How to Record Bad Debt Expense Journal Entry

Businesses often extend credit to customers, allowing them to purchase goods or services now and pay later. The amounts owed to the business from these credit sales are recorded as accounts receivable. However, there is always a risk that some of these accounts will never be collected, becoming what is known as bad debt.

Accounting for bad debt ensures that expenses are matched with the revenues they helped generate. This article guides you through the journal entries to record bad debt expense.

Understanding Bad Debt Accounting Methods

Businesses employ different methods to account for bad debt, with the choice significantly impacting how these uncollectible amounts are recognized in financial statements. The direct write-off method is one approach, characterized by its simplicity. Under this method, bad debt expense is recorded only when a specific account is determined to be uncollectible.

While straightforward, the direct write-off method generally does not align with Generally Accepted Accounting Principles (GAAP) for material amounts. It violates the matching principle, which dictates that expenses should be recognized in the same accounting period as the revenues they helped generate.

The allowance method, conversely, is the preferred approach under GAAP because it adheres to the matching principle. This method anticipates that a portion of credit sales will become uncollectible and estimates this amount in the same period the sales are made. Businesses establish an “Allowance for Doubtful Accounts,” a contra-asset account, reducing total accounts receivable to reflect the estimated net amount expected to be collected.

Estimating Uncollectible Accounts

Before recording bad debt expense under the allowance method, businesses must estimate the amount of accounts receivable they expect to be uncollectible. Two common approaches are used for this estimation: the percentage of sales method and the aging of accounts receivable method. These methods help determine the figure that will be used in the subsequent journal entries.

The percentage of sales method, often referred to as the income statement approach, estimates bad debt expense as a percentage of total credit sales for a given period. This percentage is typically derived from historical data regarding uncollectible accounts and industry trends. For instance, if a business historically finds 2% of its credit sales uncollectible, it would apply this percentage to current period credit sales to estimate the bad debt expense.

The aging of accounts receivable method, also known as the balance sheet approach, focuses on the outstanding balances in accounts receivable. This method classifies individual customer accounts based on how long they have been outstanding. Older receivables are generally considered to have a higher probability of being uncollectible, so a higher percentage is applied to them. The sum of these estimated uncollectible amounts for each aging category provides the desired ending balance for the Allowance for Doubtful Accounts.

Recording the Initial Bad Debt Expense

Once the estimated amount of uncollectible accounts is determined using one of the aforementioned methods, the business records the initial bad debt expense for the accounting period. This entry is a fundamental part of the allowance method, ensuring that the expense is recognized in the same period as the related revenue.

The standard journal entry involves a debit to “Bad Debt Expense” and a credit to “Allowance for Doubtful Accounts.” Bad Debt Expense is an income statement account that reduces net income. The Allowance for Doubtful Accounts, a contra-asset account, reduces the gross accounts receivable balance on the balance sheet.

For example, if a business estimates that $5,000 of its accounts receivable will be uncollectible, the journal entry would be: Debit Bad Debt Expense for $5,000 and Credit Allowance for Doubtful Accounts for $5,000. This entry directly impacts the income statement by increasing expenses and adjusts the balance sheet by reducing accounts receivable.

Writing Off Specific Uncollectible Accounts

After the initial estimation and recording of bad debt expense, specific customer accounts are eventually identified as truly uncollectible. When this occurs, these accounts must be formally removed from the accounts receivable records through a write-off. This action signifies that the company no longer expects to collect payment from that particular customer.

The journal entry to write off a specific uncollectible account involves a debit to “Allowance for Doubtful Accounts” and a credit to “Accounts Receivable.” This entry reduces both the Allowance for Doubtful Accounts and the Accounts Receivable balance. For instance, if a $500 account owed by a customer is deemed uncollectible, the entry would be to debit Allowance for Doubtful Accounts for $500 and credit Accounts Receivable for $500.

This write-off entry does not affect Bad Debt Expense or net income, as the expense was already recognized when the initial estimate was made. This entry is merely a reclassification of assets on the balance sheet, reducing gross accounts receivable and utilizing the previously established allowance.

Accounting for Recoveries of Written-Off Accounts

Occasionally, a business may receive payment for an account that was previously written off as uncollectible. While unexpected, these recoveries require specific journal entries to properly account for the cash received and to adjust the relevant accounts. The process typically involves two distinct steps.

The first step is to reverse the original write-off, re-establishing the customer’s account in accounts receivable. This is achieved by debiting “Accounts Receivable” and crediting “Allowance for Doubtful Accounts.” For example, if a $300 account previously written off is now collected, the entry would be to debit Accounts Receivable for $300 and credit Allowance for Doubtful Accounts for $300. This action effectively puts the receivable back on the books.

The second step is to record the actual cash collection, similar to any other cash receipt from a customer. This involves debiting “Cash” and crediting “Accounts Receivable.” Following the previous example, the second entry would be to debit Cash for $300 and Credit Accounts Receivable for $300. Like write-offs, these recovery entries do not directly impact Bad Debt Expense or net income, but rather adjust the allowance and accounts receivable balances.