How to Account for Bad Debt with the Allowance Method

Companies take a chance on consumers. When credit is extended to anyone, there's some level of risk involved. Hopefully, for most companies, the risk is minimal. Reimbursement managers have to track the trend of bad debts to determine when the price is too high. They do this with the allowance method for writing off bad debts. There are key components to the process.

Instructions

Difficulty: Moderate

1. Look at the history of all accounts within the business. At this point, it is crucial to determine what happens annually with write-offs. If the company traditionally writes 3 percent of its sales to bad debts, then 3 percent should play a major role in the allowance for current expenses.
2. Set up an allowance account. This is called a contra account, and the accountant will be familiar with setting up and maintaining this account. Work with the accountant by showing the justification for the percentage that has been chosen. It shouldn't require much haggling.
3. Make adjustments based on actual write-offs. Hopefully, the majority of the accounts receivable will be resolved within the first quarter of the following years. This varies by industry. Once it is determined which accounts are actually no good, submit the adjustments to the accountant so that changes may be made to the contra account.
4. Reevaluate the allowance for the coming year. The expense may increase or decrease from one year to the next. It is important to look at the behavior of the accounts to determine if there is a need to adjust the allowance for bad debt.