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CandleFocus Glossary Editor
Allowance for Doubtful Accounts (AFDA) is an accounting contra asset account used to reflect the amount of receivables that it is expected will not be collected from customers. A company will set up an AFDA account in the same accounting period as the original sale is made, and an offsetting entry is made to the Bad Debt Expense account.
The AFDA account and the Bad Debt Expense account are used to provide an estimate of the total amount of uncollectible accounts receivable. The concept behind the AFDA and the Bad Debt Expense accounts is simple: a company will estimate the total amount of receivables it expects to be uncollectible and record that amount as an expense. This estimated amount is known as the allowance for bad debts and is added to the company’s balance sheet as a contra asset account.
The amount of the allowance for doubtful accounts is calculated based on the company’s current level of accounts receivable and its historical experience with uncollected accounts. The two most common methods used to estimate uncollectibles are the percentage of sales method and the accounts receivable aging method.
The percentage of sales method uses the company’s historical percentage of accounts receivable that were not collected to determine the estimated amount of bad debt. For example, if the company historically has had 10% of its accounts receivable not collected, the company would set up an AFDA account in the same accounting period equal to 10% of the current accounts receivable balance.
The aging of accounts receivable method looks at the customer account balances and predicts which ones will not be paid. The AFDA account is set up with an estimated amount that can be used to offset the customer accounts that are not expected to be collected.
The AFDA account must be regularly reviewed and adjusted based on changes in the company’s accounts receivable balances, the customer payment patterns, and the percentage of customer accounts that will be uncollectible. The AFDA and the Bad Debt Expense accounts must be monitored and reported regularly to ensure the validity of the estimates and prevent large uncollectible customer accounts from having an unexpected effect on the income statement.
The AFDA account and the Bad Debt Expense account are used to provide an estimate of the total amount of uncollectible accounts receivable. The concept behind the AFDA and the Bad Debt Expense accounts is simple: a company will estimate the total amount of receivables it expects to be uncollectible and record that amount as an expense. This estimated amount is known as the allowance for bad debts and is added to the company’s balance sheet as a contra asset account.
The amount of the allowance for doubtful accounts is calculated based on the company’s current level of accounts receivable and its historical experience with uncollected accounts. The two most common methods used to estimate uncollectibles are the percentage of sales method and the accounts receivable aging method.
The percentage of sales method uses the company’s historical percentage of accounts receivable that were not collected to determine the estimated amount of bad debt. For example, if the company historically has had 10% of its accounts receivable not collected, the company would set up an AFDA account in the same accounting period equal to 10% of the current accounts receivable balance.
The aging of accounts receivable method looks at the customer account balances and predicts which ones will not be paid. The AFDA account is set up with an estimated amount that can be used to offset the customer accounts that are not expected to be collected.
The AFDA account must be regularly reviewed and adjusted based on changes in the company’s accounts receivable balances, the customer payment patterns, and the percentage of customer accounts that will be uncollectible. The AFDA and the Bad Debt Expense accounts must be monitored and reported regularly to ensure the validity of the estimates and prevent large uncollectible customer accounts from having an unexpected effect on the income statement.