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L.6 · INTERMEDIATE · 2 MIN

Bad Debts: When Customers Don't Pay

When a company sells on credit, some customers will never pay. GAAP requires estimating these losses upfront using the Allowance Method, rather than waiting for default.

Quiz · 5 questions ↓

Formula

Bad Debt Expense = Receivables x Estimated Default Rate

Key point

Watch for companies that suddenly lower their bad debt estimates to boost earnings. If receivables are growing faster than revenue, collection problems may be hiding.

Key insight

Days Sales Outstanding (DSO) is the investor's check on receivables quality. Rising DSO means it takes longer to collect, which may signal deteriorating customer creditworthiness.

Check-in

Company's accounts receivable ages: 0-30 days $50M, 31-60 days $20M, 61-90 days $10M, 90+ days $15M. Last year the bad-debt allowance was 3% of total A/R. What's a disciplined current allowance?
Check your understanding

Sit with the ideas.

AFDA had a beginning balance of $45,000. During the year, the company recorded bad debt expense and wrote off $12,000 of uncollectible accounts. The ending AFDA balance is $51,000. What was bad debt expense for the year?

Why:
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Other lessons in this course.

  1. 01Accrual vs Cash Accounting
  2. 02Depreciation: Spreading the Cost of Assets
  3. 03Stock-Based Compensation: The Hidden Cost
  4. 04Adjusting Entries: Why Period-End Matters
  5. 05Revenue Recognition: The ASC 606 Five-Step Model
  6. 06Bad Debts: When Customers Don't Pay— reading now
  7. 07Inventory: FIFO vs. LIFO and Why It Matters
  8. 08PP&E Deep Dive: Four Depreciation Methods and Asset Disposal
  9. 09The Cash Flow Statement: Follow the Actual Money
  10. 10DuPont Analysis: Decomposing Return on Equity
  11. 11EPS and Dilution: The Most Watched Number on Wall Street
  12. 12Deferred Taxes: Why Tax Expense Differs from Taxes Paid
  13. 13Lease Accounting: The Hidden Debt That Isn't So Hidden Anymore
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