Allowance for doubtful accounts

Definition

Allowance for doubtful accounts is a contra-asset account on a company's balance sheet that reduces the total amount of receivables to reflect those expected to be uncollectible. It helps in providing a more accurate picture of a company's financial health by anticipating potential losses from bad debts.

5 Must Know Facts For Your Next Test

1. The allowance for doubtful accounts is estimated based on historical data and management's judgment.
2. This account ensures that the revenue reported on the income statement is more accurately matched with the expenses incurred.
3. Adjusting entries for this allowance are typically made at the end of each accounting period.
4. An increase in the allowance for doubtful accounts will decrease net accounts receivable on the balance sheet.
5. Methods such as percentage of sales and aging of receivables analysis are commonly used to estimate the allowance.

Review Questions

• Why is it important to have an allowance for doubtful accounts?
• How does an increase in the allowance for doubtful accounts affect the balance sheet?
• What methods can be used to estimate the allowance for doubtful accounts?

Related terms

Bad Debt Expense:

Expense recognized when a receivable is deemed uncollectible.

Contra-Asset Account: An account that reduces asset balances, such as accumulated depreciation or allowance for doubtful accounts.

Aging of Receivables: A method used to estimate uncollectible accounts by categorizing receivables based on how long they have been outstanding.