Balance sheet approach to bad debt explained, including how it works, formulas, examples, GAAP compliance, and comparison with the income statement method.
Shyam Agarwal 
Managing bad debt is essential for maintaining accurate and reliable financial statements for your company. One of the most widely used methods for estimating uncollectible accounts is the balance sheet approach to bad debt.
This method helps businesses predict future credit losses based on the accounts receivable balance, ensuring that financial statements comply with GAAP and accurately reflect the company’s financial health.
In this guide, you’ll learn:
The Balance Sheet Approach to bad debt is an accounting method that estimates uncollectible customer invoices based on the Accounts Receivable (AR) balance. It ensures that the Allowance for Doubtful Accounts (ADA) on the balance sheet is accurate.
Instead of analyzing past credit losses in relation to sales, this method examines the amount of accounts receivable expected to become uncollectible.
The goal is to determine the correct ending balance of the Allowance for Doubtful Accounts.
To understand bad debt calculations, it is important to know what is the normal balance side of accounts receivable. Accounts receivable normally carries a debit balance, meaning it increases when credit sales are recorded and decreases when customers pay. The balance sheet approach relies on this debit balance to estimate how much of receivables may not be collected.
The balance sheet approach uses one of two methods:
A fixed percentage (based on historical data) is applied to the ending AR balance.
Formula:
Bad Debt Expense = (Desired Allowance for Doubtful Accounts) – (Existing Allowance Credit Balance)
Invoices are categorized by age (e.g., 0–30 days, 31–60 days, 61–90 days, 90+ days).
Older receivables have higher uncollectible percentages.
Formula:
Allowance for Doubtful Accounts = Σ (Accounts Receivable by Age × Estimated Uncollectible %)
This method better reflects actual customer payment behavior and risk.
Banks, lenders, and auditors prefer this method because it provides a realistic estimate of uncollectible amounts based on current receivables not past revenue.
The balance sheet approach plays a key role in presenting accounts receivable on financial statements accurately. By adjusting the allowance for doubtful accounts, companies ensure receivables are shown at their expected collectible value. This improves transparency for management, auditors, lenders, and investors reviewing the company’s financial position.
| Age Category | AR Balance | Estimated % Uncollectible | Expected Bad Debt |
| 0–30 days | $100,000 | 1% | $1,000 |
| 31–60 days | $50,000 | 5% | $2,500 |
| 61–90 days | $20,000 | 15% | $3,000 |
| 90+ days | $10,000 | 40% | $4,000 |
Total Allowance Required:
$1,000 + $2,500 + $3,000 + $4,000 = $10,500
If the existing ADA balance is $6,000, then:
Bad Debt Expense = $10,500 – $6,000 = $4,500
This $4,500 is recorded on the income statement.
Many readers ask, does accounts receivable go on income statement reporting. Accounts receivable itself does not appear as a separate line on the income statement. Instead, bad debt expense is recorded there, while accounts receivable remains on the balance sheet, adjusted through the allowance for doubtful accounts.
| Feature | Balance Sheet Approach | Income Statement Approach |
| Focus | Accounts Receivable | Credit Sales |
| Purpose | Estimate ending Allowance balance | Estimate current period bad debt expense |
| Accuracy | High | Moderate |
| Common Use | GAAP reporting, audits | Quick estimates |
| Preferred By | Auditors, AR teams, lenders | Small businesses |
The balance sheet method is more accurate and is the standard for large companies.
Bad debt does not appear as a separate line.
Instead:
minus
This results in:
Net Accounts Receivable (the amount expected to be collected)
A common misunderstanding is whether is accounts receivable a liability. Accounts receivable is not a liability because it represents money customers owe to the business. Liabilities reflect obligations the company must pay, while accounts receivable represents future cash inflows, which is why it is treated as an asset.
The Balance Sheet Approach to bad debt is one of the most reliable methods for estimating uncollectible accounts. By focusing on the accounts receivable balance and applying realistic percentages, businesses obtain an accurate Allowance for Doubtful Accounts and a clearer picture of collectible revenue.
It ensures compliance, improves financial accuracy, and strengthens credit risk management, making it the preferred method for modern accounts receivable teams.
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