Allowance for Doubtful Accounts

I was trying to set up an "allowance for doubtful account" as a Contra Asset account for the A/R account. When I took over this account, there was a very old receivable and the thought was that it would not be collected. Before the year was over, I wanted to set up the allowance before going forward. I set up the account as a sub account to A/R, but Quickbooks required a customer account to match the allowance to. We were not ready to write it off at that time, I just wanted it in the proper year. Also, I would want to do an account adjustment on a percentage of sales annualy.

Setting up an Allowance for Bad Debts REQUIRES that you take a bad debt write-off.  There is no other way to do this...like I said... this is the whole reason for doing so.

Although that is a true statement, I want to do indirect write-offs NOT direct write offs. In keeping with the matching principle, I need to record in the proper period. Since I do not know in advance who will default on amounts owed, I do not know who to deny credit to and who to write off up front. Therefore, using a percentage of sales method, I can write off an amount each year then later adjust the accounts by debiting "Allowance for Doubtful Accounts" and crediting Accounts Receivable/customer.

When I tried to set this up using a G/L entry, the A/R entry required a customer to do a direct write off. I don't want to do direct write-offs - I want to do indirect write-off's.

I know Quickbooks is a pretty watered down accounting program, and maybe this is asking too much from this software. This is why I like Peachtree better.

That would probably work OK as long as I just use "Customer X" as a dummy write off customer. I'll have to play with that. Thanks for the suggestion. The work around is still using a direct write off method, but the actual customer is not written off until I'm ready to do the write off.

As far as not being GAAP compliant, you are only half correct. QuickBooks is forcing us to be not GAAP complaint - or at least not giving us the ability to select the proper method for the customer.

I quote -

"Generally accepted accounting principles (GAAP) require that companies use the allowance method when preparing financial statements. The use of the allowance method is not permitted, however, for purposes of reporting income taxes in the United States because the Internal Revenue Service (IRS) does not allow companies to anticipate these credit losses. As a result, companies must use the direct write-off method for income tax reporting."

If you were thinking from a tax reporting standpoint, you were correct. Companies that  use the direct write off method have to evaulate the "Materiality Constraint" as well as the "Matching Principle". The direct write-off method usually does not best match sales and expenses because bad debts expense is not recorded until an account becomes uncollectible, which often occurs in a period after that of the credit sale.
 

Again, thanks for the tip, I'll play with it after the year end audits.

I have been preparing taxes for almost fifty years...I always think from that standpoint.

Try what I said, take a look at the reports...if you don't like it, just go back to the GJ and delete it...takes minutes for the entire process!

Quickbooks is not perfect...but then what is?  When these things are brought to their atrtention (and there is enough call for it) they WILL make changes...let them know...eventually you will see it happen.  I remember when Quickbooks first came out and a couple of my clients came in with reports...unbelievable!

They have come a long way...

I just tried it. A couple of problems with this method. First, I can't make it a sub account to A/R due to the different account types. This would not show my A/R as "Net Realizable Receivables". Second, even though my account numbers are different by 00001, it sorts by account type and not account number. Due to that, it does not align properly in the COA, and might be confusing to others with a normal balance of a credit. A possible problem on down the road would be if a customer does not want to write their customer off with-in the 12 month period, then it is no longer a current asset but a long term asset classified as a current asset. This could come up if a receivable dribbles in a little money every so often, and there is a little bit of hope that the account would become paid in full. I'll play with Essjay's idea a little bit. I think that might give me a work-around. Thanks for the idea.

I'm not sure what you are saying, qb.

Allowance for Bad Debts is a contra-account against accounts receivable and is a GAAP principle. 

The only way to do that is to sub it to Accounts Receivable. If left alone as a different asset type it appears as a negative unattached to accounts receivable...this is incorrect.

This has always been how Allowance for Bad Debts has worked within the balance sheet.  Please note this excerpt:

US accounting practice

Allowance for bad debts are amounts expected to be uncollected, but still with possibilities of being collected (when there is no other possibility for them to be collected, they are considered as uncollectible accounts). For example, if gross receivables are $100,000 and the amount that is expected to remain uncollected is $5,000, net current asset section of balance sheet will be:

              Gross a/c Receivable                    $100,000.00

             Less; Allowance for Bad Debts           5,000.00

             Net Receivables                             $   95,000.00

In financial accounting and finance, bad debt is the portion of receivables that can no longer be collected, typically from accounts receivable or loans. Bad debt in accounting is considered an expense.

There are two methods to account for bad debt:

1. Direct write off method (Non-GAAP) - a receivable which is not considered collectible is charged directly to the income statement.
2. Allowance method (GAAP) - an estimate is made at the end of each fiscal year of the amount of bad debt. This is then accumulated in a provision which is then used to reduce specific receivable accounts as and when necessary.

Because of the matching principle of accounting, revenues and expenses should be recorded in the period in which they are incurred. When a sale is made on account, revenue is recorded along with account receivable. Because there is an inherent risk that clients might default on payment, accounts receivable have to be recorded at net realizable value. The portion of the account receivable that is estimated to be not collectible is set aside in a contra-asset account called Allowance for doubtful Accounts. At the end of each accounting cycle, adjusting entries are made to charge uncollectible receivable as expense. The actual amount of uncollectible receivable is written off as an expense from Allowance for doubtful accounts.

Nope...that does not violate my description.

But I can't see how that is going to appear correctly in the balance sheet...maybe its too late in the day...

Rustler..usually only large public corporations would do this...its a statement-for-shareholders-or-bankers type of thing.

qb I kind of understand what you are saying about it being a management or planning tool, but it strikes me as non-sensical.

It's like me having a $50 bill tucked away in my wallet and saying all I have is $10 I can see in there on me, in my head I know I have more. So who am I fooling.

thanks though, at least I had the flow of how it went right.