Concept
Why Use an Allowance?
GAAP requires the allowance method because it matches bad debt expense to the period of the related sale (matching principle). The direct write-off method is NOT acceptable under GAAP for financial reporting.
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FARLesson 2 of 5
The Allowance Method
Example
Setting Up the Allowance
A company estimates $5,000 of its $200,000 in receivables will be uncollectible. Adjusting entry: Debit Bad Debt Expense $5,000, Credit Allowance for Doubtful Accounts $5,000. The allowance is a contra-asset that reduces A/R on the balance sheet.
Example
Writing Off a Specific Account
Customer ABC's $800 balance is deemed uncollectible. Write-off entry: Debit Allowance for Doubtful Accounts $800, Credit Accounts Receivable $800. Note: this does NOT affect total assets or the income statement — NRV stays the same.
Key Point
Recovery
If a written-off account is later collected, reverse the write-off first (Debit A/R, Credit Allowance), then record the cash receipt (Debit Cash, Credit A/R).
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Practice questions from this module to reinforce what you learned.