Question

If my ending AR account has a balance of $26,000, it also had $15,000 write off and bad debt expense was not included of $2,000 what’s the balance. My teacher said it’s $24,000 because a write off does not affect the balance but you have to subtract bad debt expense. Why?

Answer 1

Write off explanation:

Let’s take an example:

If yesterday, I was fully expecting to be paid on my accounts receivables (A/R) and suddenly my customer was nowhere to be found, I’d be forced to conclude I will never be paid.

If that were the case, I’d write off the receivable, crediting A/R and debiting a bad debt expense.

In laymen’s terms, net income would go down (due to the bad debt expense) and assets would go down (i.e. writing off of a worthless receivable).

The more common scenario is where reasonable doubt of being repaid exists.

This can be evidenced by age of the receivable. If the customer is a month overdue, it could easily be an oversight. If they are 60–90 days overdue, it is more indicative that they may be experiencing liquidity problems (which are not to say they are). If they are 120 days overdue, the concern becomes greater and your chances of collecting become less.

None of this is to say you’ll never be paid but, generally speaking, the older the receivable is, the less likely you are to collect.

This is where a provision for doubtful accounts comes into play. As the name suggests, there exists ‘some’ level of doubt on the collectability of your receivables.

This level of doubt results in a provision entry being made.

A debit is made to bad debt expense and the credit is made to allowance for bad debts, a contra account to accounts receivable.

The gross receivable is still there on the books, but a ‘reserve’ has now been recorded against that receivable. This means that if it is ever deemed as uncollectible (i.e. 100%), the amount is “written off.”

When a provision entry is made, the effect is the same as if you wrote it off - debit bad debt expense (i.e. lower income) and credit A/R - allowance for bad debt (lower assets).

When the write-off actually occurs, however, since it has already been provided for, there is no net effect to either the income statement or balance sheet. There is often a timing difference between the two events (i.e. provision versus write-off) when “75% sure” turns into “100%” sure a year later. You’d be basically crediting A/R and debiting A/R-allowance for doubtful accounts. The “net” A/R would remain unaffected.

Bad Debts:

Bad debt is a loss that a company incurs when credit that has been extended to customers becomes worthless, either because the debtor is bankrupt, has financial problems or because it cannot be collected.

So the balance here is $26000- $2000= $24000