Quick Answer: The provision for doubtful accounts (also called the allowance for doubtful accounts or bad debt provision) is a contra-asset account that reduces accounts receivable to its net realizable value. You record it by debiting Bad Debt Expense and crediting Allowance for Doubtful Accounts. When a specific account is confirmed uncollectible, you write it off by debiting the allowance and crediting AR — with no impact on the income statement.
Allowance Method vs. Direct Write-Off Method
GAAP and IFRS require the allowance method for financial reporting. The direct write-off method is only acceptable for tax purposes (in the US) or when bad debts are immaterial.
- Allowance method: Estimates uncollectible amounts in advance, matching expense to the period of the sale. Records bad debt expense before specific accounts are identified as uncollectible.
- Direct write-off method: Records expense only when a specific account is determined uncollectible. Violates the matching principle and is not GAAP-compliant for material amounts.
1. Estimating the Provision (Period-End Adjusting Entry)
At each reporting date, companies estimate the expected credit losses on their receivables. There are two primary estimation approaches:
Income Statement Approach (Percentage of Sales)
This method bases the provision on a percentage of credit sales for the period. It emphasizes the income statement (matching expense to revenue).
Example: Credit sales of $500,000 with a historical bad debt rate of 2%:
Cr. Allowance for Doubtful Accounts — $10,000
(2% of $500,000 credit sales)
Balance Sheet Approach (Aging of Receivables)
This method classifies receivables by age and applies increasing percentages to older balances. The allowance balance is adjusted to match the required ending balance.
Example aging schedule:
| Age Category | Amount | Estimated % | Provision |
|---|---|---|---|
| 0-30 days | $200,000 | 1% | $2,000 |
| 31-60 days | $80,000 | 3% | $2,400 |
| 61-90 days | $40,000 | 10% | $4,000 |
| Over 90 days | $20,000 | 25% | $5,000 |
| Total Required | $340,000 | $13,400 |
If the current allowance balance is $4,000 (credit), the adjusting entry is:
Cr. Allowance for Doubtful Accounts — $9,400
($13,400 required balance less $4,000 existing credit balance)
2. Writing Off a Specific Uncollectible Account
When a specific customer account is confirmed uncollectible (e.g., customer bankruptcy, collection efforts exhausted):
Cr. Accounts Receivable [Customer Name] — $3,500
(No P&L impact — expense was already recorded under allowance method)
Notice that the write-off affects only balance sheet accounts. Total assets remain unchanged because the reduction in AR is offset by the reduction in the contra-asset allowance.
3. Partial Write-Off
Sometimes a customer pays a portion of an outstanding balance, and the remainder is written off:
Example: Customer owes $5,000, pays $2,000, and the remaining $3,000 is deemed uncollectible:
Dr. Cash — $2,000
Cr. Accounts Receivable [Customer] — $2,000
Write off remainder:
Dr. Allowance for Doubtful Accounts — $3,000
Cr. Accounts Receivable [Customer] — $3,000
4. Recovery of Previously Written-Off Account
If a customer whose account was previously written off later pays:
Dr. Accounts Receivable [Customer] — $3,500
Cr. Allowance for Doubtful Accounts — $3,500
Step 2 — Record the cash receipt:
Dr. Cash — $3,500
Cr. Accounts Receivable [Customer] — $3,500
The two-step process ensures the customer's payment history is complete in the subsidiary ledger, which supports future credit decisions.
5. Direct Write-Off Method (Non-GAAP)
Under the direct write-off method, no allowance is established. Bad debt expense is recorded only when a specific account is confirmed uncollectible:
Cr. Accounts Receivable [Customer] — $3,500
(Direct write-off — not GAAP compliant for material amounts)
This method is simpler but overstates assets and understates expenses until the write-off occurs. The IRS permits this method for tax purposes, which is why many small businesses use it for tax reporting while using the allowance method for GAAP financial statements.
IFRS 9 Expected Credit Loss Model
Under IFRS 9, companies must recognize expected credit losses (ECL) using one of three models:
- Simplified model (trade receivables): Always recognize lifetime ECL — no need to assess significant increase in credit risk
- General model: Recognize 12-month ECL initially; shift to lifetime ECL when credit risk increases significantly
- Purchased credit-deteriorated model: For financial assets that have already experienced significant credit deterioration at purchase
Unlike the incurred-loss model under IAS 39, IFRS 9 requires forward-looking information to be considered when estimating credit losses.
Impact on Financial Statements
Balance Sheet
Accounts Receivable (Gross) less Allowance for Doubtful Accounts equals Net Realizable Value. The allowance reduces the carrying amount to reflect the amount expected to be collected.
Income Statement
Bad Debt Expense appears as an operating expense (or within selling expenses). Under the allowance method, it is recognized in the same period as the related revenue — satisfying the matching principle.
Cash Flow Statement
Changes in the allowance are a non-cash adjustment. When using the indirect method, increases in the allowance are added back to net income because the expense did not require a cash outflow.
Common Mistakes to Avoid
- Double-counting expense: Do not record Bad Debt Expense again when writing off a specific account under the allowance method — the expense was already recorded
- Negative allowance: If write-offs exceed the allowance balance, the allowance can go negative (debit balance). This indicates under-provision and requires an additional adjusting entry
- Ignoring recovery procedure: Always use the two-step recovery process (reinstate, then collect) rather than just debiting cash and crediting the allowance directly
- Mixing methods: Do not switch between allowance and direct write-off for the same set of receivables — choose one method for financial reporting and apply it consistently
