Bad Debt Overview, Example, Bad Debt Expense & Journal Entries

You can debit your Cash account and credit your Accounts Receivable account. How you create a bad debt recovery journal entry depends on your original bad debt journal entry. When a debt becomes bad, you write off bad debt in your accounting books.

The accounts receivable aging method offers an advantage because it gives AR teams a more exact basis for estimating their uncollectibles. The final collection probability is however still an average and individual outstanding accounts could skew calculations. For instance, Customer A might routinely clear 100% of bills within days, but Customer B might have a tendency to default. Every business assumes the risk of non-payment when offering sales on credit.

AccountingTools

There are two ways to record bad debt expenses in your accounting statements. In accrual accounting, companies recognize revenue before cash arrives in their accounts and must record expenses in the same accounting period the revenue originated. Units should consider using an allowance for doubtful accounts when they are regularly providing goods or services “on credit” and have experience with the collectability of those accounts. The following entry should be done in accordance with your revenue and reporting cycles (recording the expense in the same reporting period as the revenue is earned), but at a minimum, annually.

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.

Entering payments after making a journal entry for bad debts?

This uncollectible amount would then be reported in Bad Debt Expense. In the Aging Method, the estimate comes from the amount of accounts receivable sitting on the home accounting and personal finance software books past the due date by age, ie 30 days, 60 days, 90 days, or over 90 days. The longer an account balance remains overdue, the less likely it is to be paid.

During the bad debt collection process, you might collect part or all of your debt. Once you recover bad debt, record the income, update your accounting books, and report the recovery to the IRS (if applicable). Using the example above, let’s say a company expects that 3% of net sales are not collectible. If the total net sales for the period is $100,000, the company establishes an allowance for doubtful accounts for $3,000 while simultaneously reporting $3,000 in bad debt expense. As of January 1, 2018, GAAP requires a change in how health-care entities record bad debt expense. Before this change, these entities would record revenues for billed services, even if they did not expect to collect any payment from the patient.

Stay up to date on the latest accounting tips and training

Another category might be 31–60 days past due and is assigned an uncollectible percentage of 15%. All categories of estimated uncollectible amounts are summed to get a total estimated uncollectible balance. That total is reported in Bad Debt Expense and Allowance for Doubtful Accounts, if there is no carryover balance from a prior period. If there is a carryover balance, that must be considered before recording Bad Debt Expense. The balance sheet aging of receivables method is more complicated than the other two methods, but it tends to produce more accurate results. For financial reporting purposes the allowance method is preferred since it means the loss (bad debts expense) is recognized closer to the time of the credit sales.

Most bookkeepers decide a customer will not pay an invoice based on how long past due the invoice is and after failed collection efforts. Increase the bad debt expense account with a debit and decrease the accounts receivable account with a credit. Continuing our examination of the balance sheet method, assume that BWW’s end-of-year accounts receivable balance totaled $324,850.