in the allowance for doubtful
accounts is P10,000. Doubtful accounts are estimated at 3% of accounts receivable.

Journal entry

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IV percent of sales

Percent of sales
The amount of sales for the year is multiplied by a certain rate to
get the doubtful accounts expense. The rate may be applied on
credit sales or total sales.

Theoretically, the rate to be used is computed by dividing the bad

debt losses in prior years by the charge sales of prior years.

The rate thus obtained is multiplied by the current year's charge

sales to arrive at the doubtful accounts expense.

Practically, however, there is no substantial difference if in the

computation of the rate, the basis is total sales of the prior
periods.

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IV percent of sales

Percent of sales
In such a case, the rate thus obtained is multiplied by the current year's total sales to get the doubtful
accounts expense.

This procedure of determining the rate has the advantage of eliminating the extra work of making a
record of cash sales and credit sales.

However, this approach may prove unsatisfactory when there is a considerable fluctuation in the
proportion of cash and credit sales periodically,

Argument for percent of sales method

When the "percent of sales" method is used in computing doubtful accounts, proper matching of cost
against revenue is achieved.

This is so because the bad debt loss is directly related to sales and reported in the year of sale.

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IV percent of sales

Percent of sales

Thus, this method is an income statement approach because it favors the income statement.

Argument against percent of sales method

The main argument against this method is that the accounts receivable may not be shown at estimated
realizable value because the allowance for doubtful accounts may prove excessive or inadequate.

Thus, it becomes necessary that time to time the accounts should be "aged" to ascertain the probable loss.

As a consequence, the rate applied on sales should be revised accordingly.

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IV percent of sales

Percent of sales

Illustration

The following accounts are gathered from the ledger.

If doubtful accounts are estimated at 1% of net sales, the doubtful accounts expense is P50,000 (1% x P5,000,000) and
recorded as follows:

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IV percent of sales

Percent of sales
If this method is used, the resulting amount of the computation is already the amount of the
doubtful accounts expense and not the required allowance, in contradistinction with the aging
method and the percent of accounts receivable method.

The allowance balance before adjustment is ignored in determining the doubtful accounts
expense to be recorded.

However, the allowance for doubtful accounts should have an adjusted balance of P70,000 with
the beginning allowance of P20,000 plus the adjustment of P50,000.
Allowance of doubtful accounts computation:

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V Correction in allowance for doubtful accounts

When the allowance is insufficient, there's a need to increase the allowance, the adjustment will be:

When the allowance is excessive, there's a need to decrease the allowance, the adjustment will be:

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V Correction in allowance for doubtful accounts

Note:
A decrease in the allowance should be only to the extent of the allowance balance or just become zero. If the decrease in
the allowance exceeds the balance of the doubtful accounts expense, the excess will be charged to miscellaneous income,
as such decrease is considered abnormal.

For example, if the amount of decrease in allowance is P30,000, and the doubtful accounts expense has a balance of
P20,000 only, the excess of P10,000 is charged to miscellaneous income. To record the adjustment:

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VI Debit balance in allowance account

Allowance for doubtful accounts is a contra-asset account with a normal balance of "credit".

However, it is also possible that the allowance account may have a "debit" balance (negative balance.)

This negative balance may happen before any adjustment to allowance account is made arising from inadequate balance
after write-off during the year.

For example, on January 1, the allowance account before adjustment has a credit balance of P30,000 and during the year
and account of P50,000 is written off and recorded as follows:

Thus, on December 31, the allowance account has a debit balance of P20,000 before adjustment.

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VI Debit balance in allowance account

If on December 31, the required allowance is P40,000 the adjustment should be:

Note that after the adjustment for the doubtful accounts, the allowance credit has P40,000, which is the required
allowance.

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VII References

• Financial Accounting Volume One by Conrado T. Valix, Jose F. Peralta,

Christian Aris M. Valix
• https://www.youtube.com/watch?v=00m9xHgg3a0
• https://www.youtube.com/watch?v=zwPhZGM9vIs&t=1197s

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Thank you
for listening!