Why and How to Budget for Bad Debts?

WHY?
There needs to be an understanding for the reason to include bad debt expense in the budget.  Assessment income in the annual budget assumes that all monies will be collected. Thus, if there are 100 units paying $250 per month for twelve months, the assessment income on the budget will be $300,000 (100 x $250 x12). However, the reality is that not all unit owners will pay their assessments and all assessment income will not be collected.    Thus, budgeted assessment income needs to be reduced for the amount that potentially will not be collected. This is done through a budget expense line item titled “Bad Debt Expense”.

Budgeting for bad debt expense can be difficult.  However, without a budget line item for these monies that may not be collected, the association could find itself in a cash shortfall in the upcoming year. It is recommended that the estimate be conservative – that is, estimate more bad debt rather than less. If the association collects more money than expected this can be adjusted in the following year’s budget or used for other budget line items that fall short.

HOW?
How does a manager and/or Board determine how much to budget for bad debt expense? This is a very subjective process and varies from association to association and from year to year. Here are a few suggestions to consider:

• Look to the prior years. Is there an average amount that seems to be written off each year? While this is not typical for most associations in some cases you can use bad debt write-off history to base the current year’s estimation.

• Look to local averages. Is there a percentage that seems reasonable based on other associations in the area? Again, this is not useful for most associations; however, it may give an estimate when other methods fail. Depending on the facts and circumstances in a particular association 3-5% of annual assessment income seems to be the suggested minimum.

• Look to the actual past due unit owner balances. What amounts appear to be reasonably collectable? This is the most accurate prediction to use. This takes more effort to research the current collection status of the most delinquent unit owners and to estimate the amount that can reasonably be collected by the association. List out the delinquent account balances. Then consider basing the bad debt estimate based on one of these two methods:
• Estimate actual dollar amounts to be written off by unit owner account.
• Estimate percentages  by unit owner account using the following: Fully collectible = 0% bad debt; potentially uncollectible 50% bad debt; very unlikely to be collected = 100% bad debt

Reminder – for condominiums it may be possible that the association will collect six months of assessments. The bad debt estimate can be reduced by this amount.