ACCT1001 · Financial Accounting 1
Receivables
Receivables are amounts owed to the business, and the accounting problem is that some of them will not be collected. The chapter separates trade receivables from other receivables, records them initially (including the GST leg), then tackles bad debts two ways. The direct write-off method simply removes a debt when it is known to be uncollectable — simple, but it violates matching and is not acceptable under GAAP for material amounts. The allowance method (the required one) estimates future bad debts in advance and records an Allowance for Doubtful Debts, a contra-asset, so receivables are reported at their expected recoverable amount. There are two ways to estimate the allowance: percentage of net credit sales (an income-statement / matching approach that sets the expense directly) and ageing of receivables (a balance-sheet / valuation approach that sets the target closing allowance, then backs out the expense). The chapter also covers recovering a previously written-off account and the simple-interest formula for notes receivable. You must be able to journalise both estimation methods and explain the difference.
What this chapter covers
- 017.1 Trade vs other receivables
- 027.2 Initial recognition & the GST leg
- 037.3 Approach (a): direct write-off
- 047.4 Approach (b): the allowance method (the GAAP one)
- 057.5 Subsequent recovery of a written-off account
- 067.6 Method (i): % of net credit sales (income-statement approach)
- 077.7 Method (ii): ageing of receivables (balance-sheet approach)
- 087.8 / 7.9 The two methods compared & the simple-interest formula
Worked example: the allowance method by ageing
- +1Ageing sets the target allowance balance: the allowance should end at $3,200 (the estimated uncollectable amount).
- +1Find the top-up: it already has $500, so the entry must add $3,200 − $500 = $2,700.
- +2Journalise: Dr Bad Debts Expense $2,700 / Cr Allowance for Doubtful Debts $2,700.
- +1State the net receivable: Accounts Receivable $80,000 − Allowance $3,200 = $76,800 reported on the balance sheet.
Key terms
- Allowance for Doubtful Debts
- A contra-asset account that estimates the portion of receivables not expected to be collected. It is deducted from Accounts Receivable so the balance sheet shows the net recoverable amount; it is built up and reduced by the allowance-method adjusting entries, never by writing off a specific debt directly to expense.
- Direct write-off method
- Removing a receivable (Dr Bad Debts Expense / Cr Accounts Receivable) only when it is known to be uncollectable. It is simple but violates the matching principle — the expense often falls in a later period than the sale — so it is not acceptable under GAAP for material amounts.
- Percentage of net credit sales
- An income-statement (matching) approach to estimating bad debts: the bad-debts expense is set directly as a percentage of the period's net credit sales. The amount goes straight to the adjusting entry as the expense, and the existing allowance balance is not taken into account.
- Ageing of receivables
- A balance-sheet (valuation) approach: receivables are grouped by how overdue they are, each band is assigned an estimated loss rate, and the total sets the target closing balance of the allowance. The adjusting entry is the difference between that target and the current allowance balance.
- Recovery of a written-off account
- When a debt previously written off is later paid. Under the allowance method it is recorded in two steps: first reinstate the receivable (reverse the write-off), then record the cash receipt — restoring the account so the collection is properly tracked.
Receivables FAQ
Why is the allowance method required instead of direct write-off?
Because of matching. The direct write-off method records the bad-debts expense only when a specific debt is known to be uncollectable, which is often a different (later) period from the sale that created it — so the expense is mismatched to the revenue. The allowance method estimates the expected bad debts in the same period as the sales, matching the expense to the revenue and reporting receivables at their net recoverable amount. Direct write-off is therefore not acceptable under GAAP for material amounts.
What is the difference between the percentage-of-sales and ageing methods?
They estimate the bad-debts expense from different angles. Percentage of net credit sales is an income-statement approach: it sets the expense directly as a percentage of the period's credit sales and ignores the existing allowance balance. Ageing of receivables is a balance-sheet approach: it sets the target closing balance of the allowance, then the adjusting entry is whatever is needed to move the allowance from its current balance to that target. Same goal, opposite starting point.
Do I add to or replace the existing allowance balance?
It depends on the method. Under ageing, the estimate is the target ending allowance, so you adjust by the difference between the target and the current balance (top it up, or reduce it). Under percentage of net credit sales, the estimate IS the expense, so you add that full amount regardless of the current allowance balance. Reading which method the question uses tells you how to treat the opening allowance — a frequent trap.
How do I record the recovery of a debt that was written off?
In two steps under the allowance method. First reinstate the receivable by reversing the original write-off (Dr Accounts Receivable / Cr Allowance for Doubtful Debts). Then record the cash collection normally (Dr Cash / Cr Accounts Receivable). Splitting it into two entries keeps the customer's account history complete, which matters for future credit decisions, rather than just debiting cash and crediting the allowance in one line.
Exam move
The single most important distinction here is the two estimation methods, so drill them side by side on the same data until the difference is automatic: percentage of net credit sales sets the expense directly (ignore the opening allowance), while ageing sets the target allowance balance (so the entry is the difference from the current balance). Always finish a bad-debts question by stating the net receivable on the balance sheet (Accounts Receivable minus the allowance), because that is a standard follow-on mark. Practise the two-step recovery of a written-off account, and keep the simple-interest formula (principal × rate × time) ready for notes receivable. Remember the allowance is a contra-asset and bad-debts expense is a P&L account — the entry always pairs one of each.
