Allowance For Bad Debt
Definition of 'Allowance For Bad Debt'
A valuation account used to estimate the portion of a bank's loan portfolio that will ultimately be uncollectible. When a loan goes bad, the asset is removed from the books and the allowance for bad debt is charged for the book value of the loan.
Also known as "loan-loss reserve."
Investopedia explains 'Allowance For Bad Debt'
The allowance-for-bad-debt account is needed because the face value of a bank's loans are not the actual value, since a certain portion of those assets can be reasonably predicted to go bad.
Increases to the allowance for bad debt are made by periodic loan-loss provisions, which replenish the allowance and are recorded on the income statement as an expense. The use of the allowance method tends to smooth bank earnings, which otherwise might undergo unusual fluctuations when loans that have deteriorated over long periods of time are charged off together in a single period.