the allowance for doubtful accounts is a contra asset account that equals:

The company would then write off the customer’s account balance of $10,000. You should review the balance in the allowance for doubtful accounts as part of the month-end closing process, to ensure that the balance is reasonable in comparison to the latest bad debt forecast. For companies having minimal bad debt activity, a quarterly update may be sufficient. If a company uses the contra account Accumulated Amortization, this account will typically be shown on the balance sheet. An allowance for bad debt is a valuation account used to estimate the amount of a firm’s receivables that may ultimately be uncollectible. A Pareto analysis is a risk measurement approach that states that a majority of activity is often concentrated among a small amount of accounts.

An allowance is therefore established to estimate the value of those receivables believed to be uncollectible. This entry should be recorded so the income statement and balance sheet are fairly stated at the amount expected to be collected in receivables, thus satisfying the matching principle 1 . When netted against the gross total of accounts receivable, the true value of the receivables is reported. Allowance for uncollectible accounts is a contra asset account on the balance sheet representing accounts receivable the company does not expect to collect. When customers buy products on credit and then don’t pay their bills, the selling company must write-off the unpaid bill as uncollectible. Allowance for uncollectible accounts is also referred to as allowance for doubtful accounts, and may be expensed as bad debt expense or uncollectible accounts expense.

Financial and Managerial Accounting

The allowance represents management’s best estimate of the amount of accounts receivable that will not be paid by customers. It does not necessarily reflect subsequent actual experience, which could differ markedly from expectations. If actual experience differs, then management adjusts its estimation methodology to bring the reserve more into alignment with actual results. In accrual-basis accounting, recording the allowance contra asset account for doubtful accounts at the same time as the sale improves the accuracy of financial reports. The projected bad debt expense is properly matched against the related sale, thereby providing a more accurate view of revenue and expenses for a specific period of time. In addition, this accounting process prevents the large swings in operating results when uncollectible accounts are written off directly as bad debt expenses.

  • The balance in the allowance for doubtful accounts is used to find out the dollar value of the current accounts receivable balance that is deemed uncollectible.
  • Estimates bad debt expenses based on the balance in accounts receivable, but it also considers the uncollectible time period for each account.
  • Upon review of your Allowance for Doubtful Accounts the balance may be significantly higher or lower than the actual amount of uncollectible invoices.
  • Accounts receivable is reported on the balance sheet; thus, it is called the balance sheet method.
  • Subsidiary ledgers can be utilized in connection with any general ledger account where the availability of component information is helpful.
  • Bad debts should be $400 on the basis of the aging of Accounts Receivable.

The seller undertakes the write off in the interest of accounting accuracy, but the customer is still liable for the debt. The seller retains every right to pursue payment by other legal means, such as engaging a collection service or filing a lawsuit. Secondly, the seller may recognize the debt as a bad debt expense and write off the debt. Contra accounts are used to help a company report the original amount of a transaction as well as reductions that may have happened.

How Do You Record the Allowance for Doubtful Accounts?

While assets have natural debit balances and increase with a debit, contra assets have natural credit balance and increase with a credit. The percentage of sales method and the accounts receivable aging method are the two most common ways to estimate uncollectible accounts. When customers don’t pay you, your bad debts expenses account increases.