Definitive Guide to a Bad Debt Expense Journal Entry
By Indeed Editorial Team
Published May 14, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When a company can't collect money that customers owe, it's critical to accurately record those debts on a balance sheet. The company may be able to achieve financial accuracy by recording the debts properly in their relevant journals. Learning how to enter this information into a financial document can assist you in creating a journal entry that is both accurate. In this article, we explain what a bad debt expense journal entry is, discuss types of bad debts and their importance, learn how to use the direct write-off journal method, and review examples of bad debt expense journal entries.
What is a bad debt expense journal entry?
A bad expense journal entry is the data put into books of accounts relating to debts from a company's borrowers. Bad debt, also known as doubtful debt, is a type of account receivable that specifies money a customer owes that a company believes it may not recover. When this occurs, the company deducts the amount from the customer's financial records as an expense. It's in the category of an expense because of the unlikelihood that a company's bad debts may generate any financial gain in the future.
Creating a journal entry is one of the most crucial skills to learn in accounting. Without accurate journal entries, a company's financial statement can be inaccurate. When a transaction occurs within a company, two accounts develop in the opposite direction.
Types of bad debts
There are many types of bad debts to consider, including:
With this type of bad debt, getting a loan back from the borrowers is more straightforward. The reason being the loan is usually rapid, and in a short period, the interest rate on this type of bad debt accumulates quickly. The sooner the borrowers pay off their bad debt, the better off they'll be in the long run with a moneylender, the company. The company may take less time trying to retrieve the money, resulting in the smooth running of the organization because the company's financial position may be better.
This loan is usually for companies dealing with automobiles, like purchasing and selling vehicles. The loans make it easier for companies to get back their money, which they lend out to customers during the purchase of automobiles. It's because of the high depreciation rate on the vehicles because of factors like gas mileage, fuel economy, and warranty length. Depreciation makes it easier for companies to get their loans in time because the additional expenses resulting from depreciation make it hard for borrowers to cater to the additional expenses.
Payday loans are short-term and have high-interest rates. Payday loans are one of the riskiest types of bad debt because of the high-interest rate they accumulate within a short period, making it more expensive to get compared to the other loans. A high-interest rate entices borrowers to make timely payments on their debts to avoid late and service fees, helping organizations avoid bad debts in the long run.
These are loans that an individual can gain from a company for personal expenses. The interest rate on personal loans, like on credit cards, can vary widely depending on the borrower's credit history. The interest rates on loans can range from 5% to 35%. You can pay personal loans in monthly instalments. Companies dealing with a high-interest loan get their loans back in due time because of the high accumulation of the interest within a short time. It makes it easier for the accountants in charge of accounts to record the transactions and less time trying to get the loans back.
Credit card debt
If the borrower completes a financial transaction with a high-interest credit card, the borrower may pay more throughout the transaction. The bad debt isn't the card itself but the borrower's amount to the company. To avoid accruing additional interest, borrowers can exercise self-control in their spending and make timely repayments. Loan sharks pose a serious threat to anyone in need of financial help. People who promise to lend you money without running a credit check are examples of these lenders. Borrowers may face a hefty interest rate. Working with these lenders may violate the law in some states.
These are loans that an individual can gain from a company for personal benefits. The interest rate on personal loans, like on credit cards, can vary widely depending on the borrower's credit history. You can pay personal loans in monthly instalments. Companies dealing with a high-interest loan get their loans back in due time because of the high accumulation of the interest within a short time. It makes it easier for the accountants in charge of accounts to record the transactions and less time trying to get the loans back.
Why is bad debt expense important?
A bad debt expense has several benefits, because it:
Enhances collection: Accounting for bad debt allows you to implement the collection processes. You can get your money back before submitting the report if you do it precisely.
Reflects receivables: You can account for receivables that a company collects during business operations. It's an easier way to keep track of all the accounts in the company.
Ramifications attach: A bad debt expense increases the total expense and decreases the net income. As a result, the accumulation of bad debt expense reports decreased.
Identifies default accounts: You can devise a strategy for dealing with default customer accounts. Once you locate them, it's possible to discover why you haven't been paid, reducing the impact on your financial reports.
Shows financial position: You can lower your accounts receivable by writing off bad debt on your financial statement. An increase in revenue and new business opportunities is a positive sign of a company's financial status.
Improves the accuracy of records: Recording bad debt is critical for ensuring that financial statements are accurate. It's necessary to record this information when reporting taxes, as the law mandates accurate reporting of assets and income.
Appeals to investors: Many investors use the company's financial history and documents to determine whether to invest in or conduct business with the company. They are more likely to consider investing in a company if its expense report contains accurate and encouraging data.
How to use the direct write-off journal method
There are three main steps to using the direct write-off journal method:
1. Record debts on the balance sheet
After determining that a debt is completely unrecoverable, you can record it on the balance sheet. Allowance for doubtful debts and account receivables both have the payments' total amount. The balance sheet enables you to assess your transactions within the period of operation.
2. Try to collect before writing off
Before writing off the company's accounts receivables as bad debts, a company ensures that it has gone through all its options to collect the payments. One of these options is to enlist the help of debt collectors, who have more experience negotiating with and recovering payments from customers who are in arrears. This may result in a positive outcome because the collectors are efficient at their work.
3. Identify the bad debt
An expense journal entry begins with determining which customers owe you money. Look for patterns and sudden shifts in customers' repayment habits. If a long-term customer suddenly can't make a payment, it may indicate a problem with the customer's creditworthiness. You never know when one of your clients may open up to you about their financial problems. In that case, you may want to give them more time before including the debt in the accounts receivable.
Examples of bad debt expense journal entries
Below are examples of journal entries for bad debt expenses:
An example of a bad debt journal entry for a web designer:
Web designers create, code, and plan web services for their clients in their own time and on their own schedule. A long-term client suddenly defaults on an $800 payment. The designer attempts to contact the client to find out why they haven't sent over their payment yet and discovers that the customer's phone number has been out of service for three months. After concluding that they won't receive the payment, the designer records a bad debt to write off the entry:
Account name Debit Credit
Accounts receivable $800
Bad debt expense $800
Total $800 $800
An example of a bad debt journal entry for a luxury dealership:
A luxury dealership with a large customer base sells high-end automobiles. The company has discovered three customers who have failed to make their auto loan payments on time. After attempting to collect the payment through collection agencies and failing to do so, the company records the payment in its book as a bad debt. The three customers owe $20,000, $60,000 and $40,000 in uncollectible debt, totalling $120,000. It could look like this in the journal entry:
Account name Debit Credit
Doubtful debts expense $120,000
Accounts receivable $120,000
Total $120,000 $120,000
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