Allowance for Doubtful Accounts

Allowance for Doubtful Accounts

Purpose

This policy establishes how our firm estimates and records the Allowance for Doubtful Accounts using the Percentage of Sales Method. The goal is to ensure consistent, reasonable, and supportable estimates of uncollectible revenue in accordance with generally accepted accounting principles (GAAP).

Policy Overview

Our firm uses the Percentage of Sales Method to estimate bad debt expense. Under this method, a fixed percentage of sales is recognized as uncollectible for each reporting period. This approach aligns the expected cost of uncollectible accounts with the revenue that generated them.

Percentage Range

The standard percentage applied to credit sales will fall within the range of:
0.5% – 2.5% of total sales, rounded up to the nearest $100.
This range reflects typical risk levels for small‑to‑mid‑sized service‑based businesses and may be adjusted based on client‑specific factors.

Factors Considered When Selecting the Percentage

To determine the appropriate percentage within the approved range, staff should evaluate:
  1. Historical collection patterns
    1. Trends in prior write‑offs, late payments, and recovery rates.
  2. Customer base risk profile
    1. Concentration of high‑risk customers, industry volatility, or recurring delinquency.
  3. Current economic conditions
    1. Inflation, interest rates, recession indicators, or other macroeconomic pressures.
  4. Client specific circumstances
    1. Changes in credit policies, rapid growth, new customer segments, or operational shifts.
  5. Internal team insights
    1. Observations from staff who regularly interact with client receivables, including patterns of disputes, slow‑pay customers, or seasonal fluctuations.

Application of the Percentage

Once the percentage is selected:
  1. It is applied to total sales.
  2. The resulting amount is recorded as Bad Debt Expense for the period.
  3. The same amount is credited to the Allowance for Doubtful Accounts, a contra‑asset account.

Review and Adjustment

The selected percentage must be reviewed:
  1. At least annually, or
  2. Whenever significant changes occur in client risk, economic conditions, or collection trends.
Adjustments should remain within the 0.5%–2.5% range unless management approves an exception based on documented justification.

Confidentiality

All client financial information, internal assessments, and supporting documentation used to determine allowance percentages are confidential and must be handled in accordance with firm privacy standards.


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