If your company uses "cash" basis accounting, you don't need to worry about accounting for "bad debts" because you record income only when you receive a payment from your customer. However, if your company uses "accrual" basis accounting you record income when the sale is made to your customer. If you are like most businesses, you know that a certain of your accounts will not be collectable. If you set up an allowance for bad debts, your company's books and records will be more accurate. Here is a glossary of "bad debt" accounting terms.

Accounts receivable. Money due from your customers. Your accounts receivable balance equals the dollar amount of sales that you have made to your customers on credit terms but that have not yet been paid. The accounts receivable balance is an asset of your company.

Allowance for bad debts. Your best guess at how much of your accounts receivable will not be collectable. In other words, your best guess at how much of your accounts receivable will be "bad debts." An "allowance for bad debts" account is kind of like a savings account for bad debts. Your company puts money into it on a periodic basis (usually monthly) as an expense of the company. When you decide that a particular account is not collectable, you tap the allowance for bad debts account to pay for the bad debt. Because you already made the allowance for bad debts, your profit and loss statement will not be out of whack in the particular month that you decide to "write-off" a particular account. Your company's accounting entries to "write off" a $500 account that you have decided is not collectable would look something like this: a debit to your allowance for bad debts account in the amount of $500 and a credit to your accounts receivable account for $500.

Bad debt. An account that is not collectable.

Bad debt expense. An expense account that reflects the amount of your company's accounts that are not collectable, that is the amount of your company's accounts that are "bad debts." A "bad debt expense" account is an expense account of your company. A typical company makes an estimate as to how much it has in bad debts on a periodic (usually monthly) basis. For example, your company estimates that it has about $1,200 per year in accounts that are not collectable. Your company would make the following accounting entries each month: a debit to your "bad debt expense" account in the amount of $100, and a credit to your "allowance for bad debts" account in the amount of $100. When you actually decide that a particular debt is not collectable, you would not make an entry to the "bad debt expense" account. Instead, you would debit your company's "allowance for bad debts" account for the amount of the bad debt and credit your accounts receivable account for that amount.

Bad debt recovery. An account that you "wrote-off" as not collectable, but that was later paid by the customer. When this happens, you must adjust your accounts. Your company's adjusting entries would look something like this: A debit to accounts receivable in the amount of $500 and a credit to allowance for bad debts in the amount of $500; and a debit to cash in the amount of $500 and a credit to accounts receivable in the amount of $500.