Doubtful Accounts
Question: How can bad debt expense be reported as $32,000 while the allowance for doubtful accounts shows a
balance of only $29,000?
Should those two numbers not always be identical in every set of financial statements?
Answer: In this introductory coverage, the difference in these accounts is assumed to be caused solely by the
failure of previous estimations to be accurate1. Last year, the doubtful accounts expense for this company was
reported as $7,000 but accounts with balances totaling $10,000 proved to be uncollectible. Because companies do
not go back to the statements of previous years to fix numbers when a reasonable estimate was made, the expense
is $3,000 higher in the current period to compensate.
Mechanically, the underestimation still exists in the accounting records in Year Two. It creates the $3,000 debit in
the allowance for doubtful accounts before the expense adjustment. Thus, although the current expense is $32,000
(8 percent of sales), the allowance is reported as only $29,000 (the $32,000 expense offset by the $3,000 debit
balance remaining from the prior year).
Students are often concerned because these two reported numbers differ. However, both are merely estimates. The
actual amount of worthless accounts is likely to be a number somewhat different from either $29,000 or $32,000.
Therefore, the disagreement caused by the lingering impact of the $3,000 Year One underestimation should not
be an issue as long as company officials believe that neither of the reported balances is materially misstated.
