Where selling goods on credit is a good way to expand business in terms of sales and profit, it also involves a risk of uncollectibles.
Uncollectible accounts are the accounts receivable that cannot be collected because of bankruptcy of the customer or any other reason.
When an account receivable has been determined to be uncollectible we cannot expect any future economic benefit from it. It no longer qualifies to be an asset and is therefore written off from accounts.
A certain amount of uncollectibles is considered a part of normal business operation. It should not discourage companies to sell goods on credit because if companies stop selling goods on credit due to the fear of uncollectible accounts they will also reject good customers and lose many sale opportunities. Companies adopt sound credit policies that maximize the benefit from credit sales.
Uncollectible accounts receivable is a loss of asset and decrease in revenue that is recognized by recording an expense known as uncollectible account expense
Two methods are commonly used for recognizing uncollectible accounts expense in the books of seller. These are allowance method and direct write off method.
We shall discuss both the methods one by one. Let us start with the allowance method.