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Bad Debts Expense

Moneyzine Editor
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Moneyzine Editor
1 mins
January 8th, 2024
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Bad Debts Expense

Definition

The financial accounting term bad debts expense refers to the portion of revenue a company does not expect to collect from customers. The Matching Principle dictates bad debts are recorded as an expense in the same accounting period in which the sale occurred.

Explanation

The Matching Principle is an accounting standard that states revenues generated in an accounting period need to be matched with the expenses incurred in that same accounting period. As part of the accounting cycle, an adjustment is made to lower sales by the anticipated amount of uncollected revenue.

Companies develop estimates of bad debts expense using a mix of actual (historical) data, prevailing economic conditions, and uncollectible aging information. Typically, bad debts expense is calculated as a percentage of sales revenue.

Bad debts expense is recorded as an adjustment to allowance for doubtful accounts, which is a contra asset that lowers the balance in accounts receivable (a current asset).

Example

Using two years of historical data, Company A has determined that write-off occurs at a rate of 2% of revenues. In the current accounting period, Company A's revenues were $1,000,000. The adjusting entry for bad debts expense is as follows.

Date

Account Description

Account Number

Debit

Credit

06/30/20XX

Bad Debts Expense

904

20,000

Allowance for Doubtful Accounts

419

20,000

Bad debt expense recorded in the current accounting period as 2% of $1,000,000, or $20,000

Related Terms

  • Matching Principle
    The matching principle is a financial accounting term that refers to a standard, which states that revenues generated in an accounting period need to be matched with the expenses incurred in that same accounting period.
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  • Accounting Cycle
    The term accounting cycle refers to the framework and processes followed in each accounting period. The accounting cycle begins with the identification of events and transactions, and ends with the after-close trial balance.
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  • The financial accounting term revenue is used to describe the price charged to customers for good sold, or services rendered. Revenues are reported on a company's income statement.
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  • Contra Account
    A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected on the balance sheet.
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  • Accounts Receivable (Receivables)
    Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.
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  • Acquittance
    The term acquittance refers to a document that provides evidence the debt of a borrower has been extinguished. The most common example of an acquittance is a receipt stating a debt obligation has been paid in full.
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