0Allowance Method:
Under the Allowance Method, the company makes an estimate, on the basis of some past experiences or on the basis of published industry averages, of debts which may not be realizable. As it is not yet recognized against a specific customer as to who will not be able to pay the debt, a contra-asset account named Allowance for Bad or Doubtful Debt Account will be created. This allowance for bad or doubtful debt account will be shown as a deduction to the Accounts Receivable Account on the asset side of Balance Sheet.
To Determine:
Method of showing Accounts Receivable on the Balance Sheet under Allowance Method.
Solution:
Generally, companies use two methods to record bad debts, Allowance Method and Direct Write off Method.
Under Allowance Method Net Realizable Value of Accounts Receivable is shown on the Balance Sheet after deducting Allowance for Doubtful Debt Account from it.
Explanations:
Under the Allowance Method, the company makes an estimate, on the basis of some past experiences or on the basis of published industry averages, of debts which may not be realizable in future. As it is not yet recognized against a specific customer as to who will not be able to pay the debt, a contra-asset account named Allowance for Bad or Doubtful Debt Account will be created. This allowance for bad or doubtful debt account will be shown as a deduction to the Accounts Receivable Account on the asset side of Balance Sheet.
For this expected value of Bad Debt, an adjustment entry is required to be made debiting Bad Debt Account and crediting Allowance for Bad Debt Account. For example, if at the end of an accounting period, a company makes an estimate that $ 225 in Accounts Receivable will become unrealizable, then the adjustment entry would be as follows:
Bad Debt Expense A/C-------------------------------------Dr. $225
To Allowance for Bad Debt Account $225
And, this Allowance for Bad Debt Account will be shown as a deduction to Accounts Receivable in the Balance Sheet. The total of Accounts Receivable Account will remain unaffected even after making this adjustment entry.
When this estimated value is identified against a specific customer, then it shall be written off against the Allowance Account already made. For example, if the above-mentioned amount of $225 becomes recognized against a specific customer, say, Mr. X, then the adjustment entry would be-
Allowance for Bad Debt Account-----------------------------------------Dr. $225
To Accounts Receivable – Mr. X A/c $225
Conclusion:
Thus, under allowance method, the net realizable value of Accounts Receivable is shown on the Balance Sheet after deducting expected unrealizable value.
