Lesson Objectives:- Why write-offs are used.
- Example of how to record a write-off
- How write-offs affect net realizable value.
We've talked about how to estimate the amount of uncollectibles using the allowance method from a general standpoint using both the sales and receivables methods. The bad debt figure is estimated with these methods in order to debit the bad debts expense and credit the AFDA account. If you don't remember from the previous lessons, AFDA stands for the allowance for doubtful accounts and is the contra account for the bad debt expense.
What we haven't covered yet is what to do when there is a write-off. A write-off is when we need to show the accounts receivable will not be collected.
In the case of a write-off, we will need to show that the accounts receivable account is decreasing and would need to be credited.
The debit entry would be the AFDA contra asset account because the receivable is no longer being collected. The format for the journal entry is shown above.
Now let's look at a simple example of how this concept is applied in the real world.
For this example, let's say we have a beginning AFDA amount of $ 3,000 and ending value of $6,500 and for the year of 2015, we need to write off $1,000 worth of receivables. We will go ahead and use the T-account format above to record the balances.
The $1,000 write-off amount will be a debit on the left side of the T-account. If we didn't have the write-off, we would simply subtract the beginning entry from the ending entry to come up with the adjustment amount.
Since we do have the write-off, in order to calculate the adjustment we will need to first deduct the debit amount of $1,000 from the beginning balance of $ 3,000 to come up with $2,000. Next, the $2,000 would be subtracted from the ending balance to come up with an adjustment amount of $4,500.
Next, let's record the journal entry for the bad debt expense.
To record the journal entry, we would simply take the $4,500 adjustment entry and record it as a debit to the bad debt expense account and credit to the AFDA account. If there was no write-off, the debit and credit entry would be for $3,500 instead. The entry for the write off of $1,000 is a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable.
If there happened to be a recovery for the receivable that was previously written off, we would need to record the opposite of the journal entry above. If the receivable was collected, we would record the $1,000 as a debit to accounts receivable and credit to AFDA.
Since the funds were collected in cash, there would be a second entry to debit cash and credit accounts receivable.
One thing to keep in mind is that using write-offs with the allowance method does not affect the net realizable value of the receivables.
For example, if the accounts receivable for 2014 was $12,000, it would be deducted by the AFDA of $4,000 for a net realizable value of $ 8,000. For 2015, if the accounts receivable started at $11,000 less the AFDA of $3,000, the NRV would still be $8,000.
This example explains the power of the allowance method as it keeps the net realizable value consistent between accounting periods and matches up the expenses to the appropriate period.
In the next lesson, we will be looking at the direct write-off method which differs from the allowance method.