How to Adjust Your Bad Debt Reserve
A reserve is a balance sheet account that may show as a liability or as a reduction in the value of an asset, also called a contra asset. The bad debt reserve or provision for bad debts account is a contra asset that represents a business's opinion of its ability to collect its accounts receivable. It does this by applying a previously determined percentage to the total amount owed by customers at the end of the accounting period. Specific bad debts are charged off and deducted from accounts receivable and do not form part of the reserve.
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Instructions
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Multiply the balance on accounts receivable at the end of the period by the percentage the business has determined as the bad debt reserve. For example, if the accounts receivable total is $100,000 and the business holds a 5 percent bad debt reserve, multiply $100,000 by 5 and divide by 100 to give a value of $5,000 for the reserve.
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Subtract the balance on the bad debt reserve account from the result of the previous calculation. For example if the existing reserve is $4,000, subtract that amount from $5,000. The result is a positive $1,000, showing that you need to increase the reserve. If the existing reserve is $6,500, when you subtract that amount from $5,000 the answer is minus or negative $1,500. A negative result indicates that you need to reduce the reserve.
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Credit the bad debt reserve account and debit the bad debts expense account with an increase in reserve; debit bad debt reserve account and credit bad debts expense account with a reduction in reserve.
In the first example, credit the bad debt reserve and debit the bad debts expense with $1,000 to increase the reserve. In the second example, debit the bad debt reserve and credit the bad debts expense with $1,500 to reduce the reserve.
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Tips & Warnings
In the United States, the accountancy profession recommends renaming the bad debt reserve account to provision for bad debts or allowance for bad debts, as the business is allowing for the possibility of future bad debts rather than putting money aside for a future expense.
