Definition
The term allowance for doubtful accounts refers to the contra asset to accounts receivable. Allowance for doubtful accounts represents the portion of accounts receivable the company does not expect to collect from customers.
Explanation
Not all credit sales will result in money collected from customers. Therefore the balance appearing in accounts receivable needs to be adjusted for what the company anticipates will be uncollectible. The allowance for doubtful accounts, also known as the allowance for bad debts, is used to make this adjustment.
Accounts receivable is a control account. As such, the balance in accounts receivable needs to equal the total of the individual accounts found in the subsidiary ledger. Allowance methods are used to develop estimates of bad debts, and the value of doubtful accounts is adjusted accordingly. For example, the company may have performed a study that indicates 2% of accounts receivable will never be collected from customers. In this example, the allowance for doubtful accounts would be equal to 2% of the accounts receivable balance.
This process allows the balance sheet to state accounts receivable in what is called "net realizable value." This adjustment is necessary due to the conservatism constraint, which states that when in doubt, report information that does not overstate income or assets or does not understate expenses or liabilities.
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorNovember 6th, 2024
The financial accounting term current assets is generally defined as cash and other assets that can be converted into cash within one year or one operating cycle, whichever is longer. Current assets are a subcategory of assets, which appear on a company's balance sheet.Moneyzine EditorNovember 6th, 2024
Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.Moneyzine EditorNovember 6th, 2024
A contra account is a balance sheet account that is used to offset a related asset, liability, or equity account. Contra accounts are used to ensure the proper valuation of these items is reflected on the balance sheet.Moneyzine EditorJanuary 12th, 2024
The financial accounting term conservatism constraint refers to an accounting constraint that states when in doubt, report information that does not overstate income or assets or does not understate expenses or liabilities.Moneyzine EditorJanuary 11th, 2024
The financial accounting term disposition of accounts receivable is used to describe several approaches companies can take to accelerate the receipt of cash from receivables. The two most common methods include factoring and assignment; whereby the company transfers receivables to another party in exchange for cash.Moneyzine EditorJanuary 16th, 2024- The term special allowance accounts refers to a contra asset to accounts receivable that ensures the amount appearing on the balance sheet is stated in terms of net realizable value. Special allowance accounts are required to match anticipated and real expenses with the corresponding sales revenues.Moneyzine EditorNovember 6th, 2024
