Definition
A bad debt is a receivable that will not be collected because the customer cannot or will not pay. Under the allowance method, an estimate of expected losses is recorded as an expense and credited to an allowance for doubtful debts; when a specific balance is confirmed uncollectible, it is written off against that allowance.
How it works
The allowance is a contra account that reduces trade receivables on the balance sheet to the amount expected to be collected. Under IFRS 9 the estimate uses expected credit losses, often with an ageing matrix: the older the invoice, the higher the loss rate.
The write-off itself does not change profit, because the expense was recognised when the allowance was made. If a written-off customer later pays, the write-off is reversed and the cash is recorded. Keep each customer as a party on accounts receivable so ageing and write-offs are traceable.
Example: providing for and writing off a bad debt
At year end receivables total 200,000. Based on ageing, the company expects 6,000 to be uncollectible and records that amount as bad debt expense against the allowance. In March a customer owing 1,500 goes bankrupt; the company debits the allowance and credits the customer's receivable 1,500.
| Entry | Account | Debit | Credit |
|---|---|---|---|
| Provision | Bad debt expense | 6,000 | |
| Provision | Allowance for doubtful debts | 6,000 | |
| Write-off | Allowance for doubtful debts | 1,500 | |
| Write-off | Trade receivables | 1,500 |