It's a sad but inevitable fact of business that occasionally a deadbeat customer won't pay a bill. As a business owner, you record and track in accounts receivable, or A/R, the money owed you for sales. When a customer fails to pay up and you don't expect the money in the future, you must write off the loss in A/R so you don't overstate the value of this current asset.
The easiest way to handle the journal entries for a bad debt is to directly charge A/R when you decide to write off the debt. Normally, you reach this decision several months after the original sale. The write off journal entry comprises a debit to the bad debt expense account and a credit to A/R for the amount of the write-off. If you're making a write off entry in SAP, the your software should provide account aging reports that show you how long bills remain unpaid. You might decide to write off accounts after a certain time interval – for example 90 days.
You can also use the provision method of accounting to write off bad debts, reports Accounting Tools. This is a two-step process in which you first estimate and recognize the bad debt you'll experience in the upcoming period and then later write off the account. In the first step, you enter a debit to the bad debt expense account and a credit to the provision for bad debt account for your total estimated bad debt losses for the period. The provision account is a contra-asset linked to A/R; it normally has a credit balance that reduces the net value of A/R.
Advertisement Article continues below this adUnder the provision method, when you determine that a customer is unlikely to pay, you enter a debit to the provision for bad debt account and a credit to A/R for the written-off amount. This equally reduces the balances in A/R and the provision account, thereby leaving the net value of A/R unchanged. You don't enter an expense at the time of the write-off, because you already recognized the expense when you credited the provision account at the start of the period.
Generally accepted accounting principles, or GAAP, favor the provision method. As Accounting Tools reports, one tenet of GAAP is the matching principle, which states that you should recognize an expense associated with revenue in the same period that you recognize the revenue. The direct method creates a timing mismatch between revenue and expense that distorts the actual economic performance of your company in two periods – the period of the sale and that of the write-off. If you find you've underestimated the period's provision for bad debt, you can make additional journal entries at any time to increase the size of the provision.