A bad debt is an account receivable that has been clearly identified as not being collectible. This means that a specific account receivable is removed from the accounts receivable account, usually by creating a credit memo in the billing software và then matching the credit memo against the original invoice; doing so removes both the credit memo & the invoice from the accounts receivable report.

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Accounting for a Bad Debt

When you create the credit memo, credit the accounts receivable account và debit either the bad debt expense account (if there is no reserve sầu phối up for bad debts) or the allowance for doubtful accounts (which is a reserve account that is phối up in anticipation of bad debts). The first alternative for creating a credit memo is called the direct write off method, while the second alternative sầu is called the allowance method for doubtful accounts.

Accounting for a Doubtful Debt

A doubtful debt is an tài khoản receivable that might become a bad debt at some point in the future. You may not even be able to lớn specifically identify which open invoice to a customer might be so classified. In this case, create a reserve sầu account (also known as a contra account) for accounts receivable that may eventually become bad debts, estimate the amount of accounts receivable that may become bad debts in any given period, and create a credit to enter the amount of your estimate in this reserve tài khoản, which is known as the allowance for doubtful accounts. The debit in the transaction is to the bad debt expense. When you eventually identify an actual bad debt, write it off (as described above sầu for a bad debt) by debiting the allowance for doubtful accounts & crediting the accounts receivable tài khoản.

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Example of a Bad Debt và Doubtful Debt

ABC International has $100,000 of accounts receivable, of which it estimates that $5,000 will eventually become bad debts. It therefore charges $5,000 to lớn the bad debt expense (which appears in the income statement) and a credit to the allowance for doubtful accounts (which appears just below the accounts receivable line in the balance sheet). A month later, ABC knows that a $1,500 invoice is indeed a bad debt. It creates a credit memo for $1,500, which reduces the accounts receivable tài khoản by $1,500 and the allowance for doubtful accounts by $1,500. Thus, when ABC recognizes the actual bad debt, there is no impact on the income statement - only a reduction of the accounts receivable & allowance for doubtful accounts line items in the balance sheet (which offset each other).

Thus, a bad debt is a specifically-identified tài khoản receivable that will not be paid và so should be written off at once, while a doubtful debt is one that may become a bad debt in the future and for which it may be necessary lớn create an allowance for doubtful accounts.

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