How To Record a Bad Debt Expense: Everything You Need to Know

Introduction

When you sell goods or services on credit, there’s always a risk that some customers won’t pay you back. Over time, these unpaid invoices can age and eventually become uncollectible.

These uncollectible amounts are known as bad debt expenses—money your business expected to receive but never did. It’s important to record these accurately, as they directly impact your financials. Even though you initially recorded the sale as revenue, if the payment never comes through, it doesn’t contribute to your cash flow. That’s why bad debt is treated as an expense and reduces your net income. This blog covers everything about bad debt expense—what it is, how it affects your financial statements, and how to record it with the right journal entries.

What Is a Bad Debt Expense Journal Entry?

Bad debt expense represents the estimated portion of accounts receivable that is unlikely to be collected and must be recorded to maintain accurate and compliant financial statements. When a credit sale is made, revenue is recognized, and AR is increased, but to adhere to the matching principle, businesses must also account for the risk of non-payment. This is done by estimating the uncollectible amount and recording it as a bad debt expense, typically under SG&A in the income statement.

The journal entry involves debiting the bad debt expense account and crediting the allowance for doubtful accounts—a contra-asset that reduces the net accounts receivable on the balance sheet. This approach ensures that reported income and assets aren’t overstated, supporting accurate period-end close and audit readiness. Even after amounts are written off, businesses retain the right to collect, and any recoveries are treated as separate accounting events.

Where is Bad Debt Expense Recorded? 

Bad debt expense is recorded within the general, selling, and administrative expense heads of the income statement. However, the entries to record bad debt expenses are spread throughout the financial statements. You will find out the allowance for doubtful accounts on the balance sheet as a contra asset. On the other hand, any bad debts that have been directly written off will reduce the AR balance on the balance sheet. 

What are the reasons behind bad debt expense accounts? 

Bad debts usually occur due to: 

• When customers are not satisfied with your goods or services and refuse to pay. 
• Customers are financially in a tight spot or on the verge of bankruptcy. 
• Sales teams are not efficient enough to offer better credit terms or frame negotiations without the AR team’s input, creating confusion around payment terms. 

Apart from this, one of the major reasons behind bad debt expense is if you have a higher day sales outstanding (DSO). It refers to the average number of days it takes for a business to collect payment after a sale has been made. A higher DSO means longer collection times and slower processing. This extended collection period increases the chances of receivables becoming uncollectible, leading to higher bad debt expenses. The longer the receivables are outstanding, the greater the risk that customers will default. 

Therefore, businesses with higher DSO must closely monitor their accounts receivable and proactively improve their collections by tightening their credit policies or enhancing dunning processes. Effective DSO management and employing debt collection strategies are critical to reducing the risk of bad debt and lowering the bad debt expense.

Understanding the Significance of Bad Debt Expense

Bad debt expense is an integral part of the collection process that helps reflect and mitigate credit risk, inform and prioritize collection strategies, improve financial planning, enhance customer segmentation, identify default accounts, and allocate resources. Accurately recording and analyzing bad debt expenses enables you to manage your accounts receivable and reduce your potential losses effectively.

Here are more reasons why considering bad debt expenses in the financial books is vital. 

• Reflect credit risk: Understanding bad debt expense helps you assess the effectiveness of your credit policies and identify areas where credit risk is high. This will assist you in making prompt adjustments in credit terms and implementing more stringent credit checks to mitigate credit risk.
• Inform collection strategies: Recording bad debt expenses helps analyze historical data, allowing you to rethink and refine your collection strategies. If bad debt expenses are higher than what you had expected, it means you need more aggressive collection efforts or changes in the customer credit evaluation process.
• Faster identification of default accounts: Managing bad debt expenses will help you identify customer accounts that may fail to pay before the invoice due date, and take proactive actions. With these insights, you can dive into the underlying causes of default and devise strategies to mitigate non-payments and reduce their impact on the financial statements.
• Prioritize collection efforts: Knowing the amount of bad debt expenses can help you rethink and fast-track your collection efforts. For instance, if you find certain customer accounts as high-risk or historically problematic, your collections team can focus their efforts on these accounts to prevent further loss, ensuring that the most critical accounts are addressed promptly to improve recovery rates.
• Improves financial health: Recording bad debt expenses on financial statements helps you lower the accounts receivable and show accurate income. It reflects positive financial health and enables you to pave the way for effective and accurate financial forecasting and planning. You can use this information to predict future cash flows and adjust your financial strategies to manage working capital and keep the business financially stable despite collection challenges. 

Methods of Recording Bad Debt Expense

There are two methods to record a bad debt expense: 

• Direct write-off method
• Allowance method 

• Direct write-off method The direct write-off method allows you to write-off bad debt only when a specific account is anticipated to have become uncollectible. You will write off a part of the receivables as bad debt and post a bad debt journal entry by debiting the bad debt expense and crediting the accounts receivable.

  

  Here, bad debt expense is treated as a direct loss from the uncollectible accounts that go straight against revenues, reducing the net income. In one accounting period, you may experience a heavy rise in your receivables account. Then, in the next accounting period, you may find many customers defaulting on their payments, thereby lowering your net income. However, before writing off a debt, ensure you follow these IRS guidelines:

  • You must have strong evidence to prove that your customer will default. 
  • You must show that you have already taken reasonable measures to collect the outstanding debt, like contacting the customer or solving disputes. 
• Allowance method: The allowance method is the best way to record bad debt expenses if you are dealing with large material amounts. The reason is using the contra asset account that goes against accounts receivable. A contra-asset account refers to an account with an opposite balance to accounts receivable. While this method may look more complex on paper, it gives a more accurate assessment of your ability to collect receivables. GAAP recommends that businesses use methods that comply with the matching principle. Here are the vital elements of the allowance method: 
  • Determine uncollectible invoices. In the journal entry, debit the bad debt expense and credit allowance for doubtful debt accounts. When writing off an account, debit allowance for doubtful accounts and credit the receivable account. 

Example of Bad Debt Expense Journal Entry 

Let’s take an example of a retail company, ABC Ltd., that uses an allowance method to record bad debt expenses. Lately, its collection team found out that a local boutique shop, X&Co.., is going through some financial downturn and may default in paying the last invoices. Here are the numbers: 

To record the bad debt expense in the financial books, it will first determine the amount of accounts receivable that will be uncollectible. This could be using: 

Percentage of sales 

In this method, you have to find out the percentage of net credit sales or total sales that you estimate is uncollectible. It is usually estimated by studying historical trends or anticipating credit policy. In this example, here’s what bad debt expense and accounts receivable in the books will look like. 

Now, to reflect the estimated bad debts as an expense on the income statement, you will have to adjust the allowance account on the balance sheet. 

Percentage of receivables 

This is almost similar to the percentage of sales method, but uses accounts receivable instead of sales. The result you get will be the company’s ending balance for the allowance for doubtful accounts. Note that even if there are any overdue invoices from last year, they have already been included in the AR balances in the current year. 

Now, we have an opening balance of $1000 for the allowance for doubtful accounts that need to be adjusted with estimated amounts calculated. It will ensure that the amount aligns with the anticipated uncollectibles. 

The income statement will have this adjustment value when you record the bad debt expense. The journal entry for the same will look like this. 

The allowance method is known to give a more accurate presentation of a business’s financial position. When you record bad debt expense while writing off uncollectible accounts, it will help match the expense with the period in which the related revenue was recognized. 

How Can HighRadius’s Record-to-Report Solution Help with Bad Debt Expense Journal Entry?

HighRadius’s Record-to-Report Solution simplifies and automates the process of recording bad debt expense journal entries, ensuring accuracy, compliance, and timeliness. It reduces manual intervention, enforces consistent accounting treatment, and provides greater visibility into doubtful receivables. The solution also strengthens account reconciliation by identifying and resolving anomalies early in the close cycle, reducing the risk of misstatements related to uncollectible accounts. With built-in anomaly detection and automation, finance teams can ensure accurate and reliable reporting every period.

Key benefits include:

• Automated journal entries: Reduce errors and manual workload by auto-generating entries based on predefined rules and credit policies. Our solution enables you to achieve 95% automated journal posting.
• Automated bank reconciliation: Streamline reconciliation with rule-based matching and exception handling to close faster and more accurately.
  
• Real-time tracking of doubtful accounts: Monitor aging reports and risk indicators to proactively flag bad debts.
• Seamless ERP integration: Sync data directly with your ERP for faster close cycles and improved data consistency.
• Transaction matching: Achieve up to 95% auto transaction match rate, reducing manual intervention and accelerating close timelines.
• Audit-ready documentation: Maintain clear, traceable records for compliance and internal review.

• Enhanced control and governance: Standardize write-off processes and gain oversight across business units.

FAQs

1) What are the three statements for bad debt expense?

It includes the income statement, balance sheet, and journal entry. It is a part of the general, selling, and administrative expenses in the income statement. In the balance sheet, it will be a contra asset with allowance for doubtful debt amount reduced from AR. For a journal entry, you debit the bad debt and credit AR.

2) How is bad debt shown in the balance sheet?

Bad debt expense is written as the allowance for doubtful accounts on the balance sheet as a contra asset. Any bad debts that have been directly written off will reduce the balance of accounts receivable on the balance sheet. A contra-asset refers to an account with an opposite balance to AR.