Adjusting Entry for Bad Debts Expense

Companies provide services or sell goods for cash or on credit. Allowing credit tends to encourage more
sales.
However, businesses that allow credit are faced with the risk that their receivables may not be collected.
Accounts receivable should be presented in the balance sheet at net realizable value, i.e. the most
probable amount that the company will be able to collect.
Net realizable value for accounts receivable is computed like this:
Accounts Receivable - Gross Amount
Less: Allowance for Bad Debts
Accounts Receivable - Net Realizable Value

$ 100,000
3,000
$ 97,000

Allowance for Bad Debts (also often called Allowance for Doubtful Accounts) represents the estimated
portion of the Accounts Receivable that the company will not be able to collect.
Take note that this amount is an estimate. There are several methods in estimating doubtful accounts.
The estimates are often based on the company's past experiences.
To recognize doubtful accounts or bad debts, an adjusting entry must be made at the end of the period.
The adjusting entry for bad debts looks like this:
Dec 31 Bad Debts Expense
Allowance for Bad Debts

xxx.xx
xxx.xx

Bad Debts Expense a.k.a. Doubtful Accounts Expense: An expense account; hence, it is presented in
the income statement. It represents the estimated uncollectible amount for credit sales/revenues made
during the period.
Allowance for Bad Debts a.k.a. Allowance for Doubtful Accounts: A balance sheet account that
represents the total estimated amount that the company will not be able to collect from its total Accounts
Receivable.
What is the difference between Bad Debts Expense and Allowance for Bad Debts?

Bad Debts Expense is an income statement account while the latter is a balance sheet account. Bad
Debts Expense represents the uncollectible amount for credit sales made during the period. Allowance for
Bad Debts, on the other hand, is the uncollectible portion of the entire Accounts Receivable.
You can also use Doubtful Accounts Expense and Allowance for Doubtful Accounts in lieu of Bad Debts
Expense and Allowance for Bad Debts. However, it is a good practice to use a uniform pair. Some say
that Bad Debts have a higher degree of uncollectibility that Doubtful Accounts. In actual practice,
however, the distinction is not really significant.

Here's an Example
Gray Electronic Repair Services estimates that $100.00 of its credit revenue for the period will not be
collected. The entry at the end of the period would be:
Dec 31 Bad Debts Expense

100.00

Allowance for Bad Debts

100.00

Again, you may use Doubtful Accounts. Just be sure to use a logical (and uniform) pair every time. For
example:
Dec 31 Doubtful Accounts Expense

100.00

Allowance for Doubtful

Accounts

100.00

If the company's Accounts Receivable amounts to $3,400 and its Allowance for Bad Debts is $100, then
the Accounts Receivable shall be presented in the balance sheet at $3,300 the net realizable value.
Accounts Receivable (Gross Amount)
Less: Allowance for Bad Debts
Accounts Receivable - Net Realizable Value

$ 3,400
100
$ 3,300