Adjusting for Bad Debts

Do you extend credit to your customers? If so, do you have any accounts receivable at year end that you know are uncollectible? If you do, the end of the year is a good time to make an adjusting entry in your general journal to write off any worthless accounts.

You extend credit to your regular customers, and normally do not experience any trouble collecting from them. Since you rarely have trouble collecting from your customers, you have not set up a reserve for bad debts. However, as you review your accounts receivable at year end, you notice that a particular customer, now insolvent, still owes you $750. You are certain that you will never be paid. Write off this account by making the following adjusting entry:

Debit Credit

Bad debt expense 750

Accounts receivable 750

To record bad debts for the year ended 12/31/2004

Be sure to write off this account in your accounts receivable ledger, so that it agrees with your general ledger.

If you extend credit to numerous customers, and your experience is that a certain amount of your sales on account will be uncollectible, you should probably set up a reserve for bad debts. That way, your books and financial statements will more accurately reflect your true financial picture. At the end of every year, you should evaluate your accounts receivable and adjust your allowance for bad debts accordingly. Your accountant may be able to help you do this.

You extend credit to your customers, and experience tells you that a small amount of your sales on account will never be collected. On December 31, 2004, you evaluate your accounts receivable. You estimate that $1,000 of your receivables will not be collectible. On December 31, 2003, you estimated that $800 of your receivables at that time were uncollectible and your reserve for bad debts account in the general ledger currently reflects that $800 balance. You need to make the following adjusting entry to record this $200 increase in estimated bad debts:

Debit Credit

Bad debt expense 200

Allowance for bad debts 200

To adjust allowance for uncollectible accounts at 12/31/2004

For what to do if you’ve written off a bad debt, but the customer later pays some or all of what he owes, see bad debt recoveries.