how to estimate bad debt expense
two primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected bad debt expense can be estimated using statistical modeling such as default probability to determine its expected losses to delinquent and bad debt the statistical calculations can utilize historical data from the business as well as from the industry as a whole the specific percentage will typically increase as the age of the receivable increases to reflect increasing default risk and decreasing collectibility alternatively a bad debt expense can be estimated by taking a percentage of net sales based on the company s historical experience with bad debt companies regularly make changes to the allowance for credit losses entry so that they correspond with the current statistical modeling allowances the 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 for example 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 accounts receivable less than 30 days old will not be collectible and 4 of accounts receivable at least 30 days old will be uncollectible therefore the company will report an allowance and bad debt expense of 1 900 70 000 1 30 000 4 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 the sales method applies a flat percentage to the total dollar amount of sales for the period for example based on previous experience a company may expect 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 example of bad debt expenseas part of its 2021 annual report amazon reported details in its notes to the financial statements regarding accounts receivables allowance for doubtful accounts and bad debt expense although bad debt expense is not explicitly called out in its financial statements assumptions can be made based on footnote disclosures about their allowance estimates 1from the financial statement snippet above the important words to note is net and other this means that the gross amount of accounts receivable have been reduced instead of showing the gross accounts receivable and an offsetting allowance for doubtful accounts amazon has combined these two amounts at the end of 2021 amazon reported 32 89 billion of accounts receivable 1more information about this balance is disclosed in the notes below based on the note disclosure amazon s allowance for doubtful accounts is 1 1 billion this means the gross amount of accounts receivable is actually over 1 billion higher than what the company is showing on its financial statements 2 however due to conservatism this balance has been reduced in addition it s important to note the change in the allowance from one year to the next because the allowance went relatively unchanged at 1 1 billion in both 2020 and 2021 the entry to bad debt expense would not have been material however the jump from 718 million in 2019 to 1 1 billion in 2022 would have resulted in a roughly 400 million bad debt expense to reconcile the allowance to its new estimate 2