What is the allowance for doubtful accounts?

The allowance for doubtful accounts sits directly below accounts receivable on the balance sheet with a negative balance, pulling the AR total down to net realizable value — what the business actually expects to collect. It is an estimate, not a certainty, and it updates each period when bad debt expense is recorded.

Most businesses calculate the allowance using a percentage-of-sales method or an aging analysis. The aging method is more accurate: apply different loss-rate percentages to each aging bucket — perhaps 1% on current invoices, 5% on 31–60 day, 20% on 61–90 day, 50% on 90-plus day — and sum the result. When a specific invoice is confirmed uncollectable, the write-off removes both the AR and an equal amount of the allowance. Net receivables stay flat at that moment.

Small businesses on cash-basis accounting may not use this account at all — losses are recognized only when cash fails to arrive. For those on accrual, keeping a realistic allowance prevents unpleasant surprises at year-end when the accountant reviews the aged balances.