One important year-end process that should not be overlooked is reviewing the Accounts Receivable balances for accuracy and collectability. If your business uses the cash accounting method, this process will not apply to you. However, if your business used the accrual accounting method you want to make sure that before you run the final year-end financial statements, the receivables account gets a good review.
What should you do if you come across receivables that you are certain you will not get payment for? The one thing you should not do is delete the receivable account. If you delete the account, the history of that customer, at least for that particular transaction, is gone. Instead of deleting the transaction you should create a journal entry to record the uncollectible income (receivable).
To make the journal entry you will need 2 accounts which you might need to set up if they are not part of your Chart of Accounts. The accounts are: Allowance for Doubtful Accounts and Bad Debt Expense.
The Allowance for Doubtful Accounts sits on the Balance Sheet, immediately after the Accounts Receivable and offsets the Receivables balance. The Bad Debt expense account is included in the expenses section on the Income Statement, it offsets the Revenue/Sales.
Let’s use an example to help clarify things.
In December, XYZ company has an outstanding receivable of $10,000 for Susan Mbeti from January which the accountant is certain is uncollectible. The accountant will need to create a journal entry to debit the Bad Debt expense for $10,000 and credit the Allowance for Doubtful Accounts for $10,000. That is:
Bad Debt Expense $10,000
Allowance for Doubtful Accounts ($10,000)
Note to include: “To write-off uncollectible Susan Mbeti receivable
The journal entry above will increase the expense (and hence reduce income) by $10,000. It will also reduce the outstanding receivable on the books of the business by $10,000. Remember that when the invoice to Mbeti was created and sent out in January, a journal entry was made at that time to increase the total business receivables by $10,000 and the offset was an increase in revenue/sales for the same amount. Our journal entry in December reverses the entry created back in January; it just uses 2 new accounts to do this.
Sounds complicated? It can become complicated if you have several receivable accounts that are uncollectible or where some are partially uncollectible. Please reach out to your CPA or accountant for help to ensure that your entries are correct and your year-end financials are sound.
DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting, or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.
