Bad debt write off accounting entry
Allowance method is a better alternative to the direct write-off method because it is according to the matching principle of accounting. In allowance method, the doubtful debts are estimated and bad debts expense is recognized before the debts actually become uncollectible. Bad debts expense is recognized early because bad debts are probable and they can be estimated to a fairly accurate extent therefore they fulfill the criteria of for recognition accounitng contingent losses and it is necessary to recognize bad debts expense.
- Bad debts expense Accounts receivable , At the end of first year, the company needs to recognize an allowance for doubtful accounts based on the percentage of accounts receivable.
- The company estimates bad debt based on the percentage of sales method.
- Allowance for Doubtful Debts.
Recognition Entry The first step in the allowance method is to pass an adjusting entry at the end of an accounting period to recognize estimated bad debts expense. Unlike direct write-off method, we do not credit accounts receivable at this stage because it is actually a control account of many individual debtor accounts and we do not yet not know which particular debtor will make a default.
What would the credit be? The company estimates bad debt based on the percentage of sales method. The account is removed from the Accounts Receivable balance and Bad Debt Expense is increased. Statement of retained earnings Net income Net profit from the Income statement impacts the Statement of retained earnings in two ways. When an account is deemed to be uncollectible, the business must remove the receivable from the books and record an expense.
We only know the estimated amount of receivables which are likely to end up uncollected. Therefore a provision account called allowance for doubtful accounts is credited in the adjusting entry.
Bad Debts Expense Allowance for Doubtful Accounts The bad debts expense account, just like any other expense account, is closed to income summary account of the period. The allowance for doubtful debts is contra-asset account.
It is presented on balance sheet by subtracting it from accounts receivable as shown below: Allowance for Doubtful Debts.