Now it’s time to go on to some advanced topics such as depreciation, bad debts, accounting for supplies, returns of merchandise, and closing our income and expense accounts. You’ll briefly get a preview of how to handle each
Bad Debts
It is a normal function of a business to sell things on credit. This is certainly true if you happen to be a credit card company. Sometimes, however, unfortunately, your customers do not pay everything they owe you. Thus arises a situation known as a bad debt and a challenge for an accountant. How might you properly account for a receivable that you own but can no longer be collected?
There are two ways to do this. First, recall that a receivable is an asset and hence increasing it requires a debit to the account. However, if part of a receivable no longer can be collected, the receivable account must be credited. The cost of losing that receivable is and expense and must be used to reduce your capital account. One could go about this several ways.
Suppose Sally Inc. had receivables of $10,000 and found it could no longer collect $500 of this. The transaction could be recorded as so.
Credit Accounts receivable
Debit Bad Debts Expense
However, a business might want to keep track of how much of the receivables have been determined to be uncollectable. If there is too many, then there is a serious problem with the business and the customers it has. It may decide to create a subset account as an offset of the main receivable account. The transaction might appear as so:
Credit Allowance for Uncollectable Accounts
Debit Bad Debts Expense
On a trial balance or balance sheet, Accounts receivable for Sally Inc. might show up as so:
Accounts Receivable $10,000
Less: Allowance for Uncollectable Accounts 500
$ 9,500
Depreciation
A business that has property that it uses to create income needs to properly apply a cost of ownership of that property to each year it helps the business create income. Think about that for one minute. If you buy large equipment the first year of your business and not for a long time after that, and you expense the purchase only in the first year, your expenses each year after will be distorted.
A capital asset (an asset used to produce income and is depreciated) is listed on the company’s books at its current value and each time depreciation is recorded, an expense account is debited. For instance, if Sally Inc. has a large machine that it uses and records the depreciation for the first year on that machine. It’s entry might look as so:
Credit Allowance for Depreciation $500
Debit Depreciation Expense $500
The trial balance or balance sheet item for this piece of equipment might look like this:
Machinery $20,000
Less: Allowance for Depreciation 500
$19,500