How to record an allowance for doubtful accounts

Bad debt is money your business expected to collect but never did. It usually comes from customers who can't or will not pay their invoices, even after follow-ups. These uncollectible amounts sit in your accounts receivable and inflate your expected income unless you account for them properly. That’s where the allowance for doubtful accounts comes in. Recording an allowance for doubtful accounts helps your business properly account for bad debt.

What is the allowance for doubtful accounts?

The allowance for doubtful accounts is a contra-asset account that reduces your accounts receivable balance to reflect the money you likely will not collect. It estimates how much of your outstanding invoices may go unpaid.

Instead of waiting for the specific customer to default, you plan ahead by setting aside a portion of receivables as potential bad debt. This makes your finances more accurate and helps avoid overstating revenue.

Under Generally Accepted Accounting Principles (GAAP), you must match bad debt expenses to when the related revenue was earned and not when the invoice went unpaid. The allowance method helps you meet that standard.

Around 82% of business failures are tied to poor cash flow management. Unpaid invoices are a major factor. Tracking doubtful accounts keeps your books clean and protects against inflated profits.

You will adjust the allowance balance regularly based on experience, customer risk, and industry norms. This proactive approach gives you a more realistic view of what your business actually expects to collect.

When to record an allowance for doubtful accounts

You should record an allowance for doubtful accounts at the end of each accounting period—usually monthly, quarterly, or annually. This ensures your financials reflect both the revenue you've earned and the risk that a portion of it may never be collected.

The timing aligns with the matching principle under GAAP, which requires you to record expenses in the same period as the related revenue. If you wait until an invoice becomes uncollectible, your income statement will show inflated earnings for the earlier period, and earnings will hit later.

Any business that offers credit terms needs to estimate potential losses upfront. The more receivables you carry, the more critical it becomes to update the allowance regularly. Almost half of all B2B invoices in the U.S. are paid late, and 7% are written off entirely. You risk overstating assets and net income if you do not adjust your allowance based on actual trends.

Changes in customer payment behavior, economic conditions, or historical write-off patterns are strong signals that it's time to update your allowance.

How to calculate the allowance for doubtful accounts

Some companies deal with steady, predictable cash flow. Others face late payments and credit risk that varies from month to month. That’s why there are two main methods for estimating bad debt.

You should use the percentage of sales method if your bad debt losses are stable and predictable or if you are just starting out and do not have detailed aging data. On the other hand, the aging method is more suitable if you want a more precise estimate and have access to solid accounts receivable reports.

Percentage of sales method

The percentage of sales method estimates bad debt based on a fixed percentage of total credit sales during a specific period. This approach assumes a consistent relationship between your sales and historical defaults.

To calculate the allowance, you multiply your total net credit sales (not total revenue) by an estimated bad debt percentage. This percentage is typically based on your company’s historical data or industry averages.

For example, if our business recorded $500,000 in credit sales last year, and past experience shows that 2% of those sales typically go unpaid, your estimated bad debt expense would be $10,000.

You would then record $10,000 as your allowance for doubtful accounts, reducing the value of your accounts receivable on the balance sheet and increasing your bad debt expense on the income statement.

This method is simple and fast. It’s most useful for businesses with steady customer behavior and a predictable credit environment. However, it doesn't consider individual receivables' age or risk level, which may lead to under- or overestimations if customer payment patterns shift.

If you're unsure what percentage to use, start by analyzing the past 12 to 24 months of credit sales and actual write-offs. Over time, refine the estimate as your data becomes more consistent.

Aging of accounts receivable method

The aging of the accounts receivable method takes a more detailed, data-driven approach. It separates your outstanding invoices into age brackets—typically 0–30 days, 31–60 days, 61–90 days, and over 90 days past due. Each group is then assigned a different probability of default based on how long the invoice has remained unpaid.

The older the receivable, the less likely it is to be collected. Once an invoice is over 90 days past due, the likelihood of collection drops significantly, and it continues to decline after that.

This method is more accurate than the percentage of sales methods because it reflects current customer risk and real-time collection trends. It also allows your finance team to focus on the most overdue accounts, which are the highest risk.

The aging method is especially helpful for businesses with a large volume of invoices or customers with varying payment habits. It takes more time to prepare but gives a clearer view of how much you are likely to collect.

If you’re manually sorting through hundreds of transactions to build your estimate, platforms like Ramp can help. Ramp uses AI to categorize expenses and detect patterns in your transaction history, making it easier to apply consistent logic when estimating doubtful accounts.

How do you record a journal entry to allow for doubtful accounts?

Businesses record a journal entry for the allowance for doubtful accounts at the end of each reporting period. This task is typically handled by the finance team or accountant responsible for closing the books and preparing financial reports.

1. Estimate the expected bad debt. Start by calculating how much of your accounts receivable may not be collected. Use either the percentage of sales method or the aging of accounts receivable method to arrive at this estimate. For example, if the result is $8,000, that’s the amount you will use for the journal entry.
2. Record the initial journal entry. Once you have your estimated bad debt, create the journal entry. You will debit “Bad Debt Expense” from your income statement and credit “Allowance for Doubtful Accounts” from your balance sheet. If the estimate is $8,000, both accounts will reflect that amount. This step builds the reserve without changing your actual accounts receivable balance.
3. Update the entry periodically. At the end of each reporting period, reassess your allowance. Record only the difference if the new estimate is higher or lower than the existing account balance. For example, if your current allowance is $5,000 and your updated estimate is $7,500, you would record an additional $2,500. This keeps your estimates aligned with actual collection risk and ensures your books stay accurate over time.
4. Write off specific accounts when confirmed uncollectible. When a customer account is officially deemed uncollectible, you don’t record it as a new expense. Instead, reduce both the “Allowance for Doubtful Accounts” and “Accounts Receivable” by the same amount. If a $1,200 invoice is written off, both accounts are adjusted downward by $1,200. This clears the invoice without impacting the income statement again.

How the allowance impacts financial statements

The allowance for doubtful accounts plays a critical role in how you report revenue and receivables. It directly impacts two core financial statements: the balance sheet and the income statement. Both rely on this estimate to present a true picture of your company’s financial health.

Impact on the balance sheet

On the balance sheet, the allowance appears as a contra-asset account directly linked to accounts receivable. It reduces the gross receivables balance to reflect only the net realizable value, which is the amount you reasonably expect to collect from customers.

For example, if your accounts receivable total is $100,000 and your allowance is $7,000, the balance sheet will show $93,000 as your net receivables. This keeps the asset side of your balance sheet realistic and avoids overstating your short-term liquidity.

This is especially important for external users of your financials, like lenders and investors, who rely on receivables to assess your company’s cash position. Inflated receivables can mislead them into thinking you have more cash coming in than you actually do.

Impact on the income statement

The bad debt expense associated with the allowance appears on the income statement as part of your operating expenses. This is not recorded when a specific invoice becomes uncollectible. Instead, it’s recorded when you estimate it based on your current receivables and historical data.

This treatment supports the matching principle under GAAP, which requires expenses to be recognized in the same period as the revenue they help generate. For instance, if you make a $12,000 sale on credit in Q1 and expect $600 of that to go unpaid, the $600 expense should also be recorded in Q1 and not months later when the invoice is written off.

If you don’t record the allowance correctly, your income statement will show inflated earnings in earlier periods and unexpected losses later on. That inconsistency makes it harder to track profitability and plan for growth.

One way to maintain consistency in your reporting is to automate your transaction coding. Ramp integrates directly with platforms like QuickBooks, NetSuite, and Sage Intacct, syncing updated financial data in real-time to ensure your statements reflect the most accurate version of your books.

Why tracking doubtful accounts keeps your business financially sharp

Tracking doubtful accounts helps you stay ahead of cash flow problems and avoid overstating revenue. It keeps your financial statements clean, accurate, and GAAP-compliant. When handled correctly, the allowance gives you an early warning system for customer risk and shifting payment trends.

A consistent allowance process also strengthens investor and lender confidence. It shows that your team monitors receivables closely and understands how to manage risk. That’s essential when you're scaling, raising working capital, or navigating uncertain markets.

Tools like Ramp give you the visibility and control to track and manage doubtful accounts with confidence. From AI-powered categorization to ERP integrations and multi-entity automation, Ramp helps you tighten up your process and reduce the risk of surprises during close.