Calculate bad debt expense by multiplying the company’s credit sales by the estimated percentage of uncollectible accounts.
- Percentage of Sales Method: Calculate bad debt expense by multiplying the company’s net credit sales for a given period with an estimated bad debt percentage. This percentage is derived from historical data or industry benchmarks, representing potential losses from uncollectible accounts.
- Aging of Accounts Receivable Method: Employ an aging schedule to classify outstanding accounts receivable by their duration. Assign varying percentages of uncollectibility based on past collection trends to each category. Multiply the amounts in each category by their respective bad debt percentages and sum them to estimate the bad debt expense.
- Direct Write-Off Method (Not Recommended): This method is used when a specific customer’s account is confirmed as uncollectible and is written off. However, it doesn’t align with generally accepted accounting principles as it doesn’t match expenses with corresponding revenues.
Remember, the “Allowance for Doubtful Accounts” is a contra-asset account offsetting accounts receivable on the balance sheet. It signifies the anticipated uncollectible amount, aiming to accurately portray potential bad debt losses while following accounting norms. The choice of calculation method depends on historical data, industry practices, and accounting policies, often advised through consultation with financial experts.