Bad debt expense is an expense account which represents accounts receivable the firm expects to go uncollected.
An accounts receivable is created when a firm sells a good or service and allows the customer to pay for the good or service at a future date. Some customers, however, are likely to default on their obligations.
Bad debt expense can be recognized under one of two methods: the allowance method or the direct write-off method.
Under the allowance method, the firm estimates the amount of accounts receivable expected to go uncollected and establishes a reserve account for the estimated uncollected debts. This reserve account is a contra account for accounts receivable. This contra account is usually called allowance for doubtful accounts. The amount of bad debt expense recognized in a period corresponds to the allowance for doubtful accounts. Under the allowance method, firms recognize bad debt expense by debiting bad debt expense and crediting allowance for doubtful accounts. Firms reporting under U.S. GAAP are required to use the allowance method.
Under the direct write-off method, the firm expenses the uncollectible debts on an account-by-account basis. In other words, firms recognize a bad debt at the time the firm deems the debt uncollectible. The accounting entry for a bad debt under the direct write-off method is to debit bad debt expense and credit accounts receivable.
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