Some customers will never pay. The question is when to record that loss. The allowance method records it in the same period as the sale, using an estimate, before anyone knows which customers will default. This post covers the two ways US textbooks make that estimate (percentage of sales and aging of receivables), the entries for writing off and recovering an account, and why the direct write-off method is not acceptable under GAAP when bad debts are material.
Why Not Just Wait?
The direct write-off method records bad debt expense only when a specific account is declared uncollectible:
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | 900 | |
| Accounts Receivable | 900 |
It is simple, and US tax rules require it. But it often puts the expense in a later year than the sale that caused it, and it leaves receivables on the balance sheet above what will be collected. Under GAAP it is acceptable only when bad debts are immaterial. Everywhere else, use the allowance method.
How the Allowance Method Works
At period-end you estimate how much of the receivables will not be collected. You record that estimate in a contra-asset account, Allowance for Doubtful Accounts:
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | X | |
| Allowance for Doubtful Accounts | X |
The balance sheet then reports receivables at net realizable value: Accounts Receivable minus the allowance. The only question is how to find X, and the two methods answer it differently.
The Example: Northgate Supply, December 31
Credit sales for the year were $600,000. Accounts Receivable is $120,000. Before adjustment, the allowance already has a $1,400 credit balance left over from last year's estimate.
Method 1: Percentage of sales (income statement approach)
Past experience says 1% of credit sales go bad. The expense is simply:
$600,000 × 1% = $6,000
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | 6,000 | |
| Allowance for Doubtful Accounts | 6,000 |
The existing $1,400 balance is ignored. This method estimates the expense directly, and the allowance ends wherever it ends: 1,400 + 6,000 = $7,400. It matches expense to sales well, but the balance sheet figure is a by-product.
Method 2: Aging of receivables (balance sheet approach)
Receivables are grouped by how long they are past due, and older balances get higher loss rates:
| Age | Balance | Est. % uncollectible | Required allowance |
|---|---|---|---|
| Not yet due | 80,000 | 1% | 800 |
| 1–30 days past due | 22,000 | 4% | 880 |
| 31–60 days | 10,000 | 10% | 1,000 |
| 61–90 days | 5,000 | 25% | 1,250 |
| Over 90 days | 3,000 | 50% | 1,500 |
| Total | 120,000 | 5,430 |
$5,430 is the required ending balance of the allowance, not the expense. The adjustment tops up whatever is already there:
Required $5,430 − existing credit $1,400 = $4,030
| Account | Debit | Credit |
|---|---|---|
| Bad Debt Expense | 4,030 | |
| Allowance for Doubtful Accounts | 4,030 |
If the allowance had a $600 debit balance instead (more was written off during the year than was estimated), the adjustment would be 5,430 + 600 = $6,030. Either way, the allowance ends at $5,430, and net receivables are 120,000 − 5,430 = $114,570.
Writing Off an Account
In February, a customer owing $900 goes bankrupt:
| Account | Debit | Credit |
|---|---|---|
| Allowance for Doubtful Accounts | 900 | |
| Accounts Receivable | 900 |
There is no expense here. The expense was recorded last year, when the estimate was made. The write-off uses up part of the allowance, and net receivables do not change: both Accounts Receivable and the allowance fall by $900.
Recovering a Written-Off Account
In June, the same customer unexpectedly pays the $900. Make two entries. First, reinstate the receivable:
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | 900 | |
| Allowance for Doubtful Accounts | 900 |
Then record the collection:
| Account | Debit | Credit |
|---|---|---|
| Cash | 900 | |
| Accounts Receivable | 900 |
Reinstating first keeps the customer's history accurate: the account shows it was eventually paid, which matters if they ask for credit again.
A Note on CECL
US GAAP now measures credit losses under the current expected credit loss (CECL) model in ASC 326. It requires an estimate of lifetime expected losses that reflects forecasts, not just past experience. For trade receivables, an aging schedule with rates adjusted for current conditions remains the standard practical method, so the mechanics above still apply. The IFRS version of this idea, the provision matrix under IFRS 9, is explained in our expected credit losses guide.
Common bad debt mistakes
- Booking the full aging total as the expense. Under aging, the schedule gives the target balance. Adjust for what is already in the allowance.
- Adjusting the existing balance under percentage of sales. The reverse mistake. Percentage of sales gives the expense directly; the existing balance does not matter.
- Getting the direction of a debit balance wrong. A debit balance in the allowance means the adjustment must be larger to reach the required credit balance.
- Debiting Bad Debt Expense on a write-off. Under the allowance method, write-offs hit the allowance only.
- Recording a recovery as revenue. Reinstate the receivable through the allowance, then collect it.
The single write-off entry also appears as Problem 13 in our journal entry practice problems. The full estimation cycle is practiced on Accountely's bad debt challenges, where both methods are graded line by line. The allowance's place on the balance sheet is covered under contra accounts.
Frequently Asked Questions
What is the difference between the percentage of sales and aging methods?
Percentage of sales estimates bad debt expense directly as a percentage of credit sales, ignoring the existing allowance. The aging method estimates the required ending balance of the allowance from overdue receivables, and the expense is whatever adjustment reaches that balance.
What is the journal entry to write off a bad debt under the allowance method?
Debit Allowance for Doubtful Accounts and credit Accounts Receivable. No expense is recorded, because the expense was recognized when the allowance was set up.
How is a recovered bad debt recorded?
First reinstate the receivable (debit Accounts Receivable, credit Allowance for Doubtful Accounts), then record the cash collection (debit Cash, credit Accounts Receivable).
Why does the allowance method matter?
It matches bad debt expense to the period in which the sales were made, and shows receivables at the amount the company expects to collect. The direct write-off method does neither, which is why it is not allowed under GAAP when bad debts are material.