How do companies account for the possibility that some of their customers might not pay down the road?

How do companies account for some customers not paying?

Saturday, February 13, 2021

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Uncollectible Accounts Receivable

There are two different methods used to estimate uncollectible accounts receivable. These forecasting methods include: percentage of sales method and the accounts receivable aging method. While each of the methods use the same accounts (being debited and credited) they will typically result in different dollar amounts for the journal entry (Kimmel, Kieso, & Weygandt, 2011).

The percentage of sales method is based on the relationship between uncollectible accounts receivable and the number of credit sales that created them (Kimmel, Kieso, & Weygandt, 2011). Using this method the company obtains the credit sales information from its general ledger. The total dollar amount of debits to accounts receivable will represent the credit sales. This is the formula needed,

Percentage of credit sales not collected = accounts receivable not collected / credit sales

In contrast to the percentage of sales method the accounts receivable aging method estimates bad debt expense by classifying accounts receivable according to the length of time they have been outstanding. This is used to estimate the probability of noncollection for each category of debt. Receivables are categorized into periods which are multiples of payment terms, e.g., net 30 n/30. Thus the classification schedule is 0–30. Then the probability of noncollection is calculated based on the number of days that the accounts go past due. For example, if an account is on a n/30 and goes 60 days this provides a schedule that shows the likelihood of which account will pay late or not at all.

References

Kimmel, P. D., Kieso, D. E., & Weygandt, J. J. (2011). Financial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons.

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~Citation~

Vincent Triola. Sat, Feb 13, 2021. How do companies account for some customers not paying? Retrieved from https://vincenttriola.com/blogs/ten-years-of-academic-writing/how-do-companies-account-for-the-possibility-that-some-of-their-customers-might-not-pay-down-the-road

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