Bad Debt Expense: Definition and How to Calculate It

Bad Debt Expenses

Last Updated March 12, 2024

Dealing with bad debt is an unfortunate reality for many businesses. Bad debt expense refers to the portion of accounts receivable that is no longer collectible from customers. In this article, we’ll explore what bad debt expense is, how to find it, calculate it, and record it according to United States and IRS guidelines.

What is a bad debt expense?

Bad debt expense is an accounting term that refers to the amount of money a company expects to lose because some customers will not pay their bills. It’s an essential aspect of financial reporting, as it reflects the true financial position of a business by accounting for the possibility of uncollectible debts.

How to find bad debt expense

To find the bad debt expense, you need to analyze your accounts receivable and determine the portion that is likely to be uncollectible. This can be done using the direct write-off method or the allowance method.

How to calculate bad debt expenses

How to directly write off your accounts receivable

The direct write-off method is a simple way to calculate bad debt expense. You simply write off the specific customer accounts that are deemed uncollectible. To calculate bad debt expense using this method, follow these steps:

  1. Identify the specific customer accounts that are unlikely to be collected.
  2. Debit the bad debt expense account and credit the accounts receivable account for the total amount of the uncollectible debts.

How to calculate bad debt expenses using the allowance method

The allowance method is a more complex but more accurate way to calculate bad debt expense. It involves estimating the amount of uncollectible debts based on historical data and current economic conditions. To calculate bad debt expense using this method, follow these steps:

  1. Estimate the percentage of accounts receivable that will be uncollectible.
  2. Multiply the estimated percentage by the total accounts receivable to calculate the bad debt expense.

What is the percentage of bad debt formula?

The percentage of bad debt formula is:

Percentage of Bad Debt=Bad Debts/Net Credit Sales×100

  • Bad Debts = The total amount of uncollectible debts
  • Net Credit Sales = Total credit sales – Sales returns and allowances

How to record a bad debt expense

Recording a bad debt expense is essential for accurate financial reporting. There are two main ways to record bad debt expense: using the direct write-off method or the allowance method.

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

To record a bad debt expense using the direct write-off method, follow these steps:

  1. Debit the bad debt expense account and credit the accounts receivable account for the specific customer accounts that are deemed uncollectible.

Recording a bad debt expense for the allowance method

To record a bad debt expense using the allowance method, follow these steps:

  1. Debit the bad debt expense account and credit the allowance for doubtful accounts account.
  2. When specific customer accounts are identified as uncollectible, debit the allowance for doubtful accounts account and credit the accounts receivable account.

In conclusion, understanding and properly accounting for bad debt expense is crucial for maintaining accurate financial records and ensuring the financial stability of your business. By following the guidelines outlined in this article, you can effectively calculate and record bad debt expenses according to the United States and IRS guidelines.