Bad debt expense: definition, formula, and examples
Bad debt expense is the cost of receivables a company no longer expects to collect. Here is how to calculate it, the journal entries, and how to keep it low.
Bad debt expense is the cost of credit sales a company no longer expects to collect. When a customer fails to pay an invoice, the receivable that was once an asset becomes a loss, and that loss is booked as bad debt expense on the income statement.
Most bad debt is not bad luck. It is the predictable result of invoices that aged out of reach: accounts that drifted from 30 to 90 to 180 days past due while no one followed up consistently. The earlier and more reliably you work an overdue account, the smaller this number gets.
How to calculate bad debt expense
There are two ways to size bad debt expense, depending on the method you use.
Under the allowance method, you estimate uncollectible amounts before any specific account is confirmed bad. Two common approaches:
Percentage of credit sales: Bad debt expense = Credit sales x Estimated uncollectible rate
Percentage of receivables (aging): Required allowance = Sum of (each aging bucket x its loss rate)
Under the direct write-off method, there is no estimate. You record bad debt expense only when a specific invoice is declared uncollectible, for the exact amount written off.
A worked example
Suppose a company books 500,000 in credit sales for the quarter and, based on history, expects 2% to go uncollectible.
Bad debt expense = 500,000 x 0.02 = 10,000
The aging approach can be more precise because it weights older receivables more heavily. Say the aging report shows:
- Current: 200,000 at 0.5% expected loss = 1,000
- 31 to 60 days: 80,000 at 2% = 1,600
- 61 to 90 days: 40,000 at 10% = 4,000
- Over 90 days: 25,000 at 40% = 10,000
The required allowance is 16,600. If the allowance already holds 4,000 from prior periods, you record 12,600 of bad debt expense to top it up.
Direct write-off vs the allowance method
The direct write-off method is simple but flawed. It records the expense only when an account is confirmed dead, often in a period long after the sale. That breaks the matching principle, since the revenue and its related loss land in different periods. The IRS allows it for tax, but GAAP does not for financial reporting.
The allowance method estimates losses in the same period as the sale, so the income statement reflects the true cost of those sales as they happen. It is the GAAP-compliant approach and the one most finance teams use. The trade-off is that it relies on an estimate you have to revisit each period.
Journal entries
Under the allowance method, recording the estimate:
Debit: Bad debt expense 10,000 Credit: Allowance for doubtful accounts 10,000
When a specific account is later confirmed uncollectible, you write it off against the allowance, with no new expense:
Debit: Allowance for doubtful accounts 3,000 Credit: Accounts receivable 3,000
Under the direct write-off method, there is no allowance. You hit the expense directly when the account goes bad:
Debit: Bad debt expense 3,000 Credit: Accounts receivable 3,000
If a written-off customer later pays, you reverse the write-off and record the cash, which recovers the loss you previously booked.
How to reduce bad debt
Bad debt is mostly a follow-up problem, not a credit problem. A few levers move the number:
- Vet credit before you extend it. Set limits and terms based on a customer's ability to pay, and revisit them as their payment behavior changes.
- Invoice cleanly and on time. Disputes and errors are a leading reason invoices stall, and stalled invoices age into write-offs.
- Follow up early and every time. The probability of collecting drops sharply once an invoice passes 90 days. Consistent outreach in the first 60 days is where most recovery happens.
- Act on the aging report. Treat each account that crosses a bucket as a trigger for action, not a line on a month-end report nobody works.
- Pursue accounts before write-off. Many accounts marked uncollectible are simply under-worked, not unrecoverable.
How Rex keeps bad debt low
Most bad debt comes from accounts that aged out while no one chased them. Rex closes that gap. It works the entire ledger continuously, opening an invoice the moment it ages and following up on a schedule tuned to each account, so receivables do not drift quietly toward write-off. When a customer raises a dispute or asks for a plan, Rex handles it or escalates the judgment call to a person, while keeping every other account moving.
Because Rex catches slipping invoices early and stays on them, fewer accounts ever reach the over-90 bucket where losses concentrate. The bad debt you book reflects genuinely uncollectible accounts, not ones that simply fell through the cracks. See how Rex runs collections end to end.
Frequently asked questions
- What is bad debt expense?
- Bad debt expense is the amount of accounts receivable a company expects it will not collect, recorded as an expense on the income statement. It reflects sales made on credit that turn into uncollectible debt.
- How do you calculate bad debt expense?
- Under the allowance method, multiply credit sales or outstanding receivables by an estimated uncollectible rate. For example, 2% of 500,000 in credit sales gives a 10,000 bad debt expense for the period.
- Is bad debt expense a debit or a credit?
- Bad debt expense is a debit. The offsetting credit goes to the allowance for doubtful accounts (under the allowance method) or directly to accounts receivable (under the direct write-off method).
- What is the difference between bad debt expense and the allowance for doubtful accounts?
- Bad debt expense is the cost recorded on the income statement for a period. The allowance for doubtful accounts is the running contra-asset balance on the balance sheet that reduces gross receivables to what you expect to collect.