Recording bad debt expense can seem complicated, but following some key steps can make the process straightforward. Here is an overview of how to record bad debt expense properly in your books.
What is Bad Debt Expense?
Bad debt expense is an accounting entry that is made when a customer debt is deemed uncollectible. It represents the estimated loss from not being able to collect the full amount owed by a customer. This expense is deductible for tax purposes.
For example, if a customer owes your business $1,000 but you estimate that you will only be able to collect $700, you would record $300 as bad debt expense. This reduces your net income and accounts for the expected loss from the uncollectible portion of the debt.
When to Record Bad Debt Expense
Under the accrual method of accounting, bad debt expense should be recorded in the same accounting period as the related revenue. For example, if you made a sale in October but don’t expect to collect the full amount, you would record the bad debt expense in October rather than waiting until a later period.
For the cash method of accounting, bad debt expense is not recorded until the debt is determined to be worthless. This is usually when collection efforts have failed after a reasonable period of time.
Estimating Bad Debt Expense
Bad debt expense is an estimate of uncollectible accounts. There are two main methods to estimate bad debt expense:
- The percentage of sales method – Determine an estimated percentage of credit sales that will be uncollectible based on past experience. Apply that percentage to the total credit sales for the period to calculate bad debt expense.
- The accounts receivable aging method – Analyze accounts receivable and categorize them by age. Estimate uncollectible amounts for each age category based on past history and customer data. Total the expected uncollectible amounts from each age category to determine bad debt expense.
The percentage of sales method is simpler, but the aging method provides a more detailed estimate based on the age and status of existing receivables. Use the method that fits your business and availability of customer data.
Journal Entry to Record Bad Debt Expense
Recording bad debt involves a journal entry that debits bad debt expense and credits allowance for doubtful accounts. Here is an example:
| Account | Debit | Credit |
| Bad Debt Expense | $1,000 | |
| Allowance for Doubtful Accounts | $1,000 |
The debit to bad debt expense increases expenses on the income statement. The credit to allowance for doubtful accounts is a contra-asset account that offsets accounts receivable on the balance sheet.
Accounts Impacted
Here are the key accounts impacted by the bad debt expense journal entry:
- Bad Debt Expense – This income statement account is debited to increase expenses for the estimated uncollectible amount from customers.
- Allowance for Doubtful Accounts – This contra-asset account is credited to increase the balance. The offset reduces net accounts receivable on the balance sheet.
- Accounts Receivable – Accounts receivable is not directly impacted by the journal entry, but the higher credit balance in allowance for doubtful accounts reduces the net receivables reported on the balance sheet.
Recording Actual Write-Offs
After recording estimated bad debt expense, specific customer accounts may later be identified as uncollectible. These accounts need to be written off by removing them from accounts receivable.
The journal entry would be:
| Account | Debit | Credit |
| Allowance for Doubtful Accounts | $500 | |
| Accounts Receivable | $500 |
This decreases allowance for doubtful accounts and accounts receivable by the same amount. It has no further impact on the income statement.
Bad Debt Expense vs. Bad Debt Write-Off
It is important to understand the difference between recording bad debt expense and writing off an uncollectible account:
- Bad debt expense – An estimate of bad debts. Recorded as an operating expense on the income statement.
- Bad debt write-off – Removal of a specific uncollectible account from accounts receivable. No income statement impact.
Bad debt expense aims to match estimated uncollectible amounts with revenue in the same accounting period. The write-off later reconciles allowance for doubtful accounts when specific accounts are deemed uncollectible.
Recoveries After Write-Off
In some cases, you may collect funds after an account has been written off. This is called a recovery. Recoveries should be recorded with a debit to cash and a credit to allowance for doubtful accounts. For example:
| Account | Debit | Credit |
| Cash | $100 | |
| Allowance for Doubtful Accounts | $100 |
This increases the allowance balance and can offset future bad debt expenses. Recoveries are credited to allowance for doubtful accounts rather than sales or accounts receivable in order to avoid distorting revenue trends.
Conclusion
Recording bad debt involves estimating uncollectible amounts, making journal entries, and later reconciling write-offs of specific accounts. Understanding these steps allows you to accurately represent bad debts in your financial statements. Key points include:
- Estimate bad debt using the percentage of sales or aging methods
- Make journal entries to record estimated bad debt expense and specific write-offs
- Understand the difference between bad debt expense and write-offs
- Record recoveries of previously written-off accounts as credits to allowance
Properly recording bad debts takes some work, but is critical for accurate financial reporting. By following the right processes you can feel confident that your books capture bad debt amounts appropriately.
Frequently Asked Questions
When should bad debt expense be recorded?
Under the accrual method of accounting, bad debt expense should be recorded in the same accounting period as the related revenue. This matches the estimated expense with the period of the sale. Under the cash method, bad debt expense is not recorded until the debt is determined to be worthless.
What is the allowance for doubtful accounts?
The allowance for doubtful accounts is a contra-asset account that offsets accounts receivable. It represents management’s estimate of the amount of accounts receivable that will become uncollectible in the future. The allowance is increased with credited entries for bad debt expense.
What methods can be used to estimate bad debt expense?
Two common methods for estimating bad debt expense are the percentage of sales method and the aging accounts receivable method. The percentage of sales method applies an estimated uncollectible percentage to total credit sales. The aging method analyzes individual receivables by age and applies percentages based on past history.
When should an actual write-off be recorded?
Specific accounts should be written off after collection efforts have failed and management has determined the accounts to be uncollectible. This often occurs after a set period of time, such as 180 days past due. Write-offs decrease the accounts receivable balance.
What is the difference between bad debt expense and a write-off?
Bad debt expense is an estimated, income statement account reflecting expected uncollectible amounts from revenue in the current period. A write-off actually removes the bad account from accounts receivable on the balance sheet when it is finally deemed uncollectible.
Where do recoveries after write-off get recorded?
If previously written-off accounts are collected, the recovery is recorded as a debit to cash and a credit to the allowance for doubtful accounts. This avoids distorting current period revenue on the income statement.
Example of Recording Bad Debt
Here is an example walkthrough of recording bad debts throughout the accounting process:
- ABC Company has $100,000 of credit sales in Year 1
- Based on experience, they estimate 2% of sales will be uncollectible
- Bad debt expense journal entry:
- Debit: Bad Debt Expense – $2,000
- Credit: Allowance for Doubtful Accounts – $2,000
- In Year 2, ABC writes off $1,500 of accounts as uncollectible:
- Debit: Allowance for Doubtful Accounts – $1,500
- Credit: Accounts Receivable – $1,500
- In Year 3, ABC collects $500 of previously written off accounts:
- Debit: Cash – $500
- Credit: Allowance for Doubtful Accounts – $500
This example shows the full process of estimating bad debt, recording write-offs, and handling recoveries.
Key Takeaways
- Estimate bad debt expense based on past history and customer data
- Record estimated bad debt expense through a journal entry debiting bad debt expense
- Write off specific uncollectible accounts by crediting accounts receivable
- Credit recoveries to allowance for doubtful accounts, not revenue accounts
- Ensure the accounting accurately reflects expected and actual bad debt amounts
Properly recording bad debts takes attention and effort. But accurately capturing these expenses is vital for financial statement integrity and representing the true financial performance of a business.
