A company ages its accounts receivables to determine its end of period adjustment for bad debts. At the end of the current year, management estimated that $43,625 of the accounts receivable balance would be uncollectible. Prior to any year-end adjustments, the Allowance for Doubtful Accounts had a credit balance of $3,665. What adjusting entry should the company make at the end of the current year to record its estimated bad debts expense?

The required adjusting entry to record estimated bad debts expense is as follows:

Debit Bad Debts Accounts with $39,960

Credit Allowance for Doubtful Accounts with $39,960

Being the adjustment to bring the Allowance for Doubtful Accounts up a new credit balance of $43,625.

Explanation:

The Allowance for Doubtful Accounts had a credit balance of $3,665.  Since management had estimated that $43,625 of the Accounts Receivable balance would be uncollectible, this means that the difference $39,960 ($43,625 - $3,665) would be the adjusting amount to bring the balance up-to-date.

Remember that the Allowance for Doubtful Accounts is a contra account to the Accounts Receivable.  It is used to reduce the balance of the Accounts Receivable based on collectibility judgement or estimate which management makes out of experience.  The balance in this account is, therefore d,educted from the Accounts Receivable in the Balance Sheet in order to obtain the net Accounts Receivable balance.

The account that expenses the increase in this account is the Bad Debts Expense Account, which is taken to the Income Statement to reduce the income.