In short
The allowance method estimates uncollectible receivables at each reporting date and records them in a contra-asset account (the allowance for doubtful accounts), so receivables are shown at the amount expected to be collected.
Key takeaways
- Bad debt expense is the amount needed to bring the allowance to its required balance.
- Writing off a specific account reduces the allowance and receivables equally; it doesn't change expense or net receivables.
- The direct write-off method, which expenses accounts only when written off, isn't allowed under US Generally Accepted Accounting Principles (GAAP) when bad debts are material.
Example
The allowance has a $4,000 credit balance before adjustment and the aging requires $18,000, so bad debt expense is $14,000.
Where it's tested
FAR: Cash, Receivables & Bad Debts — study notes, a five-minute revision sheet and practice questions.
Practise: 3 questions
Question 1 of 3 · 0 answered
A company writes off a specific $8,000 account as uncollectible using the allowance method. What is the effect on total assets and net income?