Last updated by
March 1, 2021
The easiest way to adjust accounts receivable balances is to directly write off a customer's account that is deemed uncollectible. This is as bad debt expense.
The beautiful thing about accounting is that anything can be adjusted. Sometimes mistakes happen that need to be adjusted, other times balances become uncollectible and need to be adjusted. These examples require different methods of adjustment.
The easiest way to adjust accounts receivable balances is to directly write off a customer's account that is deemed uncollectible. This is defined as bad debt expense.
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The bottom line is an accounts receivable adjustment is a debit or a credit applied to the amount a customer owes. What that adjustment looks like is what will be described below, as there are different ways and different methods.
Assume you made a credit sale of $2000 to one of your customers. After 90 days of trying to collect the $2000, you learned the customer was not going to pay. This situation requires the amount to be written off. The journal entry looks like this:
The effect of this entry is to record an expense on the income statement which reduces net income and remove the asset from your balance sheet which reduces assets.
Assume you made a credit sale for $2,000 to one of your customers. A week or so later, the customer calls and says the invoices are incorrect. The correct amount should have been $1,750 which amounts to a $250 error. Upon further research you find the customer is correct and you make the following adjustment.
The effect of this entry is to reduce sales on the income statement by $250 the amount of the error and also reduce accounts receivable.
A direct write off means you permanently remove an uncollectible amount from accounts receivable; whereas, creating an allowance for uncollectible accounts keeps the amount in accounts receivable but creates an offset balance reflecting the potential uncollectible amount.
This offset or contra account is called allowance for doubtful accounts. The allowance for doubtful accounts is netted with gross accounts receivable to create a net accounts receivable amount. This net amount is a true reflection of collectible accounts receivables.
The direct write off of bad debt entry was described above. The entry for allowance for doubtful accounts is as follows.
The effect of this entry is to record an expense on the income statement which reduces net income and then create an offset or contra amount to accounts receivable on the balance sheet.
The allowance for doubtful accounts is a credit balance which offsets the debit balance of accounts receivable. The allowance for doubtful accounts would appear something like this when displayed on the balance sheet.
For tax purposes you must use the direct write-off method for bad debt expense. The IRS does not allow a tax return deduction unless the accounts receivable amount is deemed completely uncollectible. Every effort must be made to collect prior to writing off the amount.
This of course makes sense because the IRS is motivated to collect as much tax as possible, they don’t want people prematurely taking deductions.
Accounts receivable adjustments take time, resources and cost money. So, the best approach is to minimize or eliminate the need for adjustments. Accounts receivable adjustments can be avoided by taking the following actions.
Many adjustments to accounts receivable are the result of billing mistakes.
The adjustments are numerous and most of these are the result of poor communication. Typically, in most businesses, regardless of size, the person preparing the invoice is different from the person making the sale.
It is also true that sales people tend to rush on to their next sale and are not as concerned with the details leaving an order processor to make assumptions which rarely turns out well.
Two practical tips that might help address this communication issue are:
The order request template would contain all the details necessary to complete an accurate order, including specialized notes.
This does not remove the responsibility from the order processor who should also go slowly and double check their work, and ask questions if doubt arises.
These steps may take more time upfront but will prevent customer frustration and save the company time and money.
Collection procedures may be the single best policy to implement in a business. Why, because it increases the effectiveness of collecting cash which is what fuels the business.
It is easy to focus on sales rather than collection, particularly in a fast-growing business, but failure to focus on collection of accounts receivable will pose problems down the road.
Here are some basic steps that every company should implement.
While there are many other collection strategies, these simple strategies will keep a company focused on what is past due and will increase the speed at which invoices are paid. The longer you wait to collect, the less likely those payments will be made.
Sometimes the best defense is done before the battle even begins. If a company will implement a credit policy, train their salespeople, and be consistent in applying the policy it will prevent collection issues in the future.
Here are a few simple steps to consider:
This is one of the simplest and best methods to collect a past due balance and avoid creating a bigger past due balance issue. When a customer has a need, they are more likely to pay and you also start to identify trends.