Understanding Bad Debt and Allowance Methods

Direct Write Off Method

Write off bad debts only when certain of non-payment.

Impact on Income Statement

Immediate profit reduction upon writing off bad debts.

Bad Debts Expense

Amount recognized as uncollectible debt.

Allowance Method

Plan ahead using a contra asset account.

Allowance for Doubtful Accounts

Contra asset account for estimated uncollectible receivables.

Matching Principle

Expenses recorded in the same period as revenues.

Accounts Receivable

Amount owed to a company by customers.

Recovering for Allowance

Adjust entries for payments received on previously written off debts.

Estimating Bad Debts Expense

Methods include percent of sales and balance sheet approaches.

Percent of Sales Method

Current sales multiplied by bad debt percentage.

Balance Sheet Approach

Estimates bad debts based on accounts receivable.

Percent of Receivable Method

Estimates bad debts without impacting income statement.

Aging of Receivables Method

Estimates uncollectible debts based on receivable age.

Disposal of Receivables

Selling receivables for cash and factoring fees.

Factoring Fee Expense

Cost incurred when selling receivables.

Pledging Receivables

Using receivables as collateral for loans.

Adjusting Entries

Entries made to correct or update accounts.

Cash Impact

Cash received from recovering bad debts.

Credit Allowance for Doubtful Accounts

Adjustment made when estimating bad debts.

Debiting Bad Debts Expense

Record expense when estimating bad debts.

Current Bad Debts Expense

Calculated as total estimated minus previous allowance.

Ending Balance Calculation

Ending A/R multiplied by estimated uncollectable percentage.