How to Calculate Bad Debt Expenses

A bad debt in business typically is the result of unpaid accounts receivable. Companies sell goods on credit to increase the opportunity for better profits. Customers must pay the company within a certain number of days. When the account goes unpaid, companies must write off these accounts. The loss goes against net income and reduces profits earned for the current period. Two different methods exist for estimating bad debts: percent of sales and percent of receivables. Each one requires a historical analysis to determine the calculation for bad debts.

Instructions

Percent of Sales

1. Review the previous year's credit sales and accounts receivable collections. Collect information on the amount of bad debts written off in the previous year.

2. Divide the amount written off by total credit sales. This results in a percentage of credit sales that will probably be written off in the future.

3. Multiply the percentage from Step 2 by current open accounts receivable. This represents the total bad debts a company can expect to write off in the future.

Percent of Receivables

1. Review the previous year's aging of accounts receivable. This reports accounts receivable aged in 30-day, 60-day, 90-day and 120-day increments.

2. Compute the amount of receivables written off in the previous year from each category on the aging report.

3. Add the total receivables written off during the year. Divide by total accounts receivable for the year.

4. Multiply the percentage from Step 3 by the total outstanding receivables in the current aging report. This is the total bad debts a company may expect to write off.

References

• "Fundamental Financial Accounting Concepts"; Thomas P. Edmonds, et al.; 2011