The Allowance for Doubtful Accounts

Allowance

1.The allowance for doubtful accounts is a reduction of the total amount of accounts receivable appearing on a company’s balance sheet, and is listed as a deduction immediately below the accounts receivable line item

2.The allowance for doubtful accounts represents management’s best estimate of the amount of accounts receivable that will not be paid by customers. 


3.The allowance for doubtful accounts is a balance sheet accounts that reduces the reported amount of accountants receivable.however, it is not acceptable for income tax reporting

Estimation Techniques for the Allowance for Doubtful Accounts

There are several possible ways to estimate the allowance for doubtful accounts, which are:

• Risk classification. Assign a risk score to each customer, and assume a higher risk of default for those having a higher risk score. 

• Historical percentage. If a certain percentage of accounts receivable became bad debts in the past, then use the same percentage in the future. This method works best for large numbers of small account balances.

• Pareto analysis. Review the largest accounts receivable that make up 80% of the total receivable balance, and estimate which specific customers are most likely to default. Then use the preceding historical percentage method for the remaining smaller accounts. This method works best if there are a small number of large account balances.

Accounting treatment for allowance

 If a company is using the accrual basis of accounting, it should record an allowance for doubtful accounts, since it provides an estimate of future bad debts that improves the accuracy of the company’s financial statements. Also, by recording the allowance for doubtful accounts at the same time it records a sale, a company is properly matching the projected bad debt expense against the related sale in the same period, which provides an accurate view of the true profitability of a sale.

11.abc  company made 5% allowance on its receivable based on past experiences.the journal  entry will be

Debit	bad debt accounts
Credit	receivable allowance

11.When the amount of receivable allowance decreased the journal  entry will be

Debit	receivable allowance
Credit	bad debt accounts