What is An Allowance And How To Record Allowances In Accounting

An allowance is a Contra Account which is deducted from the relevant accounts either on Income Statement or on Balance Sheet in order to match the Expenses with the relevant Revenues on income statement or to calculate the Net Realizable Value of relevant Accounts on balance sheet. Examples of allowances are Allowance for Doubtful Accounts, Allowance For Accumulated Depreciation, Sales Allowances, Purchases Allowances, etc.

In case of selling and buying of goods and services, an allowance is a reduction in the selling price offered by the seller to the buyer to retain the goods because of minor defects.

How To Record Allowances In Accounting

Recording of Allowances in Accounting depends upon the types of allowances which are described below:

1. Sales Allowances

2. Purchases Allowances

3. Allowance for Doubtful Accounts

4. Allowance for Accumulated Depreciation

 

1. Sales Allowances

Sales allowance is offered by the sellers to the buyers (which may be accepted or rejected by the buyer), so that the buyer may retain the minor defective goods at a below standard price. In this case, the journal entry is shown below:

                                    Sales Allowances a/c XXX

                                                                      Accounts Receivable a/c  XXX

                                               (Sales Allowances Given To Customers)

2. Purchases Allowances

When the buyer accepts the offer made by the seller to him, he received purchases allowance from the seller or supplier for retaining the minor defective goods at a below standard price.

In this case, the journal entry from the point view of business is shown below:

                                 Accounts Payable a/c  XXX

                                                                      Purchases Allowances a/c  XXX

                                     (Purchases Allowances Received From Seller / Supplier)

3. Allowance for Doubtful Accounts

Allowance for Doubtful Accounts / Provision for Doubtful Debts is an estimation of unpaid invoices either on the basis of percentage of sales (Income Statement-Approach) or Aging of Accounts Receivable (Balance Sheet-Approach).

The Journal Entry is given below:

       Uncollectible Accounts Expense a/c  XXX

                                                                Allowance for Doubtful Accounts a/c  XXX

                                   (Allowance for Doubtful Accounts is created for the Period)

4. Allowance for Accumulated Depreciation

It is the total of depreciation charged to expense in the relevant accounting periods.

The entry is recorded as shown below:

                   Depreciation a/c  XXX

                                               Allowance for Accumulated Depreciation a/c  XXX

                                                    (Depreciation for the Period is Recorded)