Bad debt: the allowance, the write-off and the tax return
Northwind's allowance from its year-end aging, the write-off when a customer fails, why the tax return waits for the write-off, and how a credit note, a refund and a write-off differ.
Some customers won't pay. US GAAP asks you to say so before it happens. Northwind's September close booked an allowance for credit losses of $160 on a receivable nobody was late on (AJE-5, from the adjusting entries lesson). That's the current expected credit loss model: expected losses over a receivable's life, from the day it's booked.
Northwind expects to lose 2% of what customers owe it: $160.
| Account | Debit | Credit |
|---|---|---|
| 6600Bad debt expense | 160.00 | |
| 1290Allowance for credit losses | 160.00 | |
| Balanced | 160.00 | 160.00 |
Nothing is overdue, and an allowance is still required: the current expected credit loss model asks for the losses expected over a receivable's whole life from the day it is booked, not for losses that have already happened. With no history of its own, Northwind estimates from its trade's experience. The credit goes to a contra account rather than to the receivable, because no customer has defaulted — the invoice is still owed in full, and the balance sheet shows both what is owed and what is expected to arrive.
September's estimate.
December 31: the allowance from the aging
ASC 326 doesn't prescribe a method. An aging schedule with a loss rate per bucket is one the standard names. Northwind's rates are its own estimate, built from what its trade loses and adjusted for what it knows about its customers. Older buckets carry more.
The allowance already holds $160, so the entry is the difference: $1,295 of bad debt expense. Net receivables on the balance sheet are $21,445. For the year, bad debt expense is $1,455, and not one invoice has been written off.
True the allowance up to the aging's requirement.
| Account | Debit | Credit |
|---|---|---|
| 6600Bad debt expense | 1,295.00 | |
| 1290Allowance for credit losses | 1,295.00 | |
| Balanced | 1,295.00 | 1,295.00 |
January: Kestrel goes under
In January 2027 Kestrel Fitouts files for bankruptcy and Northwind expects nothing from its $2,400 invoice. It's written off against the allowance. Both lines are on the balance sheet, so the write-off doesn't touch profit. The loss was expensed when it was expected.
Write off Kestrel's INV-1002 against the allowance.
| Account | Debit | Credit |
|---|---|---|
| 1290Allowance for credit losses | 2,400.00 | |
| 1200Accounts receivable (INV-1002) | 2,400.00 | |
| Balanced | 2,400.00 | 2,400.00 |
The allowance held $1,455 for the whole book and Kestrel alone took $2,400, so it's now $945 short. Nothing is restated. The next estimate tops the allowance back up, and the shortfall reaches expense in the period the estimate changed. If the trustee later pays something, that's a recovery: reinstate the receivable against the allowance, then apply the cash.
Allowance method
- Good at
- The loss lands in the period of the sale
- Receivables shown at what's expected to be collected
- Watch for
- An estimate to make and defend every period
- Its own schedule to keep
- Best for
- US GAAP statements: an audit, a lender, a priced round
Direct write-off
- Good at
- No estimate
- Matches how the tax deduction works
- Watch for
- Not GAAP where expected losses are material
- Overstates receivables until the customer fails
- Best for
- The tax return, and books where losses are immaterial
The tax return doesn't follow the allowance. Federal tax deducts a bad debt only in the year a specific debt becomes worthless, so Northwind's book expense and its deduction land in different years. The page below works it.
Credit note, refund or write-off
Pages in this lesson
1 page goes deeper, about 5 minutes in all. Read them in order, or open the one you need.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Background reading explains; it is never the authority for a rule. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 326-20-30-1 (opens in a new tab)The allowance presents receivables at the amount expected to be collectedFree after registration
- ASC 326-20-30-3 (opens in a new tab)An aging schedule is an accepted way to estimate the allowanceFree after registration
- ASC 326-20-35-8 (opens in a new tab)Write-offs come out of the allowance; recoveries are recorded when receivedFree after registration
- ASC 326-20-30-10C (ASU 2025-05) (opens in a new tab)A practical expedient for the allowance on current receivablesFree after registration
- ASC 606-10-32-10 (opens in a new tab)Cash expected to be refunded is a refund liability, not revenueFree after registration
- Background reading — not an authority
- Wikipedia, “Bad debt” (opens in a new tab)Bad debtFree to read
- Wikipedia, “Credit note” (opens in a new tab)Credit noteFree to read
The full map is in US GAAP, and where these rules come from.
The words this lesson teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Allowance for credit lossesThe contra-asset holding the expected credit losses on receivables, so AR is presented at the amount expected to be collected
- CECLCurrent expected credit losses — the ASC 326 model that books lifetime expected losses from day one using history, current conditions and reasonable forecasts. ASU 2025-05 adds a practical expedient for current AR and contract assets
- Bad debt expenseThe P&L charge that builds the allowance for credit losses — the provision, not the write-off
- Write-offRemoving an uncollectible receivable against the allowance for credit losses — under the allowance method it has no P&L effect; the expense was taken in the provision
- Direct write-off methodCharging a receivable to bad debt expense only when it is judged uncollectible, with no allowance. Not GAAP where expected credit losses are material; the federal tax rule works the same way (specific charge-off)
- Bad debt recoveryCash collected on a receivable already written off. Under GAAP it is recorded when received: reinstate the receivable against the allowance, then apply the cash. For tax, recovering an amount previously deducted is generally income
- Credit noteA reduction of what a customer owes
- RefundReturning cash already received
In the founder glossary
This lesson’s ideas, explained for the founder running the company. Each has an entry in the founder glossary.
See also
- Order to cash (AR)The receivables stack from quote to revenue: quote → order → fulfillment → invoice → collection → cash application → revenue.
- Journal entry for bad debt expenseUnder the allowance method, at each period-end debit Credit loss expense (bad debt expense) and credit Allowance for credit losses for the amount needed to bring the allowance to the expected loss on open receivables.
- Journal entry for writing off accounts receivableTo write off an uncollectible invoice under the allowance method, debit Allowance for credit losses and credit Accounts receivable. If the customer later pays, reinstate the receivable (debit Accounts receivable, credit Allowance) and record the cash.
- Journal entry for a customer refundTo refund a paid invoice, issue a credit note (debit Sales returns and allowances, credit Accounts receivable), then pay the refund (debit Accounts receivable, credit Cash).
- Bad debt expense vs write-offBad debt expense hits the P&L when the allowance for expected credit losses is built. A write-off comes later: it removes one specific invoice from receivables against that allowance and leaves the P&L alone.
- Bad debt and write-offs: allowance vs direct methodHow to book a customer who won’t pay: the GAAP allowance under ASC 326, the direct write-off the IRS requires, and what to do if the money comes back.
- AllowanceRollForwardWith the methodology shown, not just the number.
- AgingTableAR/AP buckets, 0-30-60-90+.
- CreditNoteFormDistinct from a refund and from a write-off.