There are two methods used in recording bad debt of Accounts Receivable:
- Accrue bad debt expense. This method tries to match the bad debt expense of revenues during the period the revenue is recognized. There are two ways to calculate bad debt expense under this method:
- Estimate what percentage of sales ends up uncollected as a bad debt expense. This is an income statement approach where the bad debt expense is estimated and the credit side of the entry is recorded to the Allowance for Doubtful Accounts Ledger account. Periodically, the Allowance for Doubtful Accounts ledger account must be evaluated against actual payments received, and adjusted if necessary.
- Estimate what percentage of Accounts Receivable is uncollected. This is a balance sheet approach where the Allowance for Doubtful Accounts is estimated and the debit side of the entry is recorded to bad debt expense.
- Direct write-off method. This method does not attempt to estimate or accrue bad debt expense in the period the revenue is recognized. Instead, it only recognizes bad debt expenses when an account is written off. This method is not permitted under GAAP.