Definition
An allowance for doubtful accounts is an estimate of how much of a business's accounts receivable will not be collected, recorded as a reduction of receivables on the balance sheet. It lets accrual-basis businesses recognize expected bad debt in the period of the sale rather than waiting for individual invoices to be written off.
Also called: Bad debt reserve, Provision for doubtful debts, Bad debt allowance
Allowance for doubtful accounts in practice
The allowance is usually estimated from history and the aging report, for example 1 percent of current invoices and 25 percent of invoices over 90 days past due. When a specific invoice is confirmed uncollectible, it is written off against the allowance.
Frequently Asked Questions
Do small businesses need an allowance for doubtful accounts?
Businesses preparing accrual-basis financial statements for lenders or investors usually do. Many small businesses on cash-basis accounting simply write off bad debts as they occur.
What is the difference between the allowance method and the direct write-off method?
The allowance method estimates bad debt in advance and records the expense in the same period as the sale. The direct write-off method records the expense only when a specific invoice is confirmed uncollectible, which is simpler but can push the cost into a later period.
Related terms
- Bad debt Bad debt is an invoice amount that a business concludes it will not be able to collect, usually because the client has gone out of business, disappeared, or refuses to pay and legal action is not worthwhile.
- Write-off A write-off is the accounting action of removing an uncollectible or forgiven invoice balance from accounts receivable and recording it as an expense.
- Aging report An aging report is a summary of unpaid invoices grouped by how long they have been outstanding, typically in buckets such as current, 1 to 30 days, 31 to 60 days, 61 to 90 days, and over 90 days past due.
- Accounts receivable Accounts receivable is the total amount of money owed to a business by its clients for invoices that have been issued but not yet paid.
This page is for general information only and is not legal, tax, or financial advice. Rules change and vary by location, so consult a qualified lawyer or accountant about your situation.