A customer has been invoiced a total of 5,000 for goods and the business has decided that there is doubt as to whether the customer can pay in full. They have decided to make an allowance for doubtful accounts of 500 against the accounts receivable balance.
The original invoice would have been posted to the accounts receivable control account, so the balance on the customers account before the allowance for doubtful accounts is 5,000.
An allowance for doubtful accounts is recorded in the bookkeeping records as follows:
Journal Entry for the Allowance for Doubtful Accounts
The accounting records will show the following bookkeeping entries for the bad debt expense.
|Bad debt expense||500|
|Allowance for doubtful accounts||500|
Allowance for Doubtful Accounts Bookkeeping Entries Explained
The bad debt is an expense for the business and a charge is made to the income statement through the bad debt expense account.
The amount owed by the customer is still 5,000 and remains as a debit on the accounts receivable control account. However, the credit above is placed on the allowance for doubtful accounts in the balance sheet to reflect the uncertainty over payment.
The Accounting Equation
The Accounting Equation, Assets = Liabilities + Owners Equity means that the total assets of the business are always equal to the total liabilities of the business. This is true at any time and applies to each transaction. For this transaction the Accounting equation is shown in the following table.
In this case the allowance for doubtful accounts account, which is a contra asset account, is increased by the credit entry. In addition, the income statement has been charged with the bad debt expense, reducing the owners equity.
Note: The expense in the income statement reduces the net income which reduces the retained earnings and therefore the owners equity in the business.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.