Receivables: Estimate, Collect, Analyze

Bad Debts, the Allowance Method, and Collection Speed

Receivables problems become much easier when you first identify what the question is asking you to calculate.

The Big Picture: Companies that sell on account know that some customers may not pay.

The allowance method estimates that loss before specific customers are known.

Then, once receivables are on the books, we can also ask a different question: How quickly is the company collecting them?

First: Know the Target

Percentage of Sales

Target: BAD DEBT EXPENSE

The calculation directly tells you the expense to recognize.

Aging / % of Receivables

Target: ENDING ALLOWANCE

The calculation tells you what the Allowance should equal after adjustment.

Percentage of Sales

Credit Sales = $500,000
Estimated Uncollectible Percentage = 2%
Work it first: Calculate Bad Debt Expense.
Reveal the calculation

$500,000 × 2% = $10,000 Bad Debt Expense

Entry:

Debit Bad Debt Expense $10,000
Credit Allowance for Doubtful Accounts $10,000

Does the Existing Allowance Matter?

Suppose the Allowance already has a $3,000 credit balance.

Work it first: Under percentage of sales, do you subtract the existing $3,000 from the $10,000 calculation?
Reveal the answer

No.

Percentage of sales directly estimated the expense.

Bad Debt Expense remains $10,000.

Ending Allowance:

$3,000 + $10,000 = $13,000 credit

Now Switch to Aging of Receivables

Existing Allowance = $3,000 credit

Aging analysis estimates that $13,000 of receivables will be uncollectible.
Work it first: What does the $13,000 represent?
Reveal the target

The $13,000 is the desired ending Allowance balance.

Use the Allowance T-Account

Work it first: The account has $3,000 credit but must end at $13,000 credit. What adjustment is needed?
Reveal the adjustment

$13,000 − $3,000 = $10,000 adjustment

Therefore:

Bad Debt Expense = $10,000

What If the Allowance Has a Debit Balance?

Existing Allowance = $2,000 debit

Desired ending Allowance = $13,000 credit
Work it first: How large must the adjustment be?
Reveal the calculation

First, $2,000 of credit is needed to reach zero.

Then another $13,000 is needed to reach the desired credit balance.

$2,000 + $13,000 = $15,000 Bad Debt Expense

Do not memorize “subtract the old balance.”

Draw the Allowance T-account.

Ask: What adjustment gets me from the current balance to the required ending balance?

Estimate vs. Write-Off

A specific $1,500 customer account is later determined to be uncollectible.

Work it first: Does the company record another $1,500 of Bad Debt Expense?
Reveal the write-off

No.

The expense was estimated earlier.

The write-off is:

Debit Allowance for Doubtful Accounts $1,500
Credit Accounts Receivable $1,500

Both Accounts Receivable and the Allowance decrease by the same amount, so Net Accounts Receivable does not change.

Now Analyze How Fast Customers Pay

Bad-debt accounting tells us how much may not be collected. Receivables ratios tell us how quickly receivables are being collected.

Net Credit Sales = $720,000
Beginning Net Receivables = $75,000
Ending Net Receivables = $85,000
Work it first: Calculate average net receivables and receivables turnover.
Reveal receivables turnover

Average Net Receivables:

($75,000 + $85,000) ÷ 2 = $80,000

Receivables Turnover:

$720,000 ÷ $80,000 = 9.0 times

The company collects and replaces its average receivables about nine times during the year.

Convert Turnover Into Days

Work it first: If receivables turnover is 9.0 times, approximately how many days does the company take to collect?
Reveal days to collect

Days to Collect:

365 ÷ 9.0 = 40.6 days

On average, customers take about 41 days to pay.

Higher turnover is not automatically “good” without context.

A higher turnover usually indicates faster collection, but compare it with prior periods, company credit terms, and industry expectations.

The Five Things to Remember

1
Label the target.
EXPENSE or ENDING ALLOWANCE?
2
Sales targets expense.
Percentage of sales directly estimates Bad Debt Expense.
3
Aging targets the Allowance.
Use the existing balance to find the adjustment.
4
Write-offs do not create new expense.
They use the Allowance already established.
5
Turnover measures collection speed.
Turnover = Credit Sales ÷ Average Net Receivables; Days = 365 ÷ Turnover.