Bad debt expense is the cost of customer receivables that will not be collected. GAAP does not let a company wait until a specific customer fails; it requires an estimate of expected losses on receivables at the balance sheet date, recorded in an allowance. The expense for the period is the amount needed to bring the allowance to the estimate.
This guide covers the accounting model, the estimation methods, the entries for provision, write-off and recovery, the tax difference and what auditors test. For a deeper treatment of the aging report and CECL loss rates, see accounts receivable aging and the allowance and CECL for private companies.
The accounting model
Under ASC 326-20, entities record an allowance for expected credit losses on financial assets measured at amortized cost, including trade receivables. The estimate covers losses over the contractual life of the asset and reflects historical experience, current conditions and reasonable and supportable forecasts. Assets with similar risk characteristics are evaluated in pools. The allowance is netted against gross receivables on the balance sheet, and the expense is recorded in the income statement.
The old phrase "allowance for doubtful accounts" comes from the incurred-loss model that preceded ASC 326. The current term is allowance for credit losses. For most private companies, ASC 326 took effect for fiscal years beginning after December 15, 2022. ASU 2025-05 lets private companies and certain not-for-profits that apply it assume current conditions persist over the life of current receivables and contract assets when estimating losses, for periods beginning after December 15, 2025.
Methods of estimating
| Method | How it works | Fit under ASC 326 |
|---|---|---|
| Direct write-off | Expense recorded when a specific account is judged uncollectible | Not GAAP for material receivables; matches the tax method |
| Percentage of credit sales | Expense = sales x historical loss percentage | Simple; must reflect expected losses, and the allowance must still be assessed |
| Aging (loss-rate by bucket) | Apply loss rates to each past-due bucket | Common and acceptable when rates reflect history, conditions and forecasts |
| Roll-rate or vintage | Track how balances move through buckets or by origination period | Used where data supports it |
| Specific identification | Individually reserve known problem accounts | Used with a pool method for the rest |
Most small and mid-size clients use an aging method with a specific reserve for known problem accounts. See vintage and roll-rate methods and the CECL loss-rate calculator.
Journal entries
Recording the provision
Illustrative aging at year end:
| Bucket | Balance | Loss rate | Allowance |
|---|---|---|---|
| Current | 400,000 | 1% | 4,000 |
| 1 to 30 days past due | 150,000 | 3% | 4,500 |
| 31 to 60 days | 80,000 | 8% | 6,400 |
| 61 to 90 days | 40,000 | 20% | 8,000 |
| Over 90 days | 30,000 | 50% | 15,000 |
| Total | 700,000 | 37,900 |
Balance check: 400,000 + 150,000 + 80,000 + 40,000 + 30,000 = 700,000. Allowance: 4,000 + 4,500 + 6,400 + 8,000 + 15,000 = 37,900.
The allowance account has a credit balance of 25,000 before adjustment, so the entry brings it to 37,900:
| Account | Debit | Credit |
|---|---|---|
| Bad debt expense (credit loss expense) | 12,900 | |
| Allowance for credit losses | 12,900 |
37,900 - 25,000 = 12,900. Net receivables are 700,000 - 37,900 = 662,100.
Writing off an account
When a specific account is deemed uncollectible, the entry has no effect on income or on net receivables. A customer owing 6,000 is written off:
| Account | Debit | Credit |
|---|---|---|
| Allowance for credit losses | 6,000 | |
| Accounts receivable | 6,000 |
Gross receivables and the allowance both fall by 6,000, so net receivables stay the same.
Recovery of a written-off account
If the customer later pays 1,000, reinstate the receivable and record the collection:
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 1,000 | |
| Allowance for credit losses | 1,000 | |
| Cash | 1,000 | |
| Accounts receivable | 1,000 |
The recovery restores the allowance, which is then reassessed at the next measurement date.
Direct write-off, for comparison
Under direct write-off, the entry is a debit to bad debt expense and a credit to accounts receivable at the time of write-off, with no allowance. Expense lands in the period of write-off, which can be a year or more after the sale. That is why it is not accepted under GAAP when the effect is material.
Tax treatment
For federal income tax, IRC section 166 allows a deduction for debts that become wholly or partly worthless. Most taxpayers use the specific charge-off method, so the deduction follows a write-off rather than the book allowance. An accrual-basis taxpayer can deduct only debts whose underlying income was previously included in gross income. A cash-basis taxpayer has not reported the sale, so there is no bad debt deduction for the unpaid amount.
The result is a book-tax difference: the allowance is deductible for book but not for tax until the specific accounts are written off. It creates a deferred tax asset. See book-tax differences and deferred tax assets and liabilities.
What auditors test
- Aging accuracy. Test the aging by agreeing invoice dates and amounts to the underlying documents. A wrong aging makes every downstream number wrong.
- Subsequent receipts. Examine cash received after year end on aged balances.
- Method and rates. Evaluate whether the pools, loss rates and adjustments for conditions and forecasts are appropriate and supported. Compare prior-year allowance with actual write-offs to see if management's estimate is biased. See auditing accounting estimates.
- Specific accounts. Read customer correspondence, collection history, disputes and bankruptcy filings for large past-due balances.
- Confirmations. Use positive confirmations on significant balances. See audit confirmations.
- Write-offs and credits. Review write-offs and credit memos around year end for approval and period.
- Concentration and related parties. Large customers, related parties and balances with no activity need separate evaluation.
The AR aging and allowance workpaper and aging allowance calculator support this work.
Common mistakes
- Using the same percentages every year without updating for conditions.
- Reserving only for accounts over 90 days and nothing for current balances, although ASC 326 expects expected losses on all receivables.
- Writing off an account against expense instead of against the allowance.
- Letting the allowance drift: a balance that never changes while the aging does.
- Recording recoveries as other income without reinstating the receivable.
- Confusing the book allowance with the tax deduction.
FAQ
What is the difference between bad debt expense and the allowance?
Bad debt expense is the income statement charge for the period. The allowance is the balance sheet account that accumulates expected losses and is reduced by write-offs.
Is the direct write-off method allowed?
Not under GAAP when the effect is material. It is the usual tax method.
Does a write-off change net income?
Not under the allowance method. The write-off reduces gross receivables and the allowance equally.
What is the current term for the allowance for doubtful accounts?
Allowance for credit losses under ASC 326.
How does CECL change bad debt for small companies?
It requires including current conditions and reasonable and supportable forecasts, and recognizing expected losses on all receivables, not only past-due ones. ASU 2025-05 offers a practical expedient for current receivables for private companies.
Sources
- FASB ASC 326-20, Financial Instruments, Credit Losses, Measured at Amortized Cost; EY, Financial reporting developments: Credit impairment (ASC 326), 2026 edition
- FASB ASU 2025-05, Measurement of Credit Losses for Accounts Receivable and Contract Assets (private company practical expedient); KPMG, Effective dates of ASUs (2025 and 2026)
- 26 U.S.C. 166, Bad debts, Cornell LII
- AICPA, AU-C section 540, Auditing Accounting Estimates, and AU-C section 505, External Confirmations
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AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error