Allowance for Doubtful Accounts Calculation & Journal Entry

The journal entry for the Bad Debt Expense increases (debit) the expense’s balance, and the Allowance for Doubtful Accounts increases (credit) the balance in the Allowance. The allowance for doubtful accounts is a contra asset account and is subtracted from Accounts Receivable to determine the Net Realizable Value of the Accounts Receivable account on the balance sheet. In the case of the allowance for doubtful accounts, it is a contra account that is used to reduce the Controlling account, Accounts Receivable. This variance in treatment addresses taxpayers’ potential to manipulate when a bad debt is recognized. An allowance for doubtful accounts is a contra account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid.

Uncollectible accounts expense is recorded by debiting bad debt Expense and crediting the allowance for uncollectible accounts. The business will also create a bad debt reserve – also known as an allowance for doubtful accounts – to reflect the estimation for uncollectible or bad debts. Creating a bad debt reserve reduces the accounts receivable on a company’s balance sheet. For example, a customer takes out a $15,000 car loan on August 1, 2018 and is expected to pay the amount in full before December 1, 2018.

Company

When the appropriate year-end balance is computed, it is compared with the preadjustment balance and the needed change is determined. It also should be noted that this entry is the only one made during the year to the Bad Debt Expense account. That is to say, if other factors can make one prediction better (such as total sales, general economic conditions, or geographic region), we should use them if they are easily included. When the nature and timing of the loss have been determined, our attention can be focused on a dollar measurement of the amount to be recorded.

That is, the first result of the analysis is the amount of bad debt expense for the period. Being proactive with your e-invoicing and collections process is the easiest way to reduce the number of doubtful or delinquent accounts. A reliable AR automation solution can help you achieve better cash flow, lower bad debt, and improve profits by analyzing customer behavior, risk, and past data. In that case, the allowance for doubtful accounts will be debited, and accounts receivable will be credited.

Other Allowances

When the balance on allowance for doubtful accounts is credited, the bad debt expenses are debited. Allowance for doubtful accounts falls under contra assets and not the current assets https://kelleysbookkeeping.com/accounting-software-for-startups/ section. A contra-asset account means its balance will either be zero or negative (credit balance). The allowance for doubtful accounts varies widely from industry to industry.

For instance, Customer A might routinely clear 100% of bills within days, but Customer B might have a tendency to default. The accounts receivable aging method is a subset of the percentage of receivables method. Here instead of using one average value to determine Doubtful Accounts And Bad Debt Expenses your percentage of uncollectible receivables, you’ll assign a collection probability to each of your AR aging categories. The result from your calculation in the percentage of receivables method is your company’s ending AFDA balance for the end of the period.

Formula of ADA by AR aging method

Note that the accounts receivable (A/R) account is NOT credited, but rather the allowance account for doubtful accounts, which indirectly reduces A/R. In effect, the allowance for doubtful accounts leads to the A/R balance recorded on the balance sheet to reflect a value closer to reality. The allowance for doubtful accounts is then used to approximate the percentage of “uncollectible” accounts receivable (A/R). The result of your calculation in the percentage of sales method is your adjustment to the AFDA balance.

• The accounts receivable aging method is a subset of the percentage of receivables method.
• The method looks at the balance of accounts receivable at the end of the period and assumes that a certain amount will not be collected.
• It’s also worth noting that your historical percentage of collections will likely vary between bullish and bearish economic cycles.
• Of the $50,000 balance that was written off, the company is notified that they will receive $35,000.
• You may not even be able to specifically identify which open invoice to a customer might be so classified.

In such cases, the business must first debit its AR account and credit its allowance for doubtful accounts. Accounts receivable aging is a more precise method to calculate the allowance for doubtful accounts. Here a business takes into account both payment dues and the time it has been due for.

Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must be established in the same accounting period as the sale, but can be based on an anticipated or estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account. The bad debt expense is entered as a debit to increase the expense, whereas the allowance for doubtful accounts is a credit to increase the contra-asset balance. The allowance method estimates the “bad debt” expense near the end of a period and relies on adjusting entries to write off certain customer accounts determined as uncollectable.