To estimate bad debt expense, pick one of three accepted methods — percentage of credit sales, percentage of accounts receivable, or an aging schedule — apply a loss rate drawn from your own history to the relevant base, and book the result as a debit to Bad Debt Expense and a credit to Allowance for Doubtful Accounts. Accrual accounting requires this estimate in the same period you recognize the revenue, so your income statement and balance sheet reflect what you actually expect to collect rather than the full face value of every invoice.
The three methods use the same underlying data but answer slightly different questions. Two of them target a balance on the balance sheet and back into the expense; one calculates the expense directly. Which fits depends on whether you care more about matching the expense to the period that produced the revenue or about keeping reported receivables tightly calibrated to reality.
Data You Need Before You Start
Every method draws from the same records. Pull total credit sales for the current period (cash sales don’t belong in the calculation), the ending balance of accounts receivable, and the current balance sitting in your Allowance for Doubtful Accounts. That last figure matters because two of the three methods calculate a desired ending balance for the allowance, and the expense you record is the difference between that target and whatever is already there.
You also need historical write-off data, ideally three to five years of it. If your business wrote off $75,000 against $3,000,000 in credit sales over three years, the 2.5% average is your starting loss rate. Look at direction, not just the average. A rate that has climbed each year tells you something different than one that has held steady, and the estimate should reflect the trend rather than a flat mean that hides it.
Percentage of Credit Sales
This method ties the expense directly to how much you sold on credit during the period. Divide historical write-offs by historical credit sales to get a loss rate, then apply that rate to the current period’s credit sales. A 2% rate against $500,000 in quarterly credit sales produces $10,000 in bad debt expense. That figure is the entry — you don’t look at the existing allowance balance at all.
The appeal is speed and clean matching. One number, one percentage, one entry, and the expense sits in the same period as the revenue that generated it. The weakness is that the allowance account drifts. If prior estimates ran high, the allowance keeps growing above what current receivables actually justify. If customer quality shifts, the flat rate misses it until you reset. For businesses with stable sales patterns and stable customer profiles, that drift is small enough to ignore between annual reviews.
Percentage of Accounts Receivable
Here you focus on what customers owe you right now rather than what you sold. Apply a flat estimated loss rate to the total receivables balance to determine what the allowance account should contain at period end. Receivables of $200,000 at a 5% rate give a target allowance of $10,000.
The step people miss on the first pass: that $10,000 is the target balance, not the expense. Check what the allowance already holds. If it carries a $3,000 credit balance from prior periods, you record $7,000 in expense to bring it up to $10,000. If write-offs have pushed the account into a $1,500 debit balance, you need to record $11,500 to reach the same target. The expense entry is always the plug that gets you from where the allowance sits to where it needs to be.
This approach keeps the balance sheet tightly calibrated because the estimate directly adjusts the net receivable each period. It gives up some precision in matching expense to the specific period that produced the sale, but when balance sheet accuracy is what readers of the statements care about — lenders, investors, potential buyers — that tradeoff usually favors this method.
Aging Schedule
The aging schedule is a more granular version of the receivables method. Instead of one flat percentage across the whole balance, you sort every open invoice into buckets by how long it has been unpaid and assign each bucket its own loss rate. Older invoices get higher rates because older invoices are less likely to be paid.
A typical schedule uses rates in these ranges:
- Current (0–30 days): 1–2%
- 31–60 days past due: 3–5%
- 61–90 days past due: 8–12%
- Over 90 days past due: 25–40%
Multiply each bucket by its rate, sum the results, and you have the target allowance balance. Suppose the current bucket holds $150,000, the 31–60 bucket holds $30,000, the 61–90 bucket holds $10,000, and the over-90 bucket holds $5,000. The weighted calculation might produce a target of roughly $5,600 — far more precise than applying 5% flat to the whole $195,000.
The number is only part of what the schedule gives you. Building it shows where collection problems concentrate. A 61–90 bucket that keeps growing quarter over quarter is an early warning about credit terms or follow-up. Lenders who accept receivables as collateral almost always want to see the aging before deciding how much they will lend against them.
The expense entry works the same way as the flat receivables method. Compare the target allowance to the current balance and record the difference. If write-offs during the period exceeded prior estimates and the allowance is now in a debit position, the entry has to cover the deficit and then some to reach the new target. Repeated deficits are a signal that your bucket percentages are too low.
The Journal Entry
Whichever method produced the number, the entry is the same: debit Bad Debt Expense, credit Allowance for Doubtful Accounts. Bad Debt Expense lives on the income statement and reduces net income. The allowance is a contra-asset that sits against Accounts Receivable on the balance sheet, so the credit reduces the net carrying value of receivables without touching any individual customer’s balance in the sub-ledger.
Readers of your statements see the net figure. A company with $500,000 in gross receivables and a $15,000 allowance reports $485,000 in net receivables — the amount it actually expects to collect. Gross receivables and the allowance are often disclosed separately in the notes, but the face of the balance sheet shows the net.
When a Specific Account Goes Bad
Estimating creates the allowance. Eventually a specific customer’s balance proves uncollectible and has to come off the books. When that happens, debit Allowance for Doubtful Accounts and credit Accounts Receivable for that customer’s balance. This entry does not touch the income statement, because the expense was already recognized when you built the allowance. The write-off just converts a predicted loss into a confirmed one.
If a written-off customer later pays, reverse the write-off first (debit Accounts Receivable, credit Allowance for Doubtful Accounts) and then record the cash receipt normally (debit Cash, credit Accounts Receivable). Doing it in two steps restores the payment history in the customer’s record, which matters if you ever consider extending credit to them again.
If You Fall Under CECL
Companies subject to the Current Expected Credit Losses standard under ASC 326 need to go beyond historical rates. CECL requires the estimate to reflect current economic conditions and reasonable forecasts about the future alongside your historical loss experience. Rising unemployment in your customer base or a known downturn in an industry you sell into has to be factored in even if it hasn’t shown up in your aging yet. The FASB deliberately left the method flexible so you can keep using any of the three approaches above, but the inputs must include forward-looking information rather than history alone.1Financial Accounting Standards Board (FASB). Credit Losses
This Is Your Book Number, Not Your Tax Deduction
The allowance method described here is required under GAAP for financial reporting. The IRS does not accept it for tax purposes. The tax code’s reserve method for bad debts was repealed in 1986, and most businesses must use the specific charge-off method on their tax return, deducting a wholly worthless debt in the year it becomes worthless and a partially worthless business debt only to the extent actually charged off that year.2Office of the Law Revision Counsel. 26 USC 166 – Bad Debts Your GAAP bad debt expense for a year and your tax deduction for the same year will almost never match, and most businesses maintain both figures side by side rather than trying to reconcile them into one.