The allowance method records an expense to bad debt using an estimate of accounts that are unlikely to be collected before specific customer accounts are identified as being uncollectible.
The estimate is determined by management and is based on a percentage of accounts receivable or sales.
The percentage rate may be based on historical trends, economic trends or some other form of measurement.
The method uses a contra-asset account to accounts receivable ... allowance for doubtful accounts, to maintain the estimate of accounts that will become bad debt.
The account is adjusted as accounts are written off.
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
