LOS 30.a: Explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements. NOTE: Determining the correct classification of investment securities can have important impacts on either the income statement or balance sheet, so the decision process should be consistent. An exam question or sample set can be impacted by your classification.

Most businesses give customers a certain number of days (30 to 60 days) to pay for delivered products and services. This is referred to as "extending credit to customers". Under accrual accounting, sales made on credit are recorded on the income statement. The not-yet-collected money is recorded under accounts receivable. Unfortunately, some customers will not want or be able to pay (because of bankruptcy) the company.

Company's can utilize two different approaches to account for these uncollectible accounts. The first is to account for them as they occur. Companies mostly use this method for income tax calculations and/or because its bad debts are immaterial. This method is called the "direct write-off method of accounting for bad debts". Once the company determines that an account is uncollectible, it will debit (which is an increase) the bad debt expense and credit accounts receivable (which is a decrease)

The second method used by companies, which is more consistent with the matching accounting principle, is to estimate the bad debt on an ongoing basis. This is referred to as the "allowance method for bad debt", and it is accounted for in allowance for doubtful accounts.

Accounting for Credit Sales

1) The direct write-off method

ABC sells and delivers \$200,000 in products to 3C, which has 30 days to pay.

Here's the accounting record:

The 3C account has been overdue for six months and will most likely be uncollectible. The company decides to write it off:

2) Allowance method for bad debt

ABC sells and delivers \$200,000 in products to 3C, which has 30 days to pay.

Accounting record:

The company estimates that 1% of accounts receivable will become uncollectible:

Unfortunately, 3C has declared Chapter 7 bankruptcy. The 3C account needs to be written off. Currently the Company has 400,000 in allowance for doubtful accounts:

Basics of Inventories

Related Articles
1. Investing

### Understanding Write-Offs

Write-off has different meanings depending on the context in which it is used, but generally refers to a reduction in value due to expense or loss.
2. Investing

### What is a Bad Debt Expense?

Bad debt expenses are debts a company incurs when it sells goods or services, but receives no payment or partial payment.
3. Personal Finance

### What is an Account Balance?

An account balance represents the total amount of money in a financial account at any given moment.
4. Personal Finance

### Handling High-Yield Savings Accounts

Is this the savings route for you? Read on to find out what these accounts have to offer.
5. Investing

### Explaining Double Entry Accounting

Double entry is an accounting and bookkeeping term describing the method of entering transactions into the accounting records.

### Financial Accounting

Financial accounting is the process of gathering, recording, summarizing and reporting financial data relating to a business. The ultimate goal is to accurately report the financial picture and ...
7. Investing

### What Is A Trading Account?

8. Personal Finance

### Alternate Methods Of Online Payment

Paying by credit is one of the most common methods of payment for online shopping in the U.S. However, there are many other options worth testing out.
9. Investing

### A Guide to Bank Accounts

Find out which type of bank account suits your specific needs.