Allowance For Doubtful Accounts
Definition of 'Allowance For Doubtful Accounts'
A contra-asset account that records the portion of a company's receivables, which it expects may not be collected. The allowance for doubtful accounts is only an estimate of the amount of accounts receivable which are expected to not be paid. The actual payment behavior of customers may differ substantially from the estimate.
Investopedia explains 'Allowance For Doubtful Accounts'
Losses due to bad debt are an unfortunate part of any business which extends credit to its customers. Even businesses which are extremely diligent about their credit and collections policies can expect that a certain percentage of accounts will go bad when customers either refuse to pay or are unable to pay.
Normally, the allowance for doubtful accounts is estimated based on the company's past experience. For example, the company may identify that it expects 4% of its sales to become bad debt, and thus it will adjust the allowance for doubtful accounts each quarter to ensure that this expected loss is reflected on the company's financial statements.