The allowance method of accounting for uncollectibles estimates the percentage of accounts that will be uncollectible. Once the amount is determined, an adjusting entry is made that debits the Uncollectible Accounts Expense and credits the Allowance for Doubtful Accounts (also known as Allowance for Bad Debt). When a specific account is determined to be uncollectible, the Allowance for Doubtful Accounts is debited and the Accounts Receivable account is credited. The advantage of using the allowance method is it provides a reduction of the value of receivables and recognition of expense in the period the corresponding sales have taken place.
Example:
1. December 31, 2010
Company Y believed that it has $25,000 unsettled accounts receivable for the year and an allowance should be recorded in the books.
Journal entry to establish allowance
| Debit | Credit | |
| Bad debts expense | $25,000 | |
| Allowance for bad debts | $25,000 |
2. January 25, 2011
Company Y’s customer, Company X, filed for bankruptcy. Company X had to pay Company Y $5,000.
Journal entry to write off accounts receivable from Company X
| Debit | Credit | |
| Allowance for bad debts | $5,000 | |
| Accounts receivable | $5,000 |
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