Bad Debt Expense

Let's assume that Company XYZ sells $1,000,000 worth of goods to 10 different customers.  Company XYZ records $1,000,000 in revenue on its income statement and $1,000,000 in accounts receivable on the balance sheet (we are assuming the customers have 60 days to pay). 

Company XYZ discovers that one of its customers, Big Store, is not doing very well. Big Store stops paying its bills and doesn't pay Company XYZ for $100,000 worth of goods. Company is not confident that Big Store will ever pay, so it categorizes the $100,000 as a bad debt. Company XYZ adjusts its balance sheet to show $1,000,000 in accounts receivable and $100,000 in bad debt reserves, for a net accounts receivable of $900,000.

If Company XYZ, in fact, cannot collect the $100,000 (for example, if Big Store is liquidated), Company XYZ will record $100,000 on the income statement as bad debt expense and reduce the bad debt reserves by the same amount. Note that this decreases net income.

If the company is able to collect some of that amount via bankruptcy proceedings or by hiring a company that specializes in bad debt recovery, it may have to reverse some of the bad debt expense in future periods.