What is the allowance for doubtful accounts?
Not every customer pays. The allowance for doubtful accounts (also called a bad debt provision or loss allowance) is an estimate of the receivables that will go uncollected. It sits against accounts receivable on the balance sheet:
Net receivables = Accounts receivable − Allowance for doubtful accounts
How to estimate it
- Percentage of sales: apply a historical bad debt rate to credit sales.
- Ageing method: apply higher loss rates to older invoices (for example 1% current, 5% at 60 days, 50% over 120 days).
- Specific identification: provide for named customers in difficulty.
Under IFRS 9, companies use an expected credit loss model, and many small businesses use a simplified provision matrix based on ageing.
Journal entries
- To create or increase the allowance: debit bad debt expense, credit allowance for doubtful accounts.
- To write off a specific invoice: debit allowance, credit accounts receivable (no new expense).
- If a written-off debt is later paid: reverse the write-off, then record the cash receipt.
Example
A business has $80,000 of receivables. Its ageing analysis suggests $3,200 will not be collected. It sets an allowance of $3,200, so net receivables are $76,800.
Why it matters
It stops overstated assets and profits and recognises the cost of offering credit in the same period as the sale.