To calculate the allowance for doubtful accounts, apply a historical loss rate to one of three bases: credit sales for the period, the ending accounts receivable balance, or receivables grouped by how long they have been outstanding. The first method gives you bad debt expense directly. The other two give you a target balance for the allowance account, and you record the difference between that target and the balance already sitting there as bad debt expense. The allowance itself is a contra-asset that reduces reported receivables to the cash you realistically expect to collect.
What You Need Before You Start
Pull three things from your records. First, total credit sales for the period, separated from cash sales, because only credit sales carry collection risk. Second, your ending accounts receivable balance. Third, your historical loss rate — how much bad debt your business has written off over the past several years relative to credit sales. If year after year roughly 2 percent of credit sales go unpaid, that pattern is the foundation of every estimate that follows.
For the aging method you also need an accounts receivable aging report, which sorts every unpaid invoice into time buckets based on how long it has been outstanding.
Method 1: Percentage of Sales
Multiply total credit sales for the period by your historical uncollectible percentage. That figure is bad debt expense.
Say credit sales for the quarter come to $500,000 and your history shows 2.5 percent of credit sales go unpaid. Bad debt expense is $12,500 ($500,000 × 0.025). You debit bad debt expense for $12,500 and credit the allowance for doubtful accounts for $12,500. No further adjustment is needed — this method ignores whatever balance already sits in the allowance account and simply adds to it.
The appeal is simplicity, and the expense matches the revenue that produced it, which is consistent with accrual accounting. The weakness is the same: because you never look at the allowance balance, it can drift away from a realistic estimate of uncollectible receivables over time.
Method 2: Percentage of Accounts Receivable
Multiply the ending accounts receivable balance by your estimated uncollectible percentage. The result is not bad debt expense. It is the target ending balance for the allowance account.
Suppose receivables total $250,000 and you estimate 4 percent will go unpaid. Your target allowance balance is $10,000. Now check what the allowance account already holds:
- If it carries a $3,000 credit balance from prior periods, record $7,000 in bad debt expense to bring it to $10,000.
- If write-offs during the period have pushed it to a $2,000 debit balance, record $12,000 in bad debt expense — the $10,000 target plus the $2,000 needed to erase the debit.
- If it already sits at $10,000, no entry is needed.
Skipping this step is one of the most common errors in applying the method.
Method 3: Aging of Accounts Receivable
The aging method is a more precise version of the percentage-of-receivables approach. Instead of applying one rate to the whole balance, you assign a different loss rate to each age bucket. Older invoices carry higher rates because they are less likely to be collected.
A typical schedule uses four buckets with representative rates:
- 0 to 30 days: often 1 to 2 percent
- 31 to 60 days: often 5 to 10 percent
- 61 to 90 days: often 15 to 20 percent
- Over 90 days: often 30 to 50 percent or more
Multiply each bucket by its rate and add the results. If you have $100,000 at 1 percent, $50,000 at 5 percent, and $10,000 at 20 percent, the required allowance is $1,000 + $2,500 + $2,000 = $5,500.
As with the percentage-of-receivables method, $5,500 is a target balance, not the expense. Adjust for any existing balance in the allowance before you write the entry. The aging method is widely preferred for year-end reporting because it ties the estimate to the actual composition and quality of your receivables at that moment.
Recording the Entry
Once you know the required bad debt expense, the adjusting entry is the same regardless of which method produced it. Using the aging example:
- Debit: Bad Debt Expense — $5,500
- Credit: Allowance for Doubtful Accounts — $5,500
The debit increases expenses on the income statement. The credit increases the contra-asset that sits directly beneath accounts receivable on the balance sheet, reducing gross receivables to their net realizable value.
Writing Off a Specific Account
When a specific customer’s debt actually becomes uncollectible, you write it off against the allowance. This entry does not touch bad debt expense, because the expense was already recognized when you built the allowance.
- Debit: Allowance for Doubtful Accounts
- Credit: Accounts Receivable
Both the gross receivable and the contra-asset drop by the same amount, so net receivables on the balance sheet do not change.
Recovering a Written-Off Account
If a customer later pays a debt you already wrote off, reverse the write-off in two steps. First, reinstate the receivable: debit accounts receivable and credit the allowance for doubtful accounts. Then record the cash: debit cash and credit accounts receivable. If the customer pays only part of the original amount, reinstate and collect only what was received.
Building In Forward-Looking Information Under CECL
If your business reports under GAAP, the estimate itself has to reflect more than historical experience. The Current Expected Credit Losses standard, codified as ASC 326, replaced the older “incurred loss” model. Under CECL, you estimate lifetime expected credit losses from the moment a receivable is recorded, even if no payment has yet been missed.1Financial Accounting Standards Board. Credit Losses
The measurement has to incorporate three inputs: historical experience with similar receivables, current economic conditions, and reasonable and supportable forecasts about future conditions that could affect collectibility.1Financial Accounting Standards Board. Credit Losses Beyond the horizon you can reasonably forecast, you revert to historical loss rates. Forward-looking factors typically include changes in unemployment rates, industry trends, or shifts in customer creditworthiness.2Office of the Comptroller of the Currency. Allowances for Credit Losses (Comptroller’s Handbook)
For a small business with straightforward trade receivables, the three methods above — particularly aging — remain the practical tools for building the estimate. CECL asks that the loss rates you plug in reflect what you know about the road ahead, not only what happened behind you.
The Tax Return Uses a Different Method
The allowance method calculated here is for financial statements under GAAP. It is generally not permitted on your federal tax return. The reserve method for bad debts was repealed from the tax code in 1986, and most businesses must use the specific charge-off method for tax purposes.3Office of the Law Revision Counsel. 26 U.S. Code 166 – Bad Debts That means you deduct a bad debt in the year it actually becomes worthless, not when you estimate it might.
An exception exists for certain service providers using the accrual method, who may qualify for the nonaccrual-experience method. Banks and certain financial institutions have separate rules.4Internal Revenue Service. Publication 334 (2025), Tax Guide for Small Business To claim a business bad debt deduction, you must show that you took reasonable steps to collect and that there is no reasonable expectation of payment; you do not need to file a lawsuit if you can demonstrate that a judgment would be uncollectible.5Internal Revenue Service. Topic No. 453, Bad Debt Deduction
In practice, most companies maintain both approaches in parallel: the allowance method on the books, the specific charge-off method on the return. The gap between them is a temporary timing difference that may need to be tracked for deferred taxes.