What is a Bad Debt Expense? AR Dictionary

bad debt expense formula

To record your bad debts, you debit the bad debt expense account and credit your allowance for the bad debts account. Following the matching principle, bad debt needs to be recorded during the same accounting period as your credit sale occurred. It allows you to balance the liabilities bad debts represent on your balance sheet.

bad debt expense formula

Divide the amount of bad debt by the total accounts receivable for a period, and multiply by 100. To record the bad debt expenses, you must debit bad debt expense Smart Accounting Practices for Independent Contractors and a credit allowance for doubtful accounts. Most businesses will set up their allowance for bad debts using some form of the percentage of bad debt formula.

Bad Debt Direct Write-Off 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. With 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.

What is bad debt expense current?

Bad debts expense is related to a company's current asset accounts receivable. Bad debts expense is also referred to as uncollectible accounts expense or doubtful accounts expense. Bad debts expense results because a company delivered goods or services on credit and the customer did not pay the amount owed.

Bad debt expenses are classified as operating costs, and you can usually find them on your business’ income statement under selling, general & administrative costs (SG&A). Trade credit insurance, which provides coverage for customer nonpayment in a wide range of circumstances. Bad Debt Expense increases (debit), and Allowance for Doubtful Accounts increases (credit) for $22,911.50 ($458,230 × 5%). Let’s say that on April 8, it was determined that Customer Robert Craft’s account was uncollectible in the amount of $5,000.

How to Determine Bad Debt Expense

The past experience with the customer and the anticipated credit policy plays a role in determining the percentage. Under this approach, businesses find the estimated value of bad debts by calculating bad debts as a percentage of the accounts receivable balance. If 6.67% sounds like a reasonable estimate for future uncollectible accounts, you would then create an allowance for bad debts equal to 6.67% of this year’s projected credit sales. Here, we’ll go over exactly what bad debt expenses are, where to find them on your financial statements, how to calculate your bad debts, and how to record bad debt expenses properly in your bookkeeping. It then estimates the percentage of each category that is likely to be uncollectible based on its historical experience with bad debts. These percentages are then applied to the balances in each aging category to determine the bad debt allowance.

This can help the business make informed decisions about its operations and take steps to improve its financial health. When a customer’s debt is written off as a bad debt expense, the accounts receivable balance is reduced by the amount of the uncollectible debt. Another company that was growing rapidly, Johnstone Supply, grew concerned about its exposure to potential bad debt expense as its customer base expanded.

Recording a bad debt expense using the direct write-off method

Now let’s say that a few weeks later, one of your customers tells you that they simply won’t be able to come up with $200 they owe you, and you want to write off their $200 account receivable. Biltrust’s Order-to-Cash Automation Software reduces DSO and your AR team’s manual work, optimizes your cash flow and more. Everything in 2020 changed for organizations, from AR departments having to deal with evolving work environments to low cash flow and more.

  • Working with an external accountant or CPA is a solid way to ensure that you stay on track and get the most up-to-date guidance on your business’ in-house accounting questions.
  • Finally, one might base the bad debt expense on a risk analysis of each customer.
  • This is because accounts receivable is an asset account that represents the amount of money that a business is owed by its customers.
  • Not only does this help forge better customer relationships, but it also minimizes bad debt expense by reducing the likelihood of receivables becoming uncollectible.
  • For example, a customer takes out a $15,000 car loan on August 1, 2018 and is expected to pay the amount in full before December 1, 2018.
  • Customers also receive full visibility into their outstanding balances and can seamlessly make payments through a cloud-based self-service portal.

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