How to account for bad debt? This is a short but complete guide of the terminology of bad debt accounting, illustrated with examples and journal entries. This video covers concepts such as direct write-off, various methods to calculate the bad debt allowance, how bad debt write-off and the #baddebt allowance method relate, and as a bonus how bad debt accounting works in the case of fraud in accounting statements. Let’s get started with a simple example, and build up the discussion of bad debt with step-by-step examples.

⏱️TIMESTAMPS⏱️
0:00 Introduction to bad debt accounting
0:35 Billing cycle example
2:30 Bad debt direct write-off
3:10 Allowance for doubtful accounts
3:33 Bad debt allowance income statement method
4:32 Bad debt allowance balance sheet method
6:04 Write-off versus allowance for doubtful debt
7:04 Releasing doubtful debt allowance
7:27 Bad debt vs fraud

There are several ways to calculate and record the allowance for doubtful debt. The first method is called the income statement method, as it looks at income statement data to record the allowance for doubtful debt. Based on the revenue of $400 in year 4, and historical write-offs of around 2% of sales, management decides to put aside $8 in the Allowance for doubtful debt account. The impact of recording the allowance on the income statement is: in revenue the full amount billed is recorded, the estimated credit loss gets recorded in Bad debt expense, which is an account in the category of selling, general and administrative expenses or SG&A. On the balance sheet, once we have recorded cash collections for the year, we can calculate Accounts Receivable, net of allowance for doubtful accounts. $30 opening balance for the year + $400 sales for the year - $390 collections - $8 doubtful debt allowance = $32 net accounts receivable balance.

The second method to calculate the Allowance for doubtful debt is the balance sheet method, as it looks at balance sheet data to record the allowance for doubtful debt.

Philip de Vroe (The Finance Storyteller) aims to make strategy, finance and leadership enjoyable and easier to understand. Learn the business and #accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better stock market investment decisions. Philip delivers #financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!