Bad Debt Expense: Definition and How to Calculate It

Though part of an entry for bad debt expense resides on the balance sheet, bad debt expense is posted to the income statement. Recognizing bad debts leads to an offsetting reduction to accounts receivable on the balance sheet—though businesses retain the right to collect funds should the circumstances change. To estimate bad debts using the allowance method, you can use the bad debt formula. The formula uses historical data from previous bad debts to calculate your percentage of bad debts based on your total credit sales in a given accounting period. The first method involves determining the bad debt rate by analyzing historical data. This rate is calculated by dividing the total bad debts by either the total credit sales or the total accounts receivable.

Financial Ratios Financial ratios assist investors in deciphering the massive amount of financial data reported by businesses. A ratio is nothing more than a tool for analysing bad debt expense calculator data and comparing it to other firms and reporting periods. Financial statements are accounting documents that demonstrate a company’s financial activity and performance.

How to estimate bad debt expense when using the allowance method (examples included)

The recorded bad debt expense is equal to the amount recorded on the account receivable. When a company does not have a lot of bad debt expense, this strategy is quite reliable. When the company is certain that the company will not pay, it writes off the bad debt expense. In this situation, firms can easily keep up with the number of bad debts expense. The current year’s bad debt expense is calculated by multiplying the bad debt expense percentage by the expected credit sales.

The amount of money written off with the allowance method is estimated through the accounts receivable aging method or the percentage of sales method. The percentage of sales method involves estimating bad debt expense as a percentage of total credit sales. This method assumes that a certain proportion of credit sales will eventually become uncollectible. The specific percentage used may vary depending on historical data and industry norms. The result of your calculation is what you’ll record on the accounts receivable balance sheet. When recording bad debt expense on the income statement, however, you’ll just record the adjustment value.

What is a Bad Debt Expense?

The company usually calculate bad debt expense by using the allowance method. Furthermore, the percentage is going to be derived from the historical collection data of the company. The accounts receivable aging method offers an advantage because it gives AR teams a more exact basis for estimating their uncollectibles. The final collection probability is however still an average and individual outstanding accounts could skew calculations. For instance, Customer A might routinely clear 100% of bills within days, but Customer B might have a tendency to default.

Bad debt expense, commonly known as uncollectible accounts expense, is an estimation of the accounts receivable that a company believes will not be collected. Acknowledging bad debt is essential for realistic financial reporting and maintaining a healthy cash flow. As previously stated, this debt is recorded after all attempts to collect the bill have failed. The accounts receivable is reported as a credit, whereas the bad expense debt is recorded as a debit.

Bad Debt Expense Definition and Methods for Estimating

Either way, incurring a large amount of bad debt can be crippling for a small business owner’s prospects. Let’s say that you own an electronics company and you make a sale to a customer worth $1,000. The customer uses store credit to make the purchase and receives your product upfront. A bad debt happens when a third party owes you money but you are unable to collect the debt. We’ll take a closer look at an overview, some examples and the ways you can calculate your bad debt. Connect with an expert team that will plan, implement, and deliver NetSuite migration, set up and operation.