Business Glossary

accepted way to account for bad debts. Bad debt expense may be based on the percent of credit sales for the period, an aging of the accounts receivable balance at the end of the period, or some other method (e.g., percent of accounts receivable). The allowance method results in a good matching of bad debt expense against sales. The journal entry at year-end to record anticipated uncollectibility of accounts receivable is to debit bad debts and credit allowance for bad debts. When it is known that a customer will actually not pay the balance, because of bankruptcy, for example, the entry is to debit allowance for bad debts and credit accounts receivable. If for whatever reason the customer does pay at a later date, there is a recovery; reverse the last entry and make a second entry debiting cash and crediting accounts receivable. It should be noted that firms other than small financial institutions are required to use the direct write-off method for tax purposes.

way of charging bad debt expense when an account receivable is actually deemed uncollectible. Thus, at the date it is certain that the customer will not be able to pay (in the most extreme instance, bankruptcy), the entry is to debit bad debt expense and credit accounts receivable. The advantage of this method is that it is based on fact rather than estimates. However, it is not accepted for financial reporting purposes because it fails to match bad debt expense against sales in the year of sale and does not show the realizable value of accounts receivable. It is the only method allowed for tax purposes (except for small banks and specified types of financial organizations).