How to calculate bad debt expense? (Definition, Methods, Example and Calculation).

The bad debt is a financial activity that you note down in your books to report for any bad debts that your company has discarded to pile up. If the company is using the accretion accounting, it has to note down the bad debt principles of the expenses. Also, if the company is using principles of cash accounting, the bad debts are still worse. However, if you never noted the bad debt as revenue at the initial place, there would not be an amount to “reverse” using a bad debt amount transaction.

Bad debt expenses is a term that allows company to reflect what has been literally ensuing in company business. In this, company can find the net income of a business accurately if it is not appearing more than it would be. Similarly, if someone wants to decrease company taxes and it is not giving the tax amount on profits that have never been earned, that’s why the recording of bad debt expenses is very important.

How to find bad debt expense?

Although, it can be found as other expenses of an account. If you want to find bad debt expenses, you can get them in the general ledger. Let’s take a look at the general ledger. It is also known as a (GL or general journal) and it is used in bad debts that encapsulates all the financial information which you have about your occupation or business, also it registers every information about your accounting transaction for review.

Some decades ago, the general ledger was basically a ledger like a heavy book in which a large amount of financial data of bad debts was written down by hand. Currently, it is possible to keep books with ledger paper. But as you know, writing books by hand takes (a thousand times) more. So, nowadays, several business bookkeepers and business owners are using software to make their general ledgers.

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Moreover, the Bad debt expenses are also defined as general budgets, and you can generally discover them on your business earning statement under management costs and general selling.

How to calculate bad debt expenses

There are two ways to calculate the bad debts of company’s business:

1.     by the allowance method

2.     Directly writing receivable accounts of your business.

How to write company’s receivable accounts directly?

If the company has not so many bad debts, it would apparently note down them on a case-by-case, after it becomes obvious that a client would not pay. In this scenario, company must write down a bad debt outlay transaction in a general ledger and identical to the rate of the payable account.

How do you know whether it’s time to write a bad debt off as uncollectible?

The IRS reported that the company should only note down debt if there is “no chance of the owed amount to be paid, so the company would be able to indicate that it has “put considerable steps to gather the debts.” If the company has put effort and failed to communicate with the customers by mobile or made a plan of repayment, it would be time for the debt to be written down.

How to calculate bad debt expenses using the allowance method?

If you are doing some business on your own money, you would definitely desire to find calculations of your bad debts on time by using the method allowance.

This includes raising an allowance for the bad debts, it is also known as a bad allowance for dubious accounts or debt stock), which is originally a bunch of money on your books that you take out from and pay for all the bad debts, and you’ll suffer in the end.

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Many businesses will build their allowance for bad debts by using bad debt formulas in the percentage.

What is the percentage of the bad debt formula?

Your allowance for bad debts will always be an estimate because of your setting ahead of time. Suppose your bad debts generally include many forms of the percentages of the bad debt formula, which are only your previous bad debts and are divided by your previous sales on your account.

This is the formula:

Bad debt Percentage = Total bad debts amount / Total credit amount on sales

Example

Let’s assume that you are in the business for 12 months, and which has a total of $500,000 sales in the account, and you made in the first year, $20,000 ended up uncollectable. You desire to make bad debts’ allowance for taking these bad debts into account on the time. How large should it be?

Initially, you have to find out the percentage of your bad debts:

Bad debt Percentage = $20,000 / $500,000×100

Bad debt Percentage = 4.0%

If 4% looks like a considerable estimation of uncollectible accounts for the future, you have to make bad debts’ allowance equal to 4% of the year’s targeted sales on your account.

If someone has $50,000 of sales on the credit in February, on Feb 30th he/she will note down an adjusting number in his/her share for Bad Debts account for $3,335.

However, it is not usually a strong process of bad debts for making future predictions, particularly, if company has not been doing business for long tenure or if company has huge bad debt which is destroying the percentage.

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How to record a bad debt expense?

There are two conditions in which you will write a bad debt expense in the books. When you’ve directly deemed an account uncollectable, write the receivable of that, and make a reserve for bad debts.

Recording a bad debt expense using the direct write-off method

Suppose your company wants to write directly a $900 account receivable which you believe is no longer collectible. After making the last call to the client and getting their answering machine, you will write the following data in your notebook:

AccountDebitCredit
Expense Bad debt$900
Receivable Accounts$900

Recording a bad debt expense for the allowance method

Suppose after your business calculation the bad debts percentage (see above), you have decided to make a bad debts allowance for account of $4,000 in the note books on last of month. To do this, you will write the following data:

AccountDebitCredit
Expense Bad debt$4,000
Bad debts Allowance $4,000

The allowance for your bad debts is known as account contra-asset,   it means that it would show on the saved amount sheet along with all of your assets.

Now suppose that some days later, someone from your clients asks you that we are not able to come with $900 which they owe you, and you desire to note down their $900 receivable account.

Because the drawbacks are already changed by your allowances which you made and you will make the following journal details as:

AccountDebitCredit
Bad debts Allowance$900
Receivable Accounts$900
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