Accounts Receivable and Bad Debts: Managing What Customers Owe You
Accounts receivable (AR) represents money owed by customers who have received goods or services but haven’t yet paid. Managing AR effectively is critical — outstanding receivables are only valuable if they’re actually collected.
Recording a Credit Sale
Sold goods worth $50,000 on 30-day credit terms:
Dr. Accounts Receivable $50,000
Cr. Sales Revenue $50,000When customer pays $50,000:
Dr. Cash $50,000
Cr. Accounts Receivable $50,000
The Ageing Schedule
An AR ageing schedule categorises outstanding invoices by how long they have been outstanding:
| Age Bucket | Amount | Est. Uncollectible % | Provision |
|---|---|---|---|
| 0–30 days | $100,000 | 1% | $1,000 |
| 31–60 days | $40,000 | 5% | $2,000 |
| 61–90 days | $15,000 | 15% | $2,250 |
| Over 90 days | $8,000 | 40% | $3,200 |
| Total | $163,000 | $8,450 |
Allowance for Doubtful Debts (Bad Debt Provision)
Under the matching principle, bad debt expense should be recorded in the same period as the related revenue — even before any specific customer is confirmed as defaulting. The allowance method creates an estimate based on historical experience:
Dr. Bad Debt Expense $8,450
Cr. Allowance for Doubtful Debts $8,450
(A contra-asset account that reduces AR on the balance sheet to its net realisable value)
Writing Off a Specific Bad Debt
When a specific debtor’s account is confirmed uncollectible (say $5,000):
Dr. Allowance for Doubtful Debts $5,000
Cr. Accounts Receivable $5,000
(This does NOT affect the income statement — the expense was already recorded when the provision was created.)
Lesson Summary
- AR is money owed by customers; manage it via an ageing schedule.
- The allowance method estimates bad debt expense in the same period as the sale (matching principle).
- Writing off a debt uses the allowance — it does not create a new expense at the time of write-off.
The Credit Sales Cycle: From Invoice to Collection
| Step | Event | Journal Entry |
|---|---|---|
| 1. Sale on credit | Customer purchases $5,000 of goods; payment due in 30 days | Dr Accounts Receivable $5,000 / Cr Revenue $5,000 |
| 2. Partial payment | Customer pays $3,000 | Dr Cash $3,000 / Cr Accounts Receivable $3,000 |
| 3. Full collection | Customer pays remaining $2,000 | Dr Cash $2,000 / Cr Accounts Receivable $2,000 |
| 3B. Bad debt | Customer declares bankruptcy; $2,000 is uncollectible | Dr Bad Debt Expense $2,000 / Cr Allowance for Doubtful Accounts $2,000 |
| 4. Write-off | Formal removal of uncollectible balance | Dr Allowance for DA $2,000 / Cr Accounts Receivable $2,000 |
Allowance Method: Three Estimation Approaches
| Approach | How It Works | Best For | Example |
|---|---|---|---|
| % of Sales | Multiply total credit sales by historical bad debt rate | Companies with stable credit patterns | 2% × $500,000 sales = $10,000 expense |
| % of AR (Flat) | Multiply total AR by one rate | Simple businesses | 3% × $200,000 AR = $6,000 target allowance |
| Aging Schedule | Apply different rates to AR by age bucket | Businesses with varied customer payment history | Current 1%, 31–60 days 5%, 61–90 days 15%, 90+ days 40% |
Aging Schedule Example: Horizon Events
| Age Bucket | AR Balance | Est. Uncollectible % | Estimated Bad Debt |
|---|---|---|---|
| 0–30 days | $80,000 | 1% | $800 |
| 31–60 days | $35,000 | 5% | $1,750 |
| 61–90 days | $15,000 | 15% | $2,250 |
| Over 90 days | $8,000 | 40% | $3,200 |
| Total | $138,000 | $8,000 |
On the balance sheet, Accounts Receivable appears at its net realizable value: AR balance minus the Allowance for Doubtful Accounts. This is the amount the company actually expects to collect — a more honest figure than the gross balance.
Accounts Receivable & Bad Debts Worksheet — Download, print, and complete to reinforce this lesson.