What is Allowance for Doubtful Accounts?

What is Allowance for Doubtful Accounts?

Usually, allowance for doubtful accounts will pair with accounts receivable, and it will offset the latter. The allowance is the best estimation the management has made on the amount of accounts receivable that their client will be unable to pay the company (Also see Understanding Write-offs). After subtracting the amount of allowance from the accounts receivable, the remaining sum is the total amount of accounts receivable the company predicts to get.

When the accounting firm in Johor Bahru is managing the accounts for a company that uses the accrual basis of accounting, the accountant will record an allowance for doubtful accounts if the situation above happens to the company. This is because the allowance for doubtful accounts gives a prediction on the loss that the company may experience in the future. Thus this makes the company’s financial statements more accurate.

Also, if the company records the allowance for doubtful accounts and its sales simultaneously, it may match the possible bad debt expense with the associated sale in the same accounting period. This helps in revealing the real profitability of the sale. In the balance sheet of that company, the allowance for doubtful accounts shows as a contra account, which offsets and is matched with the accounts receivable line item.

As an instance, XYZ corporation has recorded the sales of RM2,000,000 to several different clients. According to its historical experience, it predicts that it is going to incur 1% of this sum as bad debts although it is not sure of which customer will cause this loss (Also see How Can You Collect Payments for Overdue Invoices?). Thus, the steps it will take is to record the estimated 1% of bad debt (RM20,000) as a debit to a bad debt expense account and a credit to allowance for doubtful accounts. Then, it will charge the bad debt expense to expense straight away, whereas the allowance for doubtful accounts will become a reserve account that offsets the accounts receivable of RM2,000,000. That is to say, that accounts receivable have a net receivable outstanding of RM1,980,000.

After that, one of the clients is able to pay the full amount, hence brings the amount collected by the company to exceed the net receivable outstanding by RM10,000. As a result, the company will debit RM10,000 to the allowance for doubtful accounts and credit the same amount to the accounts receivable account. This is to reduce the value of outstanding accounts receivable, and at the same time, the balance in the allowance for doubtful account will reduce to RM10,000. After all, this entry has no impact on the revenue the company has earned in the current accounting period.

 

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