Allowance method

Definition

Allowance method is an accounting technique used to estimate and account for uncollectible accounts receivable. It involves creating an allowance for doubtful accounts, which reduces the accounts receivable balance on the balance sheet.

5 Must Know Facts For Your Next Test

1. The allowance method matches bad debt expense with the related revenue in the same period.
2. It requires estimating the amount of uncollectible accounts based on historical data or other methods.
3. There are two primary approaches to estimating uncollectibles: percentage of sales and aging of receivables.
4. Adjusting entries are made at the end of each accounting period to record bad debt expense and update the allowance for doubtful accounts.
5. When specific accounts are identified as uncollectible, they are written off against the allowance account, not directly against revenue.

Review Questions

• What is the primary purpose of using the allowance method in accounting?
• Name and briefly describe two approaches used to estimate uncollectible accounts under the allowance method.
• How does writing off a specific account affect the financial statements when using the allowance method?

Related terms

Bad Debt Expense: The estimated cost associated with accounts receivable that are not expected to be collected.

Aging of Receivables Method: An approach that categorizes accounts receivable by age to estimate their likelihood of being uncollected.

Percentage of Sales Method: An approach that estimates bad debts as a percentage of credit sales made during a period.