Doubtful Accounts & Bad Debts: All You Need To Know

Allowance for Doubtful Accounts | Provision for Bad Debts | Reserve for Uncollectible Accounts

Emilie N.- FCCA, CB, MBS
Emilie N.- FCCA, CB, MBS

Emilie is a Certified Accountant and Banker with Master's in Business and 15 years of experience in finance and accounting from corporates, financial services firms - and fast growing start-ups.

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Contents

What is Allowance for Doubtful Accounts | Provision for Bad Debts?

Allowance for Doubtful Accounts, or Provision for Bad Debts, is a contra-asset account with a credit balance, used to estimate the portion of uncollectible Accounts Receivable from buyers who are not expected to pay for their purchases so that balance sheet shows receivables at net realizable value.

Difference: Doubtful Accounts vs. Bad Debts

The contra-asset account for Accounts Receivable is known as Allowance for Doubtful Accounts, Provision for Bad Debts, or Reserve for Uncollectible Accounts–or any other variation of these terms, which are used interchangeably based on the applicable accounting standards and best practices.

Allowance | Provision | Reserve

for

Doubtful Accounts | Bad Debts | Uncollectible Accounts

Accounts Receivable Contra-Account: Alternative Titles
Interchangeable Terms Doubtful Accounts Uncollectible Accounts Bad Debts
Allowance Allowance for Doubtful Accounts Allowance for Uncollectible Accounts Allowance for Bad Debts
Reserve Reserve for Doubtful Accounts Reserve for Uncollectible Accounts Reserve for Bad Debts
Provision Provision for Doubtful Accounts Provision for Uncollectible Accounts Provision for Bad Debts

The titles of contra accounts receivable can differ across jurisdictions and entities.

For example, the accounting profession in the United States encourages the use of the terms allowance, provision or accumulated rather than a reserve, which could be misinterpreted as money set aside.

In other cases, doubtful accounts and uncollectible bad debts may have very distinct meaning and accounting treatment, such as:

Doubtful Accounts vs. Bad Debts
Doubtful | Bad Debts Definition Accounting Treatment
Uncollectible Bad Debts Specific identified accounts receivable that cannot be collected by a business from customers who will not pay. Write off as an expense immediately
Doubtful Accounts Estimated portion of receivables that is unlikely to be collected by a business from its customers and may become a bad debt at some point in the future. Create an allowance or provision contra asset account

Debit or Credit?

Allowance for Doubtful Accounts (aka Bad Debt Provision or Uncollectible Accounts Reserve) has a credit balance and is credited when increased because it is a contra to the asset account Accounts Receivable, which has a debit balance and is debited when increased.

Debit or Credit - Doubtful Accounts & Uncollectible Bad Debts
Account Name Account Type Debit Credit
Accounts Receivable Parent asset account Increase Decrease
Allowance for Doubtful Accounts (Provision for Bad Debts) Contra asset account Decrease Increase

Journal Entry

The journal entry to record the estimated amount of uncollectible accounts receivable is a debit to a Bad Debts expense account and a credit to an Allowance for Doubtful Accounts contra-asset account.

As an example, let’s say that Company A reports credit sales of $100,000 and it estimates that 2% of the receivables will default. The journal entry would look as follows:

Journal Entry - Doubtful Accounts & Uncollectible Bad Debts
Account Name Account Type Financial Statement Debit Credit
Bad Debt Expense Expense Income Statement $2,000
Allowance for Doubtful Accounts (Provision for Bad Debts) Contra asset account Balance Sheet $2,000

The bad debts journal entry above would reduce the amount of receivables on a balance sheet by $2,000 from gross $100,000 to net realizable value of $98,000, which is the amount of cash the company actually expects to receive for the asset.

Financial Statements

Bad Debt Expense is presented on an income statement under operating expenses and the contra-account is reported on a balance sheet in the asset section, immediately below Accounts Receivable to reduce the current balance of receivables by the estimated Allowance for Doubtful Accounts and Bad Debts.

Using the same example as per above, the balance sheet of Company A would look as follows:

Balance Sheet: Company A – 31 December 20XX
Accounts Receivable - Gross Asset $100,000
(Less: Allowance for Doubtful Accounts and Bad Debts) (Contra Asset) ($2,000)
Accounts Receivable - Net Current Net Realizable Value $98,000

This three-line breakdown of the Accounts Receivable asset enables balance sheet users to clearly see that even though customers owe $100,000 to Company A for past purchases (Gross Accounts Receivable), the company wrote off $2,000 as an operating expense (Allowance for Doubtful Accounts and Uncollectible Bad Debts) because it expects to turn only $98,000 into cash (Net Realizable Value).

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Emilie N., FCCA, CB, MBS
Emilie N., FCCA, CB, MBS

Emilie is a Certified Accountant and Banker with Master's in Business and 15 years of experience in finance and accounting from large corporates and banks, as well as fast-growing start-ups.

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