Accounting for Bad Debts Essay

380 WordsNov 20, 20082 Pages
Notes on Accounting for Bad Debts Bad debt only arises because of credit sales. If your company accepts nothing but cash, there will not be any bad debts. There are two methods to account for Bad Debts: 1. The Allowance Method a) This is the preferable method because it follows the matching principle and records bad debt expense in the same period as the credit sales and therefore is matching the bad debt expense to the sales revenue. The entry is Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts. b) An “allowance” account is used to “put aside” an amount that the company ESTIMATES to be bad. The entry is Debit Bad Debt Expense, Credit Allowance for Doubtful Accounts. c) There are two methods to “estimate” the amount of Bad Debt, for the above entry. These are: i) Use a percentage of sales to determine the amount of Bad Debt Expense or ii) Use the age of the accounts receivable to determine the amount for the Allowance for Doubtful Account. d) When an account is identified as bad, then you would write it off against the amount “put aside” in the Allowance account: Debit Allowance for Doubtful Accounts Credit Accounts Receivable e) If you “recover” or receive money from a customer AFTER you have written off their account, you have to reverse the write off entry (in d)before recording the cash received. Debit Accounts Receivable Credit Allowance for Doubtful Accounts Debit Cash Credit Accounts Receivable 2. The Direct Write Off Method a) This method does NOT follow the matching principle because it does not record bad debt expense in the same accounting period as the sales. Bad debt is only recorded when you find out that an account is not paying. This method does not use and Allowance account to estimate the bad debt and “directly” writes off the accounts receivable when accounts are identified to be bad

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