Trade receivables and the Allowance for Uncollectibles-
There are two ways to develop estimates for uncollectibles, the percent of sales method and the aging of receivables method.
Percent of sales method – The allowance account is credited (contra-asset account is increased) whenever based on the amount of sales. For example, if sales are $2,000 and if bad debts are estimated as 4% of sales, then the provision for bad debts (bad debt expense) is $8,000 (a debit to the income summary and a credit to the allowance for uncollectibles.)
Bad debt expense. (Also called provision for bad debts) is an estimate of future problems associated with sales. No specific account is expected to go bad. (If so, then the seller wouldn't sell the product to the prospective customer in the first place.) The expense is recorded as a debit to the income summary and a credit to build up) the contra-asset account called allowance for uncollectibles (or allowance for bad debts or estimated bad debts).
Writeoffs reflect specific accounts. Each writeoff is a reduction (credit) to accounts receivable and a debit (reduction) to the allowance for uncollectibles.
The aging of receivables method is applied at the end of the period.
The company reviews its outstanding receivables and determines the amount the credit that should be in the allowance for uncollectibles account. For example, if the company believes that 2% of $20,000 in total accounts outstanding will become uncollectible, then the entry debiting the income summary (as bad debt expense) and crediting the allowance for uncollectibles should be whatever amount will bring the credit balance in the allowance for uncollectibles account to $400. This method allows management to assume different rates of collection for receivables that have been on the books for differing amounts of time. For example, receivables that have been outstanding less than one month might be expected to be 98% collectible (2% bad debts) while receivables that have been outstanding for longer periods might be thought to be 90% collectible (10% bad debts).
As with the percent method, writeoffs are associated with specific accounts.