What is bad debt expense in accounts receivable?
What is bad debt expense and how do you reduce it?
Short answer
**Bad debt expense** is the cost a business records when it determines that some or all of a receivable is unlikely to be collected. It is an expense on the income statement that reduces net income and reduces the gross accounts receivable balance on the balance sheet.
**Two methods of recognizing bad debt:**
1. **Direct write-off method** — Record the expense only when a specific invoice is deemed uncollectable. Simple but violates the matching principle in GAAP; only acceptable for tax purposes.
2. **Allowance method** — Estimate bad debt at the time of sale using historical data (e.g., "3% of AR will go uncollected"). Creates an "allowance for doubtful accounts" contra-asset. This is the GAAP-required method for financial reporting.
**Journal entry (allowance method):** - Debit: Bad Debt Expense - Credit: Allowance for Doubtful Accounts
When a specific invoice is later written off: - Debit: Allowance for Doubtful Accounts - Credit: Accounts Receivable
**How to calculate your bad debt rate:** Bad debt rate = (Total invoices written off ÷ Total invoices issued) × 100
Industry benchmarks vary: B2B services typically see 1–3%; consumer receivables can run 5–10%.
**How to reduce bad debt:** 1. Verify creditworthiness before extending terms (D&B PAYDEX, trade references) 2. Require deposits from new clients 3. Shorten payment terms for high-risk accounts 4. Start collections activity early (30 days, not 90) 5. Use AI-assisted follow-up to reach more debtors before accounts age past recovery
Every dollar of bad debt reduction goes directly to gross profit — it is one of the highest-ROI activities in AR management.