Allowance for Doubtful Accounts Policy

Allowance for Doubtful Accounts is the estimation of Net Sales or closing balance of Accounts Receivable in order to find out Net Realizable Value of Accounts Receivable. It is the requirement of Matching Principle, so that Sales must be matched with Uncollectible Accounts Expense / Doubtful Debts. For this purpose, allowance for doubt accounts policy is adopted to check credit sales with customers so that there should be less chance of Bad Debts Written Off.

There are Three Types of Allowance for Doubtful Accounts Policy

(i) Sound Credit Policy

Such policy is adopted when the company wants to increase credit sales with those customers who are reliable in making payment based on their past experiences and dealings with the company.

Making a Sound Credit Policy encourages customers to make credit sales as much as they like. As a result, many customers make credit sales and hence the amount of unpaid invoices increases. The management makes credit sales to customers based on past experiences and dealings with the company and hence very less possibilities of bad debts for the company.

Strict Credit Policy

If the Credit Policy is too strict, then the company discourages the customers to make credit sales with them as most of these customers don’t have good credit standing or the company needs cash to meet current obligations i.e., it wants to improve Working Capital to operate the business.

Liberal / Easier Or Lenient Credit Policy

If the credit policy is too lenient, then it encourage every customer to make credit sales with the company whether the credibility of the customer is good or low standing. It is very risky option but if the company has enough cash to meet obligations, then this policy may work to increase number of sales and gains profits at the end. But the company may change this aggressive credit policy if it fails for few months.