Allowance for Doubtful Accounts

What Is an Allowance for Doubtful Accounts?

An allowance for doubtful accounts is a contra account that nets against the total receivables introduced on the balance sheet to reflect just the amounts expected to be paid. The allowance for doubtful accounts estimates the percentage of accounts receivable that are expected to be uncollectible. In any case, the genuine payment behavior of customers might vary substantially from the estimate.

Figuring out the Allowance for Doubtful Accounts

Despite company policies and procedures for credit collections, the risk of the inability to receive payment is dependably present in a transaction using credit. Hence, a company is required to understand this risk through the foundation of the allowance for doubtful accounts and offsetting bad debt expense. As per the matching principle of accounting, this guarantees that expenses connected with the sale are kept in a similar accounting period as the revenue is earned. The allowance for doubtful accounts additionally helps companies all the more precisely estimate the genuine value of their account receivables.

Since the allowance for doubtful accounts is laid out in the equivalent accounting period as the original sale, an entity doesn't be aware for certain which definite receivables will be paid and which will default. In this manner, generally accepted accounting principles (GAAP) direct that the allowance must be laid out in a similar accounting period as the sale, however can be founded on an anticipated or estimated figure. The allowance can collect across accounting periods and might be adjusted in light of the balance in the account.

Recording the Allowance for Doubtful Accounts

Two primary methods exist for assessing the dollar amount of accounts receivables not expected to be collected.

Percentage of Sales Method

The sales method applies a flat percentage to the total dollar amount of sales for the period. For instance, in view of previous experience, a company might expect that 3% of net sales are not collectible. On the off chance that the total net sales for the period is $100,000, the company lays out an allowance for doubtful accounts for $3,000 while at the same time reporting $3,000 in terrible debt expense.

Assuming the accompanying accounting period brings about net sales of $80,000, an extra $2,400 is reported in the allowance for doubtful accounts, and $2,400 is kept in the second period in terrible debt expense. The aggregate balance in the allowance for doubtful accounts after these two periods is $5,400.

Accounts Receivable Aging Method

The second method of assessing the allowance for doubtful accounts is the aging method. All outstanding accounts receivable are grouped by age, and specific percentages are applied to each group. The aggregate of all group results is the estimated uncollectible amount.

For instance, a company has $70,000 of accounts receivable under 30 days outstanding and $30,000 of accounts receivable over 30 days outstanding. In view of previous experience, 1% of accounts receivable under 30 days old will be uncollectible, and 4% of those accounts receivable somewhere around 30 days old will be uncollectible.

In this way, the company will report an allowance of $1,900 (($70,000 * 1%) + ($30,000 * 4%)). Assuming the next accounting period brings about an estimated allowance of $2,500 in view of outstanding accounts receivable, just $600 ($2,500 - $1,900) will be the adjusting entry amount.

Features

• The percentage of sales method and the accounts receivable aging method are the two most common ways of assessing uncollectible accounts.
• The allowance is laid out in a similar accounting period as the original sale, with an offset to terrible debt expense.
• The allowance for doubtful accounts is a contra account that records the percentage of receivables expected to be uncollectible.