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The Daily Technical #93: What is the average cost method of inventory accounting?

How to answer "What is an allowance for doubtful accounts on the balance sheet?"

January 17, 2025

Good morning. Welcome to the 93rd edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
What is an allowance for doubtful accounts on the balance sheet?

Under US GAAP, the allowance for doubtful accounts estimates the percentage of uncollectible accounts receivable.

This line item is considered a contra-asset because it reduces the accounts receivable balance.

The allowance, often called a bad debt reserve, represents management’s estimate of the amount of A/R that appears unlikely to be paid by customers.

In effect, a more realistic value for A/R that'll actually be turning into cash is shown on the balance sheet, while preventing any sudden decreases in the company's A/R balance.

Common Mistakes

  1. Classifying the allowance for doubtful accounts as a liability. Remember, it is a contra-asset, not a liability.

  2. Overlooking that "allowance for doubtful accounts" is also known as a "bad debt reserve." Use these terms interchangeably to show a comprehensive understanding of accounts receivable management.

  3. Neglecting management's responsibility in determining the allowance. Highlight that management's judgment directly impacts the allowance amount.

TL;DR

  • Allowance for doubtful accounts estimates uncollectible receivables, following US GAAP.

  • Considered a contra-asset, it reduces accounts receivable to reflect realistic cash expectations.

  • It serves as a bad debt reserve, representing uncollectible receivables as assessed by management.

  • Prevents sudden A/R drops, ensuring financial accuracy on the balance sheet.

TODAY’S QUESTION
What is the average cost method of inventory accounting?

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