Companies often sell to their customers on credit. The amount the customers owe is called accounts receivable. We would record accounts receivable at the same time the sale is made. When customers pay the payment is subtracted from their accounts receivable balance. .
Most companies use an Accounts Receivable Subsidiary Ledger, which is similar to the General Ledger. The subsidiary ledger contains detailed information about each customer's account including purchases, payments, returns and adjustments. Most companies send statements at the end of each month that list the monthly transactions and ending balance due from each customer. .
When businesses sell on credit, they run the risk that some customers will not pay their bill. Errors in billing are dealt with in an appropriate manner, and the books are adjusted as needed to correct any errors, or show returns and allowances. Still, some customers don't pay their bill and there is a way to deal with this in the books, and on the financial statements. .
This is done by setting up an account called the Allowance for Doubtful Accounts which is a contra-asset account. It has an opposite balance of an accounts receivable account. The allowance account is established each year at balance sheet date. An accounts receivable aging report is generated, which gives a history of customers accounts and which customers are late paying their bills by 30 day, 60 days, or 90 days. It is expected that if a customer has not paid their bill after 90 days there is a good chance they won't pay at all. The risk of loss goes up as accounts go unpaid for longer periods of time. .
The Allowance method is used for larger businesses that need to make an estimate of how much of the accounts receivable will not be paid before they actually write it off The concept is pretty simple. The company estimates a percentage that is going to be uncollectible and records this information in a journal entry.