The allowance for credit losses
AJE-5, the one September adjustment that is an estimate: expected losses booked from day one, and a write-off that never touches profit.
AJE-5 is different. Nothing expired and nothing was used up. Northwind looked at the $8,000 its customers owe and expects 2% of it, $160, never to arrive. Nothing is overdue, and the estimate is still required. Under the current expected credit loss model, a receivable carries an allowance for the losses expected over its whole life, starting the day it's booked, not just for losses that have already happened. The debit is bad debt expense. The credit goes to 1290 Allowance for credit losses, a contra asset older books call the allowance for doubtful accounts. It doesn't go to the receivable, because no customer has defaulted. The balance sheet shows $8,000 owed, less $160 expected to be lost: $7,840 expected to be collected.
When a specific invoice goes bad (say the customer goes under in November), it's written off against the allowance: debit the allowance, credit the receivable. Both lines are on the balance sheet, so the write-off doesn't touch profit. The expense was taken when the loss was expected. The next month-end estimate tops the allowance back up to what the remaining receivables need, and only the top-up is expense.
Wrong
Dr 6600 Bad debt expense Cr 1200 Accounts receivable Booked the day the customer goes under.
Right
Dr 1290 Allowance for credit losses Cr 1200 Accounts receivable The expense was taken in the estimate.
Writing a bad invoice straight to expense (the direct write-off method) charges the loss to the month the customer failed instead of the month of the sale, and overstates receivables until then. It isn't GAAP where expected losses are material.
Where this lesson's rules come from
The sources behind this lesson's requirements, by kind. Anything marked as a convention is ours, not the rule-maker's.
- US GAAP
- ASC 326-20-30-1 (opens in a new tab)The allowance presents receivables at the amount expected to be collectedFree after registration
- ASC 326 (opens in a new tab)Financial Instruments — Credit LossesFree after registration
The full map is in US GAAP, and where these rules come from.
The words this page teaches
Each links to its glossary definition, which also names the authority behind it and the components that render it.
- Allowance for credit lossesThe contra-asset holding the expected credit losses on receivables, so AR is presented at the amount expected to be collected
- Bad debt expenseThe P&L charge that builds the allowance for credit losses — the provision, not the write-off
- CECLCurrent expected credit losses — the ASC 326 model that books lifetime expected losses from day one using history, current conditions and reasonable forecasts. ASU 2025-05 adds a practical expedient for current AR and contract assets
- Write-offRemoving an uncollectible receivable against the allowance for credit losses — under the allowance method it has no P&L effect; the expense was taken in the provision
- Contra accountAn account with the opposite normal balance to its type, presented as a deduction from its parent — accumulated depreciation against PP&E, the allowance against ARConvention
See also
- Journal entry for bad debt expenseUnder the allowance method, at each period-end debit Credit loss expense (bad debt expense) and credit Allowance for credit losses for the amount needed to bring the allowance to the expected loss on open receivables.
- Journal entry for writing off accounts receivableTo write off an uncollectible invoice under the allowance method, debit Allowance for credit losses and credit Accounts receivable. If the customer later pays, reinstate the receivable (debit Accounts receivable, credit Allowance) and record the cash.
- Bad debt expense vs write-offBad debt expense hits the P&L when the allowance for expected credit losses is built. A write-off comes later: it removes one specific invoice from receivables against that allowance and leaves the P&L alone.
- Bad debt and write-offs: allowance vs direct methodHow to book a customer who won’t pay: the GAAP allowance under ASC 326, the direct write-off the IRS requires, and what to do if the money comes back.
- Allowance for credit lossesAn estimate of the receivables you don't expect to collect, booked against receivables before any customer defaults. GAAP calls the model CECL, for current expected credit losses.