How to Calculate Bad Debt Expenses?

how to calculate bad debt expense

Using the percentage of sales method, they estimated that 5% of their credit sales would be uncollectible. Percentage of Sales Method → The percentage of sales method can also be used to estimate the bad debt expense. The direct write-off method works by directly writing-off bad debt expenses from accounts receivable into the expense account. Whenever a company is sure a certain account balance is uncollectible, it will debit bad debt expense and credit accounts receivable for the amount.

how to calculate bad debt expense

For example, in periods of recession and high unemployment, a firm may increase the percentage rate to reflect the customers’ decreased ability to pay. However, if the company adopts a more stringent credit policy, it may have to decrease the percentage rate because the company would expect fewer uncollectible accounts. GAAP requires companies to match expenses to revenue as closely as possible. As accountants, we don’t want to go back to the prior year, change it, restate it, and publish new financials. That would be time-consuming and the users of those financials would be frustrated if we were always going back and changing the financials. So, once a year is over, and the books are closed, it’s done and we don’t go back.


This reserve, or allowance, is also referred to as a contra asset account because it “nets” or balances against the accounts receivable assets listed in the balance sheet. One company changed its approach to bad debt management after two major clients defaulted on their bills, leaving the company facing tens of thousands of dollars in losses. To make matters worse, the company had also dedicated considerable staff time and resources trying to collect on those bad debts with no success.

If your client agrees to an invoice, it is recorded by your company right away as an income – regardless of whether it has actually been paid or not. As a rule, the longer it hasn’t been paid, the slimmer the chances of an invoice ever getting paid. For example, you’d put 1% bad debt to your 0 to 30 days category, and 30% past 90 days. When bad debt does occur, you can subtract it from this bad debt account to buffer your losses. IRS states that you should only write off bad debts after you have made all possible attempts to recover the amount without success.

Autonomous Accounting

The customer, however, can be incapable of paying the company back – e.g. if they filed for bankruptcy or face unanticipated financial difficulties – resulting in the recognition of bad debt for bookkeeping purposes. The first entry reverses the bad debt write-off by increasing Accounts Receivable and decreasing Bad Debt Expense for the amount recovered. The second entry records the payment in full with Cash increasing retail accounting and Accounts Receivable decreasing for the amount received of $5000. Accounts receivable record purchases and transactions that have not yet been paid for by the customer. They are considered an asset because they are a financial resource that can be converted to cash in the near future, once the customer has paid. Companies come to BlackLine because their traditional manual accounting processes are not sustainable.

how to calculate bad debt expense

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What Is Bad Debt Expense? How To Calculate and Record Bad Debt

The method looks at the balance of accounts receivable at the end of the period and assumes that a certain amount will not be collected. Accounts receivable is reported on the balance sheet; thus, it is called the balance sheet method. The balance sheet method is another simple method for calculating bad debt, but it too does not consider how long a debt has been outstanding and the role that plays in debt recovery. The allowance for doubtful accounts method is an estimate of how much of the company’s accounts receivable will be uncollectible. This estimate is entered as an adjustment in the books at the end of each accounting period. A journal entry debiting bad debt expense and crediting allowance for uncollectible accounts will be made with the estimate amount.

  • The understanding is that the couple will make payments each month toward the principal borrowed, plus interest.
  • This entry assumes a zero balance in Allowance for Doubtful Accounts from the prior period.
  • A company can estimate bad debt expense by taking the percentage of net sales, on the basis of the company’s historical experience with bad debt.
  • Accounts receivable is a permanent asset account while sales is a revenue account that resets every year.
  • In order to be compliant with the GAAP, you need to report your bad debt using the allowance method.

When accountants ultimately write off an accounts receivable as uncollectible, they can then debit dummy allowance for doubtful accounts and credit that amount to accounts receivable. Using this method allows the bad debts expense to be recorded closer to the actual transaction time and results in the company’s balance sheet reporting a realistic net amount of accounts receivable. Bad debts will appear under current assets or current liabilities as a line item on a balance sheet or income statement. For example, the bad debt expense account shows the amount of money a company has lost from customers who have fallen behind on their payments.

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