Bad debt expense
Definition
Bad debt expense is the cost a business recognizes for credit sales it does not expect to collect from customers. Under the allowance method it is estimated each period and matched to the related sales, while the direct write-off method records it only when a specific account is deemed uncollectible.
Formula
Bad debt expense (percentage of sales method) = Credit sales × Estimated uncollectible percentage
Why it matters
Selling on credit always carries some risk of non-payment, and ignoring that risk overstates both profit and receivables. Recording bad debt expense helps you see the true cost of offering credit terms and decide which customers to extend credit to.
Example
A supplier has credit sales of $80,000 for the year and historically fails to collect 2% of them. Under the allowance method it records bad debt expense of $80,000 × 2% = $1,600: Debit Bad Debt Expense $1,600, Credit Allowance for Doubtful Accounts $1,600.
Common questions
What is the difference between the allowance method and the direct write-off method?
The allowance method estimates uncollectible amounts in advance and matches the expense to the period of the sale, which is consistent with GAAP. The direct write-off method records the expense only when a specific invoice is written off and is generally acceptable only when bad debts are immaterial.
What if a written-off customer later pays?
You reverse the write-off by reinstating the receivable, then record the cash collection against it. Under the allowance method, the reinstatement debits Accounts Receivable and credits the Allowance for Doubtful Accounts.
Related Terms in Invoicing & Sales
Customer statement of account
A customer statement of account is a summary sent to a customer listing all invoices, payments, and credits over a period, along with the balance owed. Unlike an invoice, it does not bill for new goods or services but shows the overall account status.
Dunning
The structured sequence of reminders sent to a customer with an overdue balance, escalating in tone and channel over time. Automating dunning is one of the most reliable ways to reduce days sales outstanding.
Collections
The process of pursuing payment on overdue invoices, from reminders and statements through payment plans to legal action or external agencies. Effective collections depend on accurate aging data and a consistent escalation policy.
Credit Memo
A document issued to reduce the amount a customer owes, used for returns, overcharges, agreed discounts or service failures. It can offset a future invoice or support a refund, and in VAT and GST systems it also adjusts the tax reported.
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