How to Write Off a Bad Debt Against the Allowance for Doubtful Accounts

Businesses that buy and sell goods and services on credit must account for late payments and uncollected invoices. In the allowance method, make adjusting entries to the "allowance for doubtful accounts" and "bad debt expense" accounts for the estimated bad debt expense at the end of an accounting period -- usually, a year. Allowance for doubtful accounts is a contra account that reduces accounts receivable, which is a balance-sheet current-asset account. Bad debt expense is an income-statement account. The company writes off an uncollectible amount by removing it from both accounts receivable and allowance for doubtful accounts.

Instructions

1. Estimate the amount of bad debt as a percentage of credit sales. Use historical bad-debt percentages, industry averages or the published information from comparable companies to estimate the unrealizable bad-debt expense.

2. Debit bad-debt expense and credit allowance for doubtful accounts to record the estimate for bad debts. For example, if your credit sales are $100,000, the estimate for bad debts using a 2 percent rate is $100,000 times 0.02, or $2,000.

3. Write off uncollectible amounts against the allowance for doubtful accounts. After you have made repeated attempts to collect on an account and determined that the customer is unable to make payment, debit allowance for doubtful accounts and credit accounts receivable to remove the amounts from your accounting records. Continuing with the example, if a $250 account is overdue for more than three months and the customer continues to experience cash-flow problems, debit allowance for doubtful accounts and credit accounts receivable by $250 each to write off this overdue account.

4. Record a payment on a previously written-off account. This is a two-step process. First, debit accounts receivable and credit allowance for doubtful accounts to restore the account to your books. Second, debit cash and credit accounts receivable to record the cash payment. Concluding the example, if the customer's business improves and he is able to settle the $250 bill, first debit accounts receivable and credit allowance for doubtful accounts by $250 each; then debit cash and credit accounts receivable by $250 each to restore and clear the overdue balance.

Tips & Warnings

• You may estimate bad debts based on the aging of the various accounts in accounts receivable. Aging refers to the number of days that an account is overdue. For example, you may determine, based on your prior experiences, that 50 percent of accounts that are more than 60 days overdue will remain uncollected; use that as your bad-debt estimate.

• The Internal Revenue Service requires companies to use the direct write-off method, in a bad debt expense is recorded only after you determine that an overdue amount is uncollectible. You must use the allowance method for financial-reporting purposes. However, small private companies may use the direct method for both financial reporting and tax purposes.

• Debits increase asset and expense accounts, and they decrease revenue, liability and shareholders' equity accounts. Credits decrease asset and expense accounts, and they increase revenue, liability and shareholders' equity accounts. Debits decrease allowance for doubtful accounts, while credits increase it.

References

• CliffsNotes.com; Evaluating Accounts Receivable; August 2011
• Jacksonville State University, College of Commerce and Business Administration: The Allowance Method of Accounting for Bad Debts
• "Bookkeeping Tips"; Recording Bad Debt Expense for Tax Vs. Book Purposes; American Institute of Professional Bookkeepers