Bad Debt Expense
What is a 'Bad Debt Expense'
Bad debt expense represents the amount of uncollectible accounts receivable that occurs in a given period. Bad debt expense occurs as a result of a customer being unable to fulfill its obligation to pay an outstanding debt due to bankruptcy or other financial problems. This expense is the cost of a business having the inability to collect its debts.
Explaining 'Bad Debt Expense'
Even if a receivable has been deemed uncollectible and written off to bad debt expense, the business retains the right to collect funds in the event of a bankruptcy court asset distribution or sudden change in the vendor’s ability to pay. Bad debt expense occurs because an entity extends credit to customers. Since a company may elect to forgo upfront payment, it incurs the risk of customers having the inability to pay for goods or services. Therefore, bad debt expense is used as a financial metric to determine if the credit and collection process is efficient.Direct Write-Off vs. Allowance Method
There are two different application methods of recognizing bad debt expense. One is called the direct write-off method. Using this method, uncollectible accounts are specifically written off as they become uncollectible. This occurs upon receipt of a bankruptcy notice or after a specified period of time. Although the direct write-off method ensures the exact amount of uncollectible accounts is recorded, it fails to uphold the matching principle in which the expense is not always recognized in the same period as the revenue. For this reason, bad debt expense may be calculated using the allowance method. The allowance method establishes an estimated dollar amount of uncollectible accounts in the period the revenue is earned.
Calculating Bad Debt Expense Using Allowance Method
When using the allowance for uncollectible accounts, the estimated amount of bad debt expense is calculated in one of two main ways. First, an aging schedule is utilized to determine the duration of time a receivable has been outstanding. Using industry averages and company historical figures, a business takes a specific percentage of each age group and charges this estimate to bad debt expense. The specific percentage typically increases as the age of the receivable increases. This is because default risk increases and collectability decreases as a bill ages. Alternatively, a business may calculate bad debt expense by taking a percentage of net sales. This fixed rate is calculated based on the company’s historical experiences with bad debt.
Financial Statements
Bad debt expense is generally classified as a selling or administrative expense and is found on the income statement. It is one component used in the calculation of net income. The related accounts to bad debt expense, accounts receivables and allowance for doubtful accounts, are both reported on the balance sheet.
Bad Debt Expense FAQ
What is the bad debt expense?
In bad debt expense, a receivable is no longer collectible because a customer can't fulfill their obligation to pay an outstanding debt as a result of bankruptcy or other financial problems.
How do you calculate bad debt expense?
Calculating your bad debts involves some form of the percentage of bad debt formula, which is just your past bad debts divided by your past credit sales.
What is the journal entry for bad debt expense?
The journal entry is a debit to the bad debt expense account and a credit to the accounts receivable account. It might be of necessity to reverse any related sales tax that was charged on the original invoice, which requires a debit to the sales taxes payable account.
Where is bad debt expense on income statement?
It appears in a line item in the income statement, within the operating expenses section in the lower half of the statement.
When can you write off bad debt expense?
Writing off a bad debt is necessary when the related customer invoice is considered to be uncollectible. Otherwise, a business will carry an inordinately high accounts receivable balance that overstates the amount of outstanding customer invoices that will eventually be converted into cash.
Can you reverse bad debt expense?
The accounting for a bad debt recovery is a two-step process, as follows: Reverse its original recordation. If the original entry was instead a credit to accounts receivable and a debit to bad debt expense (the direct write-off method), then reverse it.
What are the two methods for recording bad debt expense?
(1) the Direct Write-off Method and (2) the Allowance Method.
Further Reading
Bad Debt" Expense": Not a Member of the Class of Data for Measuring Operating Income: A Reply
www.jstor.org [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
www.jstor.org [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
www.tandfonline.com [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
link.springer.com [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
search.proquest.com [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
www.tandfonline.com [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
www.jstor.org [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
www.sciencedirect.com [PDF]
… I WAS pleased to learn that my remarks on bad debt "expense"' evoked a re- sponse from Professor … My major premise is that this item of "expense" does not meet the sufficient and … basic operations does not include the financial impact of events such as bad debts which were …
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Q&A About Bad Debt Expense
Does an individual have to itemize deductions to be able answer question 9 ?
No, an individual does not have to itemize deductions in order to answer question 9 .
What is bad debt expense?
Bad debt expense represents the amount of uncollectible accounts receivable that occurs in a given period. Bad debt expense occurs as a result of a customer being unable to fulfill its obligation to pay an outstanding debt due to bankruptcy or other financial problems. This expense is the cost of a business having the inability to collect its debts.
Can you give me two examples of how individuals would calculate their deduction for business and non-business bad debts using Form 1040 Schedule D ?
Yes, here are two examples of how individuals would calculate their deduction for business and non-business bad debts using Form 1040 Schedule D . Example #1 - Business Bad Debts
How does one account for bad debts?
Two different methods exist for accounting for bad debts; these include direct write-off and allowances based
What are some examples of deductible debts in each category (business and non-business)?
Examples of deductible debts include credit card charges, accounts receivable, loans made to friends or relatives, etc.
What are some things that you learned from reading the IRS's article on Bad Debt Expense?
I learned that a taxpayer may deduct a business or nonbusiness bad debt if it becomes worthless during the tax year, and if certain other requirements are met.
How does an individual know when to claim a deduction for a business or nonbusiness bad debt?
An individual knows when to claim a deduction for a business or nonbusiness bad debt by keeping records and following these three steps
Where can you find more information about bad debt expense?
You can find more information about bad debt expense at https://www.irs.gov/taxtopics/tc453 .
How are bad debts accounted for?
There are two different application methods of recognizing bad debt expense. One is called the direct write-off method. Using this method, uncollectible accounts are specifically written off as they become uncollectible. This occurs upon receipt of a bankruptcy notice or after a specified period of time. Although the direct write-off method ensures the exact amount of uncollectible accounts is recorded, it fails to uphold the matching principle in which the expense is not always recognized in the same period as the revenue. For this reason, bad debt expense may be calculated using the allowance method . The allowance method establishes an estimated dollar amount of uncollectible accounts in the period that revenue is earned . When using an allowance for uncollectible accounts ,the estimated amountof bad debtexpenseis calculatedin oneof two main ways . First ,an aging scheduleis utilizedto determinethe durationof timea receivablehas been outstanding . Using industry averages and company historical figures ,a business takesa specific percentageof eachage groupand chargesthis estimateto baddebtexpense . The specificpercentagetypically increasesas thee ageofthereceivableincreases .Thisis because defaultrisk increasesand collectabilitydecreasesas abillages . Alternatively ,a businessmay calculatebad debtexpenseby takinga percentageof net sales . This fixed rateis calculated""
When was the last time that you updated your knowledge on bad debt expense?
I updated my knowledge on bad debt expense in April 2017.