Allowance for Doubtful Accounts & Bad Debt Expense

[LYAK]

I am having some trouble understanding the accounting for allowance for doubtful accounts. I understand that using the percentage of credit sales method or aging method gives management an estimate of bad debt expense. Based on the estimate, a debit is made to the bad debt expense account and a credit is made to the allowance for doubtful accounts, a contra-asset account that reduces accounts receivable to net realizable value. I was looking over a problem in one of my textbooks and became somewhat confused.

According to the problem, a company has an accounts receivable balance of $304,000 and an allowance for doubtful accounts balance of $134 (credit) at the end of 2008. During 2009, a customer defaults on a $524 balance related to goods purchased in 2008. For 2009, bad debt expense is estimated to be $8,866. The textbook specifies the debits of $524 and $8,866 are both made at 12/31/2009. The $524 debit to allowance for doubtful accounts is made before the credit to allowance for doubtful accounts of $8,866 is made, which gives it a debit balance? I have read that the allowance account cannot have a debit balance, which makes sense, since it is a contra-asset account. Also, the $534 debit reduces the $8,866 credit to the allowance for doubtful accounts, so how can a default attributable to a different period reduce the allowance account, which stores the estimated bad debt expense?

 

[kirby]

It's bad when the textbook tries to teach something without giving sufficient background info to explain it. Yes - the ENDING (month-end) balance of the Allowance acct should not be a debit balance. But - as in this problem - it can happen that DURING the month the balance can be a Debit. In the problem, there was a $524 bad debt charged to the the $314 (credit bal) allowance for a net debit of $210. So, yes you could not have closed the books with that balance. And indeed the company then posted a $8,866 credit. You can think of that as $210 of that wiping out the debit balance and the rest of the $8,866 being needed for 2009.

 

[LYAK]

It's bad when the textbook tries to teach something without giving sufficient background info to explain it. Yes - the ENDING (month-end) balance of the Allowance acct should not be a debit balance. But - as in this problem - it can happen that DURING the month the balance can be a Debit. In the problem, there was a $524 bad debt charged to the the $314 (credit bal) allowance for a net debit of $210. So, yes you could not have closed the books with that balance. And indeed the company then posted a $8,866 credit. You can think of that as $210 of that wiping out the debit balance and the rest of the $8,866 being needed for 2009.

So, technically, in this case, the $390 (the $524 default - the $134, not $314 credit balance in the allowance for doubtful accounts is an expense that is reported in the incorrect period? I know it is immaterial and within this area of accounting, estimations are greatly depended on; I am just trying to understand the accounting procedures in this area. Would a company just add this to $390 to their estimated current period bad debt expense? In the textbook, it did not seem so, as it stated simply that a company expects x amount of percent of credit sales as bad debt expense, which was $8,866, reduced by the $390 debit balance in the allowance for doubtful accounts.

 

[kirby]

When the textbook says that all that was added was for currrent credit sales (adding $8,866) then the $8,866 is not enough because the account has a existing net $390 (agree!) debit balance that needs to be brought to zero. In practice you would cover the $390 debit with a provision of $390 and then post a provision for the $8,866.

 

[LYAK]

Yeah, I'm not sure the textbook is clear enough for full comprehension of the content. Common sense and logic would lead you to treat the issue in the manner you described. It's funny how I already learned all of this content and at the time hated this area of accounting and now that I'm reviewing it, still hate it! Thanks kirby.