What is an ‘Quota For Bad Debt’
An allowance for bad debt, also known as an allowance for doubtful accounts, is a valuation account reach-me-down to estimate the portion of a bank’s loan portfolio that may ultimately be uncollectible. When a borrower defaults on a loan, the deduction for bad debt account and the loan receivable balance are both reduced for the lyrics value of the loan, or the outstanding loan balance. The allowance for doubtful accounts method is also old to record the accounts receivable that are not collectible.
BREAKING DOWN ‘Concession For Bad Debt’
An allowance for bad debt is used by lenders because the face value of a bank’s sum up loan balance is not the actual balance that is ultimately collected, since a part of the loans may default. When a borrower does not pay the principal or interest amount due on a allowance, that loan is considered to be in default, and the allowance for doubtful accounts method values the lender’s estimation for the loans that may default.
Allowance for Bad Debt and Loan Losses
Take, for example, that a lender has a $100 million loan portfolio, and the partnership uses the allowance for doubtful accounts method for bad debt. The lender determines that 2%, or $2 million, of the loan balance is at risk of inaction so the firm increases bad debt expense in the income statement, and the allowance for dubious accounts is increased by $2 million.
The allowance for doubtful accounts is a contra-asset account, drift that the allowance account reduces the loan receivable account when both remainders are listed in the balance sheet. This financial reporting helps the infer from understand the number of loans that may default. Lenders also refer to this opponent as a provision for loan loss, and some lenders may use slightly different accounts inscriptions.
Factoring in Defaults
When a lender confirms that a specific allowance balance is in default, the company reduces the allowance for doubtful accounts difference and reduces the loan receivable balance, because the loan default is no longer really part of a bad debt estimate. After this entry, the accounting logs have a balance in bad debt expense and a reduction in the loan receivable command for the loan that actually defaulted.
When Allowance Accounts Are Close
The allowance for doubtful accounts always reflects the current balance of accommodations that are expected to default, and the balance is adjusted over time to be noticeable that balance. If, for example, a lender estimates that $2 million of the credit balance is at risk of default, and the allowance account already has a $1 million steady, the adjusting entry to bad debt expense and to increase the allowance account is an additional $1 million.