Definition of the Write-off of a Bad Account
The write-off of a bad account usually refers to eliminating an account receivable due to the customer's inability to pay the amount owed.
The entry to write off a bad account depends on whether the company is using the direct write-off method or the allowance method.
Examples of the Write-off of a Bad Account
Under the direct write-off method a company writes off a bad account receivable when a specific account is determined to be uncollectible. This usually occurs many months after the credit sale occurred. The entry to write off the bad account under the direct write-off method is:
- Debit Bad Debts Expense (to report the amount of the loss on the company's income statement)
- Credit Accounts Receivable (to remove the amount that will not be collected)
In the U.S., the direct write-off method is required for income tax purposes, but is not the method to be used for a company's financial statements.
Under the allowance method a company anticipates that some of its credit sales and accounts receivable will not be collected and establishes an Allowance for Doubtful Accounts prior to knowing the specific account or accounts that will become uncollectible. The Allowance account is established and adjusted with the following journal entry:
- Debit Bad Debts Expense, and
- Credit Allowance for Doubtful Accounts
When a specific customer's account is identified as uncollectible, the journal entry to write off the account is:
- A credit to Accounts Receivable (to remove the amount that will not be collected)
- A debit to Allowance for Doubtful Accounts (to reduce the Allowance balance that was previously established)
Note that under the allowance method the write-off did not affect an income statement account. The income statement account Bad Debts Expense was affected earlier when the Allowance balance was established or adjusted.
For financial reporting purposes the allowance method is preferred since it means the loss (bad debts expense) is recognized closer to the time of the credit sales. This also means that the balance sheet will be reporting a lower, more realistic amount of its accounts receivable sooner.