Net accounts receivable is the difference between a company’s current outstanding receivables and the allowance for doubtful accounts. Companies create an allowance for doubtful accounts as they do not expect to collect 100 percent of their accounts receivable. Two methods exist for creating the allowance portion of net accounts receivable. Taking a percent of credit sales or a dollar amount from aged receivables are the two most common calculation methods. Companies can use whichever method produces the most accurate figure.
Credit sales occur when a company allows customers to purchase goods on account. Most companies will hold the receivables balance on their books internally. Accountants will maintain the balances and age them by date. Most aging reports list unpaid balances in 30-day increments. The aging reports will list all balances under categories named current, 30 days old, 60 days old, 90 days old, and 120 days old.
To calculate net accounts receivable using the percent of sales method, companies need to review their past collections of accounts receivable. This typically produces a percent of credit sales that was uncollected over a period of time. An accountant will multiply current credit sales by this percentage and determine what dollar amount of accounts receivables will be uncollectible. A journal entry posted on the general ledger will debit bad debts expense and credit allowance for doubtful accounts for the calculated figure.
The other calculation method is to determine a figure based on the accounts receivable aging report. For example, an accountant may simply take all open accounts 120 days old and older and post this amount as the allowances for doubtful accounts. The sum of all these accounts is posted into the company’s general ledger using the same journal entry presented earlier. This process may be a monthly journal entry in order to present the most accurate net accounts receivable for the financial statements.
Creating an allowance for doubtful accounts does not mean it is impossible for a company to collect these outstanding balances. The net accounts receivable is simply a calculation to produce accuracy in financial reporting. If a company does collect an open account that was written off to bad debts, the accountant will need to reverse the initial journal entry. This entry is a debit to the allowance for doubtful accounts and a credit to bad debts expense. The accountant can then post the collection of the outstanding debt and remove the receivable from the company’s books.