Uncollectible Accounts

There is always a risk that customers and other debtors might not repay you in business. When this happens, accountants call the amount owed uncollectible accounts receivable. Knowing what causes customers to default and what to do can help you create proactive strategies that reduce the risk.

What Are Uncollectible Accounts Receivable?

Trade credit is reasonably common in the business world. The larger the clients, the more likely they will request credit terms. Companies generally extend credit with repayment terms of 30 to 90 days. Some companies have lessened the repayment terms to 14 days in recent years.

Uncollectible A/R are amounts of money that a business believes customers will not repay. Nonpayment could result from customers going out of business, being unable to pay, or refusing to pay. In some cases, you might not be able to locate the debtor at all.

How To Calculate Estimated Uncollectible Accounts

You first need to determine your credit losses and then subtract them from your gross accounts receivable. Accountants use two main methods to accomplish this:

The percentage of sales method: You predict what percentage of your receivables will become uncollectible and write them off as they occur. For example, if you have $100,000 in receivables and expect that five percent will go unpaid, you would charge $5,000 to bad debt expense as each sale occurred.
The aging of receivables method: In this approach, you track how long each receivable has been outstanding. This could involve creating a spreadsheet with columns for current, 30 days past due, 60 days past due, etc. You then estimate the percentage of receivables in each category that will become uncollectible and write those off.

How To Reduce Accounts Receivable Not Collected

The best way to reduce uncollected debt is to not extend debt to entities that will not repay it. However, this is easier said than done. Consider these measures to mitigate uncollectible A/Rs:

Conduct credit checks on new customers.
Require new customers to pay a deposit.
Review the payment history of current customers before extending more credit.
Offer discounts for early payments.
Implement a collections policy and stick to it.
Monitor KPIs that measure A/R performance, such as DSO.

How To Write Off Uncollectible Accounts

After you’ve exhausted all reasonable options for collecting the debt, it’s time to write it off. Doing so will remove the amount from your accounts receivable and can reduce your company’s taxes. To accomplish this, you’ll need to make a journal entry. The debit will be to your allowance for bad debts and the credit to your accounts receivable account.

Assuming you have a chart of accounts set up in your accounting software, the journal entry would look something like this:

Debit Credit

Allowance for Bad Debts Accounts Receivable

$100 $100

Some companies reach out to their customers to inform them that they wrote off the debt. However, sometimes this is not possible. Some companies deliberately keep this information to themselves in case fortunes change and new recovery options emerge.