Allowance for Doubtful Accounts
A contra-asset estimating the portion of receivables that will not be collected.
What is Allowance for Doubtful Accounts?
The allowance for doubtful accounts is a contra-asset account that reduces gross accounts receivable to their net realizable value — the amount the company realistically expects to collect. Companies estimate uncollectible accounts using historical bad debt rates, aging schedules, or customer-specific analysis. Under GAAP, this estimate is recorded as bad debt expense on the income statement before actual write-offs occur, matching the cost to the period the revenue was recognized. The allowance method is preferred over the direct write-off method because it adheres to the matching principle and prevents overstating assets.
Example
A company has $1,000,000 in accounts receivable. Based on historical data, it estimates 2% will go uncollected. It records a $20,000 allowance for doubtful accounts as a contra-asset, reducing net receivables to $980,000 on the balance sheet, and recognizes $20,000 of bad debt expense on the income statement.
Source: FASB Accounting Standards Codification — ASC 310 Receivables