How allowance for doubtful accounts works
Rather than waiting until a specific customer fails to pay, businesses estimate upfront how much of their total receivables will probably go unpaid, based on history or the age of outstanding invoices. This estimate is recorded as a contra-asset account that sits next to accounts receivable and reduces its net value. Common estimation methods include a flat percentage of total sales or a more detailed percentage applied to each aging bucket separately.
When a specific invoice is later confirmed uncollectible, it is written off against the allowance rather than recorded as a new expense, since the estimate already accounted for it. The allowance is reviewed and adjusted periodically so it stays realistic as the customer base and payment history change. A well-maintained allowance also makes financial statements more useful for lenders, since it shows receivables at a realistic, collectible value rather than an inflated figure.
Example
A distributor has $200,000 in accounts receivable and estimates, based on past collection rates, that 2 percent will go unpaid. It sets up a $4,000 allowance for doubtful accounts, so the balance sheet shows net receivables of $196,000 instead of the full $200,000, giving a more realistic view of collectible cash.
Allowance for doubtful accounts in QuickBooks Online vs Xero
Not software-specific: both QuickBooks Online and Xero can track an allowance for doubtful accounts through a manually created contra-asset account, since neither platform calculates the estimate automatically. Many businesses maintain a simple spreadsheet based on aging report data to calculate the allowance percentage each period. The estimate itself is a judgment call based on history, not a figure either platform can calculate for you.
Related terms
How LedgerBPO handles allowance for doubtful accounts
We calculate and maintain your allowance for doubtful accounts based on your actual aging and collection history, then update it each period as the picture changes. A dedicated accountant reviews the estimate during month-end close. You get a balance sheet that reflects what you can realistically expect to collect. We adjust the allowance percentage as your customer base and payment history change over time.