Allowance for Doubtful Accounts

Module 3:
Cash, Receivables, Payables

Duration:
45-60 minutes

Level:
Beginner to Diploma-Level

➛ Understand why bad debts occur

➛ Explain the Allowance for Doubtful Accounts concept

➛ Apply the matching principle

➛ Record journal entries for estimating uncollectible accounts

➛ Distinguish between Direct Write-Off and Allowance Method

Not all customers pay what they owe. Some accounts receivable may become uncollectible.

These uncollectible receivables are called bad debts or doubtful accounts.

Accounting follows the matching principle, which means

Expenses should be recorded in the same period as the related revenue.

➛ Sales are recorded before cash is collected
➛ Some receivables may not be paid
➛ We must estimate losses in advance

That’s why we use an Allowance for Doubtful Accounts.

➛ A contra-asset account
➛ Reduces Accounts Receivable
➛ Shows the estimated amount that may not be collected

On the balance sheet

1. Direct Write-Off Method
➛ Bad debt is recorded only when a customer fails to pay
➛ Violates the matching principle
➛ Not allowed under GAAP

Journal Entry



2. Allowance Method | Preferred
➛ Bad debts are estimated in advance
➛ Matches expense with revenue
➛ Required by GAAP

There are two common estimation approaches

1. Percentage of Sales Method
2. Aging of Accounts Receivable | covered in next class

In this class, we focus on the concept, not aging details yet.

At the end of the accounting period



➧ Increases expenses
➧ Increases allowance | contra-asset

When a specific customer account is confirmed as uncollectible



No effect on expenses at this stage | already estimated earlier.

➛ Allowance for Doubtful Accounts is an estimate
➛ It ensures accurate profit reporting
➛ It improves the quality of financial statements
➛ Uses judgment and historical data

➛ What is the purpose of the allowance for doubtful accounts?

➛ Why is the direct write-off method not acceptable under GAAP?

➛ Is the allowance account an asset, liability, or expense?

➛ Which principle is satisfied by the allowance method?

➛ Write the journal entry to record estimated bad debts.

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Answers ➧ Here

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Aging of Accounts Receivable ➧ Here