The most prevalent approach — called the “percent of sales method” — uses a pre-determined percentage of total sales assumption to forecast the uncollectible credit sales. The actual payment behavior of customers, or lack thereof, can differ from management estimates, but management’s predictions should improve over time as more data is collected. The first entry reverses the bad debt write-off by increasing Accounts Receivable (debit) and decreasing Bad Debt Expense (credit) for the amount recovered. The second entry records the payment in full with Cash increasing (debit) and Accounts Receivable decreasing (credit) for the amount received of $15,000.

• Though this allowance for doubtful accounts is presented on the balance sheet with other assets, it is a contra asset that reduces the balance of total assets.
• You only have to record bad debt expenses if you use accrual accounting principles.
• In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000.
• With the account reporting a credit balance of $50,000, the balance sheet will report a net amount of $9,950,000 for accounts receivable.
• For example, a customer takes out a $15,000 car loan on August 1, 2018 and is expected to pay the amount in full before December 1, 2018.

The allowance for doubtful accounts, aka bad debt reserves, is recorded as a contra asset account under the accounts receivable account on a company’s balance sheet. It’s a contra asset because it’s either valued at zero or has a credit balance. In this context, the contra asset would be deducted from your accounts receivable assets and considered a write-off. An allowance for doubtful accounts, or bad debt reserve, is a contra asset account (either has a credit balance or balance of zero) that decreases your accounts receivable.

Understanding the Allowance for Doubtful Accounts

Companies technically don’t need to have an allowance for doubtful account. If it does not issue credit sales, requires collateral, or only uses the highest credit customers, the company may not need to estimate uncollectability. Those who are struggling with recording contra accounts may benefit from utilizing some of the best accounting software currently available.

The balance sheet method is another simple method for calculating bad debt, but it too does not consider how long a debt has been outstanding and the role that plays in debt recovery. In order to balance the journal entry, a debit will be made to the bad debt expense for $4,000. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month.

What Is a Contra Account?

The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account. Contra accounts are used to reduce the value of the original account directly to keep financial accounting records clean. The desired $6,000 ending credit balance in the Allowance for Doubtful Accounts serves as a “target” in making the adjustment. At the end of year 20, the car and the accumulated depreciation accounts will be written off from the balance sheet, as the car will be a fully depreciated asset. Sometimes, both accounts can be written in a single line if they don’t represent a large portion of the assets. In case the CA account is not listed in the balance sheet, it must be listed in the footnotes of the financial statement for the users to be informed.

All categories of estimated uncollectible amounts are summed to get a total estimated uncollectible balance. That total is reported in Bad Debt Expense and Allowance for Doubtful Accounts, if there is no carryover balance from a prior period. If there is a carryover balance, that must be considered before recording Bad Debt Expense. The balance sheet aging of receivables method is more complicated than the other two methods, but it tends to produce more accurate results. For example, say a company lists 100 customers who purchase on credit and the total amount owed is $1,000,000. The $1,000,000 will be reported on the balance sheet as accounts receivable.

How to Calculate Straight Line Depreciation

In Exhibit 1, the aging schedule shows that the older the receivable, the less likely the company is to collect it. The most common contra equity account is called “treasury stock.” This special account decreases the Running Law Firm Bookkeeping: Consider the Industry Specifics in the Detailed Guide number of shares outstanding in the market because the company repurchases some of the shares from its buyers. Therefore, it reduces the value of shareholders’ equity by the amount paid for those repurchased stocks.