By The AR Agent team · · 6 min read
The allowance for doubtful accounts is an estimate of how much of your accounts receivable you do not expect to collect. It is a contra-asset account: it sits under accounts receivable on the balance sheet with a credit balance and reduces receivables to the amount you realistically expect to turn into cash.
You build it before you know which invoices will go unpaid, then write off specific invoices against it.
Say a business has $60,000 of accounts receivable. Experience says some of that will never be paid, but nobody knows yet which invoices. The allowance records that expected loss now, as a single estimate.
On the balance sheet it looks like this:
| Current assets | |
|---|---|
| Accounts receivable | $60,000 |
| Less: allowance for doubtful accounts | ($2,400) |
| Accounts receivable, net | $57,600 |
The net figure, $57,600, is the net realizable value of the receivables: what the business expects to collect.
The SEC's balance sheet rules for public companies (Regulation S-X, Rule 5-02) list "allowances for doubtful accounts and notes receivable" under current assets, directly after receivables, and require the amount to be shown separately on the balance sheet or in a note. Our page on whether accounts receivable is an asset explains the receivable side.
The percentage-of-sales method estimates bad debts as a share of credit sales for the period. It starts from the income statement.
Say an invented consultancy made $300,000 of credit sales this year. Over the past few years, about 1% of credit sales went unpaid. The estimate for the year is:
$300,000 x 1% = $3,000
The consultancy records $3,000 of bad debt expense and adds $3,000 to the allowance, whatever the allowance balance was before.
Its weakness is that it ignores how old the outstanding invoices are.
The aging method estimates the allowance from your outstanding invoices, grouped by how long they are past due. It starts from the balance sheet. Older invoices get a higher loss rate, because they are less likely to be paid.
Using an invented aging report and invented loss rates:
| Age bucket | Balance | Estimated loss rate | Estimated uncollectible |
|---|---|---|---|
| Not yet due | $30,000 | 1% | $300 |
| 1 to 30 days past due | $15,000 | 3% | $450 |
| 31 to 60 days past due | $8,000 | 10% | $800 |
| 61 to 90 days past due | $4,000 | 20% | $800 |
| Over 90 days past due | $3,000 | 50% | $1,500 |
| Total | $60,000 | $3,850 |
The allowance should stand at $3,850. If it already has a credit balance of $1,200, the adjusting entry is the difference: $2,650.
The loss rates should come from your own history, adjusted for anything you know now, such as a customer in difficulty. Your accounts receivable aging report is where the balances come from.
Continuing the aging example.
1. Setting up or adjusting the allowance
| Account | Debit | Credit |
|---|---|---|
| Bad debt expense | $2,650 | |
| Allowance for doubtful accounts | $2,650 |
2. Writing off a specific invoice. A customer owing $900 closes down and you agree it will not be paid.
| Account | Debit | Credit |
|---|---|---|
| Allowance for doubtful accounts | $900 | |
| Accounts receivable | $900 |
The write-off does not change net receivables or expense. Both gross AR and the allowance fall by $900.
3. Recovering an invoice you wrote off. Months later, the customer pays the $900 after all. First reinstate the receivable, then record the cash.
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | $900 | |
| Allowance for doubtful accounts | $900 | |
| Cash | $900 | |
| Accounts receivable | $900 |
Generally not. The allowance method is a book accounting method, and the expense it creates is covered on our bad debt expense page. For federal income tax, the IRS works differently.
So many small businesses keep an allowance in their books and deduct only specific write-offs on their tax return. The two figures differ, and your accountant reconciles them. The IRS also says to keep records for 7 years if you claim a bad debt deduction. This is general information, not tax advice.
It has a normal credit balance. It is a contra-asset, so it works opposite to accounts receivable, which has a debit balance. Increasing the allowance credits it. Writing off an invoice against it debits it.
The aging method usually gives a better balance sheet figure, because it looks at what is actually outstanding and how old it is. The percentage-of-sales method is quicker.
Not always. A business that keeps its books on a cash basis, or uses the direct write-off method, may not have one. A business that prepares accrual financial statements for lenders or investors usually will. Ask your accountant what your reporting needs require.
It is gross accounts receivable minus the allowance for doubtful accounts: the amount you expect to collect. With $60,000 of receivables and a $2,400 allowance, net realizable value is $57,600.
The best way to keep the allowance small is to stop invoices drifting into the older age buckets. The AR Agent follows up overdue invoices by email, at the right time for each customer, using the balances in QuickBooks or Xero. It reads replies, turns "we'll pay at month end" into a tracked payment promise, and follows up if the date passes. When a customer disputes an invoice, it pauses normal chasing and brings the case to the right person on your team. Every email, promise and blocker is kept on the record, which helps when deciding whether an invoice is truly uncollectible.
Talk to us: our AI agent chases your invoices until you are paid.
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