How to Write Off Allowance for Doubtful Accounts

Businesses often extend credit to customers, creating accounts receivable. Not all accounts receivable are collected, leading to uncollectible debts. To manage this, businesses using accrual accounting employ an “allowance for doubtful accounts,” a contra-asset account established to estimate future uncollectible amounts. This article explains the process of writing off an account deemed uncollectible against this allowance.

Identifying Uncollectible Accounts

This estimate is made before specific accounts are identified as uncollectible, recognizing potential losses in advance. When a customer’s account is determined uncollectible, it is identified for write-off.

Criteria indicating an account is uncollectible include customer bankruptcy, confirming inability to pay. Prolonged non-payment, despite diligent collection efforts over 90 to 180 days past due, signals uncollectibility. This can include instances where legal action has been pursued but has proven futile, or when a customer has disappeared without a trace.

This identification process is an internal decision, supported by evidence and adherence to company policy. For instance, a company might have a policy to write off accounts over 180 days past due unless payment arrangements are in place. Once an account meets these criteria, it is ready for removal from the active accounts receivable ledger.

Recording the Write-Off

Once an account is identified as uncollectible, the next accounting step involves removing it from the accounts receivable balance and simultaneously reducing the allowance for doubtful accounts. This reflects that the customer’s debt is no longer expected to be collected. The journal entry for writing off an uncollectible account is a debit to the Allowance for Doubtful Accounts and a credit to Accounts Receivable.

For example, if a business determines a $500 account owed by customer ABC is uncollectible, the journal entry is a debit to Allowance for Doubtful Accounts for $500 and a credit to Accounts Receivable (ABC) for $500. This entry decreases both the allowance for uncollectible accounts and the customer’s outstanding balance. The balance of accounts receivable is reduced by the write-off.

Under the allowance method, this write-off does not impact the Bad Debt Expense account. The bad debt expense was already recognized when the allowance was initially estimated and recorded. Writing off an account is the removal of an anticipated loss, not the recognition of a new expense.

Impact on Financial Statements

Writing off an uncollectible account affects a company’s financial statements. On the balance sheet, both the gross Accounts Receivable balance and the Allowance for Doubtful Accounts are reduced by the same amount. For instance, if an account for $1,000 is written off, both total accounts receivable and the allowance decrease by $1,000.

The net realizable value of accounts receivable (gross accounts receivable minus the allowance) remains unchanged by the write-off. This is because the reduction in gross receivables is offset by the reduction in the allowance. Consequently, there is no impact on total assets, liabilities, or equity on the balance sheet.

On the income statement, the write-off does not affect Bad Debt Expense or Net Income. The expense was already recorded when the allowance was established. The write-off is an administrative step to remove an uncollectible account from records. It is a non-cash event, meaning it has no impact on the cash flow statement.

Recoveries and Tax Treatment

Sometimes, an account previously written off may be collected. This situation, known as a recovery, requires accounting entries. The process involves two steps: first, reversing the original write-off to reinstate the customer’s account, and second, recording the cash collection.

To reverse the write-off, the accounts receivable account for the customer is debited, and the allowance for doubtful accounts is credited. For example, if a $300 account previously written off is collected, the first entry is a debit to Accounts Receivable (Customer XYZ) for $300 and a credit to Allowance for Doubtful Accounts for $300. The second step involves recording the cash receipt, which is a debit to Cash and a credit to Accounts Receivable (Customer XYZ) for the collected amount.

For tax purposes, bad debt treatment differs from financial accounting. While financial accounting uses the allowance method, tax regulations require a direct write-off method. A deduction for a bad debt is allowed only when the debt becomes worthless, rather than when an allowance is estimated. Businesses can deduct bad debts for tax purposes, but timing and method may vary based on circumstances and tax elections. Consult a qualified tax professional for guidance.