Bad Debt Expense and Allowance for Bad Debt
To account for uncollectable receivables in accordance with Generally Accepted Accounting Principles (GAAP). Bad Debt Expense is an expense resulting from uncollectable accounts receivable. These expenses are estimated and recorded to match revenue and expense in the month of sale. This entry should be done so that the income statement and balance sheet are fairly stated at the amount expected to be collected in receivables satisfying the matching principle. The entry creates a contra accounts receivable balance. When netted against the gross total of accounts receivable, the true value of the receivables is reported.
Bad Debt can be recorded via the allowance method, or the direct method.
The allowance for bad debt measures receivables not expected to be collected. Often, it is not known which accounts receivable will be uncollectable, so the allowance account is used instead of accounts receivable. On the balance sheet the allowance is a deduction from accounts receivable and is considered a contra asset.
To estimate the amount of bad debt to accrue into the allowance each period, the following is one acceptable method.
Step 1: Use the actual write-off amount of the previous year and divide it by total credit sales in the same year. For more detailed information see: Financial Management Services
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