Accounting for
Bad Debts
Created 2009
By Michael Worthington
Elizabeth City State University
Objectives
Define uncollectible accounts and writing-off bad debts
Prepare journal entries for the Direct Method
Discuss the contra account for Accounts Receivable
Explain the matching concept
Contrast Direct __________ with the Allowance Method
Prepare journal entries for the Allowance Method using a percentage of
sales estimation
Prepare journal entries for the Allowance Method using percentage of
Accounts Receivable estimation
Doubtful Accounts
When a customer does not pay their bill when it is due,
it is said to be an doubtful _________ (bad debt or
uncollectible account)
Firms have policies that determine when
an account is considered doubtful; for
example, if account is 90 days past due
But companies continue collection efforts even when the
account is seriously past due
1
Write-Offs
Unfortunately firms cannot collect all
invoices, so they must write-off some
__________ (remove from their books)
An event triggers the write-off, perhaps a bankruptcy or
failure of an agency to collect
Even so, firms never lose hope that they can
collect at least some of their money eventually
Direct Write-Off Method
Direct Write-off Method records expense when a specific
customer’s __________ is uncollectible
Bad Debt Expense
Accounts Receivable - J.Doe
Debit
XXX
Credit
XXX
Firms must use Direct Write-Off Method for income tax
returns, even if Allowance Method is used for their financial
statements
Allowance for Uncollectible Accounts
Allowance for Doubtful Accounts appears in the assets section
of the __________ Sheet
Allowance account REDUCES the net amount of Accounts
Receivable, so it is known as a contra account (“contra” means
opposite)
Allowance for Doubtful Accounts has a credit normal balance,
even though assets generally have a debit normal balance
ASSETS SECTION OF BALANCE SHEET
Accounts Receivable
$ 210,000
Less Allowance for Doubtful Accounts
$ 40,000
Net Accounts Receivable
$ 170,000
2
Matching Concept
Match Expenses to Revenues
Record ALL expenses in the same period as the related
revenue is recorded
So companies must accrue (record) the estimated amount of
bad debt ___________ in the same period as the sales
Firms use various names for bad debts such as Uncollectible
Accounts, Doubtful Accounts or Reserve instead of Allowance
Direct Method
Allowance Method
At end of period when sales occurred
No journal entry required
Prepare journal entry to debit
estimated amount of Bad Debt Expense
and credit Allowance for DA
When specific customer’s account proves to be uncollectible
Debit Bad Debt Expense and
credit Accounts Receivable
Credit Accounts _____________ and
debit Allowance for Doubtful Accounts
Only one journal entry
Two journal entries
Percentage of Sales
Bad debts may be estimated as % of credit sales
Percentage is based on past __________ and judgment
For example, if bad debts averaged 4% of sales over last five years but
the economy was beginning a recession, management might estimate
that 5% of current credit sales will result in future bad debts
Example: Acme Inc. had credit sales of $500,000 and estimated that
5% will result in bad debts ($500,000 x 5% = $25,000)
Debit
Credit
Bad Debt Expense
$25,000
Allowance for Doubtful Accts
$25,000
3
% of Accounts Receivable
Bad debts may be estimated as a __________ of Accounts Receivable
Percentage is based on past history and judgment
For example, if bad debts averaged 2% of AR over last five years but
the economy was beginning a recession, management might estimate
that 3% of current AR will result in future bad debts
Example: Acme Inc. had Accounts Receivable of $40,000 and
estimated that 3% will result in bad debts ($40,000 x 3% = $1,200)
Adjust Allowance for Doubtful Accounts
The percentage of Accounts Receivable (AR) method requires
adjustment of the balance of the Allowance for Doubtful Accounts
If the estimated bad debts = $1,200 and balance of Allowance for
Doubtful Accounts was $1,000 credit
The balance of the Allowance for Doubtful Accounts should be
increased by $200 ($1,200 - $1,000)
Bad Debt __________
Allowance for Doubtful Accts
Debit
$200
Credit
$200
Debit Balance
If the balance in Allowance for Doubtful Accounts has a credit balance,
subtract the ____________ from the computed amount
However, if the balance in Allowance for Doubtful Accounts has a
DEBIT balance, ADD the balance in the account to the computed
amount
If the estimated bad debts = $1,200 and balance of Allowance for
Doubtful Accounts was $1,000 DEBIT
The balance of the Allowance for Doubtful Accounts should be
increased by $2,200 ($1,200 + $1,000)
Bad Debt Expense
Allowance for Doubtful Accts
Debit
$2,200
Credit
$2,200
4
Collecting Written-Off Account
Even if a firm has written-off an account, they still hope to collect at
least some of their ___________
If a customer had filed bankruptcy, eventually the trustee will pay
creditors a percentage of the debt
Reverse the write-off adjustment for the amount collected, and then
debit Cash and credit Acct Receivable
Example: wrote off balance of $2,400, but then collected one-half of the
debt from bankruptcy court
Accounts Receivable
Allowance for Doubtful Accts
Debit Credit
$1,200
$1,200
Cash
$1,200
Accounts Receivable
$1,200
SUMMARY
Direct Write-Off Method – When a specific customers’ account is
determined to be uncollectible, debit Bad __________ Expense
and credit Accounts Receivable
Allowance Method – Estimate doubtful accounts, debit Bad Debt Exp
and credit Allowance for Doubtful Accts
Then write-off specific customer’s account by debiting Allowance for
Doubtful Accts and crediting Acct Rec
Percentage of Sales Allowance Method – estimate the amount by
multiplying credit sales by the percentage
Percentage of AR Method – estimate the amount by multiplying balance
of AR by the percentage, then add to a debit balance in the Allowance
Account, or subtract a credit balance from the computed amount
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