Understanding Accounts Receivable and Allowance for Doubtful Accounts for the U.S. FAR CPA Exam
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
Accounts receivable and the allowance for doubtful accounts are key indicators of a company's liquidity, and a well-tested topic on the FAR section of the CPA exam.
What are accounts receivable and the allowance for doubtful accounts?
Accounts receivable represents amounts owed to a business by customers for goods or services provided on credit. These are short-term assets, expected to be collected within a year or the operating cycle, whichever is longer.
The allowance for doubtful accounts is a contra-asset account that reduces accounts receivable to reflect the amount expected to be uncollectible, based on historical data or another reasonable estimation method.
How are these recognized and measured?
Under U.S. GAAP, accounts receivable are initially recorded at their transaction price. An allowance for doubtful accounts is then established to account for estimated future credit losses.
How do you record a credit sale?
Example: A company sells goods worth $20,000 on credit.
- Debit Accounts Receivable $20,000
- Credit Sales Revenue $20,000
How do you establish the allowance?
Example: Based on historical data, the company estimates that 2% of the $20,000 in credit sales will be uncollectible: $20,000 × 2% = $400.
- Debit Bad Debt Expense $400
- Credit Allowance for Doubtful Accounts $400
How do you write off an uncollectible account?
Example: The company identifies a specific $500 receivable that won't be collected.
- Debit Allowance for Doubtful Accounts $500
- Credit Accounts Receivable $500
What if a written-off account is later recovered?
Example: The company later recovers $200 from an account previously written off. This takes two steps — first reinstate the receivable, then record the collection like any other payment:
- Debit Accounts Receivable $200
- Credit Allowance for Doubtful Accounts $200
- Debit Cash $200
- Credit Accounts Receivable $200
What gets disclosed?
Companies must clearly disclose their accounting policies for accounts receivable and bad debts, including how they estimate the allowance for doubtful accounts — information financial statement users need to assess the company's credit risk and liquidity.
The allowance method keeps accounts receivable stated at what's realistically collectible. Bad debt expense is estimated up front, write-offs reduce both the receivable and the allowance (not net income again), and a recovery simply reverses that process before recording the cash.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.