# 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.

Source: https://lopifi.com/learn/adjusting-entries/allowance-for-credit-losses
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**How do you estimate the allowance for credit losses under CECL?** 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](https://lopifi.com/md/glossary/cecl) 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](https://lopifi.com/md/glossary/bad-debt-expense). The credit goes to [1290 Allowance for credit losses](https://lopifi.com/md/glossary/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.

> “The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management’s current estimate of expected credit losses on financial asset(s).”

© Financial Accounting Foundation. All rights reserved.

— [ASC 326-20-30-1](https://asc.fasb.org/326/tableOfContent), The allowance presents receivables at the amount expected to be collected

When a specific invoice goes bad (say the customer goes under in November), it's [written off](https://lopifi.com/md/glossary/write-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 page's rules come from

- [ASC 326-20-30-1](https://asc.fasb.org/326/tableOfContent) — The allowance presents receivables at the amount expected to be collected (codification)
- [ASC 326](https://asc.fasb.org/326/tableOfContent) — Financial Instruments — Credit Losses (codification)

## Read further

- https://lopifi.com/md/journal-entries/bad-debt-expense
- https://lopifi.com/md/journal-entries/write-off-accounts-receivable
- https://lopifi.com/md/differences/bad-debt-expense-vs-write-off
- https://lopifi.com/md/startups/bad-debt-and-write-offs
- https://lopifi.com/md/accounting/asc-326

- **Track:** [Accounting](https://lopifi.com/md/learn/accounting)
- **Part of:** [Adjusting entries](https://lopifi.com/md/learn/adjusting-entries) — 5 min
- **Terms taught:** [Allowance for credit losses](https://lopifi.com/md/glossary/allowance-for-credit-losses), [Bad debt expense](https://lopifi.com/md/glossary/bad-debt-expense), [CECL](https://lopifi.com/md/glossary/cecl), [Write-off](https://lopifi.com/md/glossary/write-off), [Contra account](https://lopifi.com/md/glossary/contra-account)
- **Previous:** [Adjusting entries](https://lopifi.com/md/learn/adjusting-entries)
- **Next:** [The income statement, Accounting · Lesson 10](https://lopifi.com/md/learn/the-income-statement)
- **The course:** https://lopifi.com/md/learn