Allowance for doubtful accounts

Definition

Allowance for doubtful accounts is a contra-asset account used to estimate the portion of accounts receivable that may not be collected. It helps companies present a more accurate picture of their financial position by accounting for potential losses from credit sales.

5 Must Know Facts For Your Next Test

1. The allowance for doubtful accounts is recorded through an adjusting journal entry at the end of an accounting period.
2. It reduces the total accounts receivable on the balance sheet to reflect anticipated uncollectible amounts.
3. The estimation method can be based on either a percentage of sales or an aging analysis of receivables.
4. Bad debt expense is recognized in the income statement and corresponds with the allowance for doubtful accounts on the balance sheet.
5. When specific bad debts are identified, they are written off against the allowance for doubtful accounts, not directly against accounts receivable.

Review Questions

• How does the allowance for doubtful accounts affect the balance sheet?
• What are two methods commonly used to estimate the allowance for doubtful accounts?
• Why is it important to create an allowance for doubtful accounts?

Related terms

Accounts Receivable: Amounts owed to a company by customers who purchased goods or services on credit.

Bad Debt Expense: The expense recognized in the income statement when receivables are deemed uncollectible.

Contra-Asset Account: An account that reduces a related asset account, such as allowance for doubtful accounts reducing accounts receivable.