How to Calculate Bad Debt Expense Using Allowance Method

Bad debts are the debtors that are not going to pay off their due amount of money to the firm and you have to write them off from your books in order to depict the true picture of the cash flows and financial position. A firm sells some goods on credit to a particular customer and later they find out that the customer has been bankrupt and there is no way that they can recover the amount so they have to write off his account from the books and for that purpose the bad debts come into play. However, if you foresee a future and always want to carry a bad debt allowance so that at no time, the financial position of the firm is wrongly displayed you can do that by keeping an allowance which will be subtracted from your income in every fiscal year. It is called bad debt allowance. It is a bit tricky to calculate but a slight effort and concentration can help you keep a smooth maintenance of the bad debt allowance account.

Instructions

  • 1

    The bad debts allowance is created on the base of credit sales that a firm conducts over the course of a year. A particular percentage of bad debtors are decided from the top management which is to be used to base the bad debt allowance. The consistency is crucial in this regard.

  • 2

    Consider the following example:

    Company credit sales = 400000

    Uncollectable sales = 28000 (it can be a percentage as discussed in the previous step)

    You have to calculate the percentage in the example given above; if you have the percentage move to step 3 instantly. Percentage of bad debts is (28000/400000) 0.07 or 7 percent.

  • 3

    Next year the sales were 500000. Now calculate the bad debts by multiplying the percentage calculated in the previous step. You will multiple 500000 to 7% which equals 35,000. So, you have to see the difference between the last year’s bad debt allowance and this year’s bad debt allowance.

  • 4

    The difference is positive 7000 (35000-28000). So you will credit the bad debt allowance account by 7000. If the amount was negative then you should debit the account. It is easy if you practice it regularly.

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