What is the accounting treatment for bad debts?

The correct treatment for bad debts in accounting is to write them off as expenses when they are deemed uncollectible. This approach aligns with the accrual basis of accounting, which requires that expenses be recognized in the same period as the revenues they relate to, rather than when cash is received.

When a company determines that a specific account receivable is unlikely to be collected, it can reduce its accounts receivable and simultaneously recognize a corresponding expense on the income statement. This action reflects the economic reality that the company will not receive that expected cash inflow, thereby presenting a more accurate picture of financial performance.

Assessing bad debts usually involves estimating potential losses, which can be done through methods such as the aging of accounts receivable or using a percentage of sales. However, once a bad debt is confirmed as uncollectible, the proper practice is to remove it from assets and acknowledge it as an expense, which ultimately reduces net income for that period.

This treatment emphasizes the importance of presenting financial statements that truly reflect a company’s financial position, ensuring stakeholders have a clear understanding of actual revenue that can be expected.