Question: Accounts receivable and the offsetting allowance for doubtful accounts are netted with the resulting
figure reported on the balance sheet1.How does the existence of doubtful accounts affect the income statement?
Sales are made but a portion of the resulting receivables must be reduced because collection is rarely expected to
be 100 percent. Does an increase in this allowance create an expense for the reporting company?
Answer: Previously, an expense was defined as a measure of the outflow or reduction of net assets caused by
the reporting company’s attempt to generate revenues. If receivables are recorded that will eventually have to be
removed because they cannot be collected, an expense occurs. In financial reporting, terms such as “bad debt
expense,” “doubtful accounts expense,” or “the provision for uncollectible accounts” are often encountered.
The inherent uncertainty as to the amount of cash that will actually be received affects the physical recording
process. To illustrate, assume that a company makes sales on account to one hundred different customers late in
Year One for $1,000 each. The earning process is substantially complete at the time of sale and the amount of cash
to be received can be reasonably estimated. According to the revenue realization principle found within accrual
accounting, the company should immediately recognize the $100,000 revenue generated by these transactions.
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