Definition: Allowance for doubtful accounts, also called the allowance for uncollectible accounts, is a contra asset account that records an estimate of the accounts receivable that will not be collected. In other words, it’s an account used to discount the accounts receivablea ccount and keep track of the customers who will probably not pay their current balances.
What Does Allowance For Doubtful Accounts Mean?
What is the definition of allowance for doubtful accounts? The allowance method reduces the carrying value or realizable value of the receivables account on the balance sheet. In other words, this method reports the accounts receivable balance at estimated amount of cash that is expected to be collected. As opposed to the direct write off method, the allowance-method removes receivables only after specific accounts have been identified as uncollectible.
Example
The allowance-method works by first estimating bad debt for the period. Management carefully examines an accounts receivable aging schedule to estimate what amount of each account will be uncollectable. Then a journal entry is made to record the uncollectable balance by debiting bad debt expense and crediting the allowance for bad debt account.
Notice that the accounts receivable account isn’t credited. Instead the allowance account is used to reduce the receivables indirectly. This means that the customer’s balance is still recorded in the receivables account.
Most balance sheets present these two accounts separately by showing the gross AR balance and subtracting the allowances to arrive at the outstanding AR balance. This amount represents the amount of cash management actually expects to collect from its customers. This presentation isn’t required, however. Some financial statements display the net AR balance and report the allowance in note format.
If a specific account has been deemed to be completely uncollectable, for instance a customer declares bankruptcy, the company would record a journal entry to remove the account from the AR account and the allowances account by debiting allowance and crediting accounts receivable.
Summary Definition
Define Allowance For Doubtful Accounts: Allowance for uncollectibles means a method for identifying bad receivables and removing bad debt from the books.
