e.g. percentage of net credit sales : two years ago of $1000 net credit sales, $50 was uncollectable, and last year net credit sales was $2000 , and an allowance of 5% was made for bad debts , so the bad debts allowance for this period is $100.
e.g. ageing of accounts receivables : overdue accounts receivable was divided into periods of 0-30 days, 30-60 days, 60-90 days, 90-180 days, and the amounts that were never paid that were due in each period was divided by the amounts that were eventually collected for each period, giving a predictably increasing percentage of bad debts , the longer the amounts were overdue e.g. 2% at 0-30 days, 4% at 30-60 days, 20% at 60-90 days, 40% at 90-180 days.
The allowance for bad debts is an estimate of how much of a period's reported accounts receivables will eventually be not collectible, and is an attempt to predict that a bad debt has occurred , which of course , is only known for sure when the bad debt has to be written off, which will occur a long time after the credit sale is made.
Hence, at the end of a reporting period, when reporting the accounts receivables , a bad debts expense is reported for that same period, which is equal to the allowance that is made with either of the 2 methods The account , allowance for bad debts, is then a contra-asset account vs. accounts receivables asset account, and is hence increases with a contra to a debit ( for asset accounts), so is increased by a credit. Hence the recording should be,
bad debts expense - debit
allowance for bad debts - credit ( the custom is to show debit lines above credit lines).
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