# How To Calculate Bad Debt Expenses With The Allowance Method

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• The project is completed; however, during the time between the start of the project and its completion, the customer fails to fulfill their financial obligation.
• Not only does it parse out which invoices are collectible and uncollectible, but it also helps you generate accurate financial statements.
• The accounts receivable aging method groups receivable accounts based on age and assigns a percentage based on the likelihood to collect.
• A bad debt expense is a measure of the total amount of “bad debt” during an accounting period.
• If your company made \$50,000 worth of sales on credit during a given period, then you would take a bad debt expense for \$250 for that period.
• If you’re using the write-off method to report bad debts, you can simply debit the bad debt expense account and credit your accounts receivable.

This is recorded as a debit to the bad debt expense account and a credit to the allowance for doubtful accounts. The unpaid accounts receivable is zeroed out at the end of the year by drawing down the amount in the allowance account. When it’s clear that a customer invoice will remain unpaid, the invoice amount is charged directly to bad debt expense and removed from the account accounts receivable. The bad debt expense account is debited, and the accounts receivable account is credited. Bad debt expense is account receivables that are no longer collectible due to customers’ inability to fulfill financial obligations.An allowance for doubtful accounts is established based on an estimated figure. Bad debt expenses make sure that your books reflect what’s actually happening in your business and that your business’ net income doesn’t appear higher than it actually is.

## What Methods Are Used For Estimating Bad Debt?

The formula uses historical data from previous bad debts to calculate your percentage of bad debts based on your total credit sales in a given accounting period. In general, the longer an account balance is overdue, the less likely the debt is to be paid. Therefore, many companies maintain an accounts receivable aging schedule, which categorizes each customer’s credit purchases by the length of time they have been outstanding. Each category’s overall balance is multiplied by an estimated percentage of uncollectibility for that category, and the total of all such calculations serves as the estimate of bad debts.Bad debt arises when a customer either cannot pay because of financial difficulties or chooses not to pay due to a disagreement over the product or service they were sold. The direct write-off method records the exact amount of uncollectible accounts as they are specifically identified.

## What Is Bad Debt Expense?

Based on past experience and its credit policy, the company estimate that 2% of credit sales which is \$1,900 will be uncollectible. The direct write-off method involves writing off a bad debt expense directly against the corresponding receivable account. Therefore, under the direct write-off method, a specific dollar amount from a customer account will be written off as a bad debt expense.

If you have a \$75,000 balance in accounts receivable, for example, then you’d need an allowance of \$750. If the balance in the allowance were, say, \$400, then you’d have to report a \$350 bad debt expense to get back to the proper amount. The original journal entry for the transaction would involve a debit to accounts receivable, and a credit to sales revenue.

## How To Record The Bad Debt Expense Journal Entry

In accrual-basis accounting, recording the allowance for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time. In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses. Bad debt expense is the loss that incurs from the uncollectible accounts, in which the company made the sale on credit but the customers didn’t pay the overdue debt. The company usually calculate bad debt expense by using the allowance method.

## Journal Entries To Estimate And Record Bad Debt

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.

## What is allowance method for bad debts?

The allowance method involves setting aside a reserve for bad debts that are expected in the future. The reserve is based on a percentage of the sales generated in a reporting period, possibly adjusted for the risk associated with certain customers.When a debt actually goes bad — when you conclude that you won’t be able to collect on an account — you reduce both the outstanding A/R balance and the allowance by the amount of the uncollectible account. \$170Allowance for Doubtful Accounts\$17002-Sep-18Allowance for Doubtful Accounts\$170Accounts Receivables\$170With the write-off method, there is no contra asset account to record bad debt expenses. Therefore, the entire balance in accounts receivable will be reported as a current asset on the balance sheet. This entails a credit to the Accounts Receivable for the amount that is written off and a debit to the bad debts expense account. If write‐offs were less than expected, the account will have a credit balance, and if write‐offs were greater than expected, the account will have a debit balance. Assuming that the allowance for bad debts account has a \$200 debit balance when the adjusting entry is made, a \$5,200 adjusting entry is necessary to give the account a credit balance of \$5,000.