how to record bad debts
recording bad debt involves a debit and a credit entry here s how it s done the allowance for doubtful accounts nets against the total ar presented on the balance sheet to reflect only the amount estimated to be collectible this allowance accumulates across accounting periods and may be adjusted based on the balance in the account payments received later for bad debts that have already been written off are booked as bad debt recovery methods of estimating bad debtwe ve established that bad debts must be recorded but what amounts are listed on corporate financial statements this involves estimating uncollectible balances using one of two methods this can be done through statistical modeling using an ar aging method or through a percentage of net sales we ve highlighted the basics of each below the ar aging method groups all outstanding accounts receivable by age and specific percentages are applied to each group the aggregate of all groups results is the estimated uncollectible amount this method determines the expected losses to delinquent and bad debt by using a company s historical data and data from the industry as a whole the specific percentage typically increases as the age of the receivable increases to reflect rising default risk and decreasing collectibility let s say a company has 70 000 of accounts receivable less than 30 days outstanding and 30 000 of accounts receivable more than 30 days outstanding based on previous experience 1 of ar less than 30 days old will not be collectible and 4 of ar at least 30 days old will be uncollectible this means the company must report an allowance and bad debt expense of 1 900 this is calculated as if the next accounting period results in an estimated allowance of 2 500 based on outstanding accounts receivable only 600 2 500 1 900 will be the bad debt expense in the second period a bad debt expense can be estimated by taking a percentage of net sales based on the company s historical experience with bad debt this method applies a flat percentage to the total dollar amount of sales for the period companies regularly make changes to the allowance for doubtful accounts so that they correspond with the current statistical modeling allowances 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 if the following accounting period results in net sales of 80 000 an additional 2 400 is reported in the allowance for doubtful accounts and 2 400 is recorded in the second period in bad debt expense the aggregate balance in the allowance for doubtful accounts after these two periods is 5 400 