Allowance for Doubtful Accounts

Customers owe the business money, but not all of it will arrive. Rather than waiting until a specific customer fails to pay, the business estimates the likely loss in advance and records it as an allowance, sometimes called a provision.

The allowance sits on the balance sheet as a deduction from accounts receivable. If receivables are 150,000 and the allowance is 7,500, the net amount shown is 142,500, which is the amount the business expects to collect.

Estimates are usually based on past experience and on how overdue each debt is. Older debts are less likely to be paid, so a business might apply a small percentage to invoices under 30 days old and a much larger percentage to those more than 90 days overdue.

When a particular debt is finally confirmed as uncollectable, it is written off against the allowance. This approach follows the matching principle, because the expected loss is recorded in the same period as the sales that caused it.