Your Ask Joey ™ Answer

How to use the percentage of AR method to establish the allowance for doubtful accounts reserve?

The percentage of AR method is one of the allowance methods that is allowed under US GAAP. The method is tested on the FAR section of the CPA exam, and students in accounting courses are often tested on this concept as well.

This method is a balance sheet focus as the company will apply a percentage to the outstanding accounts receivable balance to determine the ending allowance for doubtful accounts (ADA) balance. You will then need to prepare the ADA rollforward to determine what the adjustment to bad debt expense for the period would be.

Example Percentage-of-AR Method

Step 1) We’ll start by calculating the ending ADA balance by multiplying the gross accounts receivable balance by managements % uncollectible estimate:

Step 2) Next, we’ll prepare the ADA rollforward using the information in the question. This results in bad debt expense of $15,000 for the period. This isn’t necessarily the journal entry that would be prepared as the company may have recorded bad debt expense throughout the year.

The ADA rollforward is used to determine specific activities, but what if we are asked about the adjusting entry to the ADA balance at period-end? The question could tell us that the ADA balance on the unadjusted trial balance at period-end is $45,000 and based on the AR aging method, the balance should be $50,000. In that situation, we would record an adjusting entry to increase the ADA balance by crediting the account for $5,000. The offset would be a debit to bad debt expense for $5,000.

Back To All Questions

You might also be interested in...

  • CECL Excel Workbook

    If you would like to use the Excel workbook that was used to create the Universal CPA lecture on CECL for debt securities, please click the link below to download the Excel workbook: CECL Calculation workbook (Universal CPA Review)

  • Journal Entry for Direct Materials Variance

    Journal Entry for Direct Materials Variance In the current year, Mission Burrito budgeted 6,000 pounds of production and actually used 4,000 pounds. Material cost was budgeted for $5 per pound and the actual cost was $8 per pound. What would the debit or credit to the direct material efficiency variance account be for the current...

  • Understanding Variance Analysis

    Variance Analysis Variance analysis is a method for companies to compare its actual performance vs its budgeted amount for that cost measurement (related to the flexible budget). The differences between the standard (budgeted) amount of cost and the actual amount that the organization incurs is referred to as a variance. By analyzing variances, the company...