The allowance method is one of the two common techniques of accounting for bad debts, the other being the direct write-off method. Allowance method is a better alternative to the direct write-off method because it is according to the matching principle of accounting. In allowance method, the doubtful debts are estimated and bad debts expense is recognized before the debts actually become uncollectible.

Bad debts expense is recognized early because bad debts are probable and they can be estimated to a fairly accurate extent therefore they fulfill the criteria required for recognition of contingent losses and it is necessary to recognize bad debts expense.

## Recognition Entry

The first step in the allowance method is to pass an adjusting entry at the end of an accounting period to recognize estimated bad debts expense. Unlike direct write-off method, we do not credit accounts receivable at this stage because it is actually a control account of many individual debtor accounts and we do not yet not know which particular debtor will make a default. We only know the estimated amount of receivables which are likely to end up uncollected. Therefore a provision account called allowance for doubtful accounts is credited in the adjusting entry. Thus:

 Bad Debts Expense 600 Allowance for Doubtful Accounts 600

The bad debts expense account, just like any other expense account, is closed to income summary account of the period. The allowance for doubtful debts is contra-asset account. It is presented on balance sheet by subtracting it from accounts receivable as shown below:

 Accounts Receivable $15,000 Less: Allowance for Doubtful Accounts − 600 Accounts Receivable, net$14,400

## Write-off Entry

In the next period, when a debt is actually determined as uncollectible, the following journal entry is passed to write it off.

 Allowance for Doubtful Debts 70 Accounts Receivable 70

As more and more debts are written off, the balance in the allowance account decreases.