What effect will the entry to record the estimate of uncollectible accounts have on the balance sheet?
The correct answer and explanation is:
The entry to record the estimate of uncollectible accounts will decrease the net accounts receivable on the balance sheet. This is because it recognizes that a portion of the accounts receivable may not be collected from customers.
When a company estimates uncollectible accounts, it records an expense called “bad debt expense” and creates a contra-asset account called “allowance for doubtful accounts.” The allowance for doubtful accounts reduces the total accounts receivable balance to reflect the amount expected to be collected.
On the balance sheet, accounts receivable are reported as an asset, representing money owed to the company by customers. However, some customers may fail to pay, so the allowance for doubtful accounts offsets the gross accounts receivable to show a more realistic value. The net accounts receivable is calculated as:
Net Accounts Receivable = Accounts Receivable – Allowance for Doubtful Accounts
By recording the estimate of uncollectible accounts, the company is acknowledging potential losses, which increases expenses on the income statement and reduces net income. On the balance sheet, the increase in the allowance for doubtful accounts decreases the net asset value.
This entry does not affect cash directly because it is a non-cash adjustment made to reflect anticipated credit losses. It improves the accuracy and reliability of financial statements by presenting accounts receivable at a value that better reflects expected cash inflows.
In summary, the main effect on the balance sheet is a reduction in the net accounts receivable value due to the allowance for doubtful accounts. This ensures that assets are not overstated and provides a more conservative and realistic view of the company’s financial position.