Amount Reported as Bad Debts Expense
The amount reported in the income statement account Bad Debts Expense pertains to the estimated losses from extending credit during the period shown in the heading of the income statement. The estimated amount of Bad Debts Expense could be based on:
- A percentage of the company's credit sales during the period, or
- The change in the total amount needed in the Allowance for Doubtful Accounts based upon the amounts customers owe on the company's accounts receivable
Amount Reported as Allowance for Doubtful Accounts
The balance reported in the balance sheet account Allowance for Doubtful Accounts is the estimated amount of Accounts Receivable that will not be collected. The balance in Allowance for Doubtful Accounts could be based upon:
- An aging of the detailed amounts in Accounts Receivable
- The result of recording the credit part of the entries to Bad Debts Expense that were based on a percentage of credit sales
Example of Bad Debts Expense and Allowance for Doubtful Accounts
To illustrate, let's assume that on December 31 a company had $100,000 in Accounts Receivable and its balance in Allowance for Doubtful Accounts was a credit balance of $3,000. As a result, the December 31 balance sheet will be reporting that $97,000 will be turning to cash. During the first 30 days of January the company does not have any other information on bad accounts receivable. However, on January 31 the company learns that an additional $1,000 of its accounts receivable may not be collected. Therefore, on January 31 the company will make an adjusting entry to debit Bad Debts Expense for $1,000 and to credit Allowance for Doubtful Accounts for $1,000. After this entry is recorded, the company's income statement for the month of January will report Bad Debts Expense of $1,000 and its January 31 balance sheet will report a credit balance in Allowance for Doubtful Accounts in the amount of $4,000.
