Allowance for Doubtful Accounts: Estimation and Write-Off Procedures
- Graziano Stefanelli
- Jun 18
- 3 min read
Accounts receivable represent amounts owed to a business by customers, but not all receivables will ultimately be collected. The allowance for doubtful accounts is a critical accounting tool used to estimate and record potential credit losses, ensuring receivables are reported at their net realizable value. This process directly affects reported earnings and reflects a company’s credit risk management practices.
1. The Purpose of the Allowance for Doubtful Accounts
The allowance for doubtful accounts is a contra-asset account that reduces the gross amount of accounts receivable to reflect only the amounts expected to be collected. This approach aligns with the accrual principle and the requirement to present receivables at net realizable value on the balance sheet.
2. Estimation Methods
The estimation of uncollectible receivables is based on management judgment, historical data, and current conditions. The most common methods include:
a) Percentage of Sales Method
A fixed percentage of total credit sales is estimated to become uncollectible, based on historical loss experience.
Example:
Credit sales: $200,000
Estimated uncollectible: 2%
Allowance = $200,000 × 2% = $4,000
b) Aging of Accounts Receivable Method
Accounts receivable are grouped by age (e.g., current, 30 days past due, 60 days, etc.), and different loss rates are applied to each group. Older receivables generally have a higher risk of default.
Example Table:
c) Specific Identification Method
Used when particular accounts are known to be doubtful (e.g., customer bankruptcy).
3. Accounting Entries
a) Recording the Allowance
At period end:
Dr. Bad Debt Expense (Income Statement)
Cr. Allowance for Doubtful Accounts (Balance Sheet, contra-asset)
Example:
Dr. Bad Debt Expense $4,000
Cr. Allowance for Doubtful Accounts $4,000
b) Writing Off Uncollectible Accounts
When a specific account is deemed uncollectible and written off:
Dr. Allowance for Doubtful Accounts
Cr. Accounts Receivable
Example:
A $1,200 receivable is uncollectible:
Dr. Allowance for Doubtful Accounts $1,200
Cr. Accounts Receivable $1,200
c) Recovery of Previously Written-Off Accounts
If a customer pays after write-off:
Dr. Accounts Receivable
Cr. Allowance for Doubtful Accounts
Dr. Cash
Cr. Accounts Receivable
4. Financial Statement Impact
Balance Sheet:Accounts receivable presented net of the allowance for doubtful accounts.
Income Statement:Bad debt expense recorded in the period of estimation, not when written off.
Disclosure:Companies must disclose estimation methods, amounts charged and written off, and significant changes in credit risk.
5. Standards Reference
US GAAP: ASC 326 (Current Expected Credit Losses), ASC 310 (Receivables)
IFRS: IFRS 9 (Financial Instruments)
6. Common Errors and Best Practices
Underestimating credit losses: Leads to overstated assets and income.
Delayed recognition of bad debts: Violates matching and conservatism principles.
Inadequate documentation: Estimation method and assumptions must be documented and supportable.
Failure to reassess allowance regularly: Update estimates with new information and trends.
7. Example: Full Cycle
Set up allowance:
Dr. Bad Debt Expense $5,000
Cr. Allowance for Doubtful Accounts $5,000
Write off $1,200 account:
Dr. Allowance for Doubtful Accounts $1,200
Cr. Accounts Receivable $1,200
Customer unexpectedly pays $600:
Dr. Accounts Receivable $600
Cr. Allowance for Doubtful Accounts $600
Dr. Cash $600
Cr. Accounts Receivable $600
The allowance for doubtful accounts provides a realistic estimate of collectible receivables and ensures that losses are recognized in the same period as the related sales. Proper estimation, regular reassessment, and transparent disclosure are essential for high-quality financial reporting and effective credit risk management.
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