A contra asset that represents management’s estimate of the amount of accounts receivable (A/Rs) that will not be paid back by the debtors (and hence become bad debts). The allowance (also, a provision or reserve) is set aside to cover uncollectible debts (receivables, notes, loans, etc.) in case customers (in credit sales) default on their payments. In that sense, this allowance is used as a tool to control the potential risks associated with an entity’s loans and credit sales.

In accrual-basis accounting, the allowance is recognized at the same time of a corresponding transaction in order to enhance the accuracy of financial reports. That implies that a bad debt expense is matched against the credit transaction, so that a more accurate picture of revenue and expenses can be formed, for a given reporting period.

The creation and maintenance of allowance for doubtful accounts also aim to stabilize operating results by softening the impact of uncollectible accounts, particularly in the case such accounts are written off (prompting recognition of a bad debt expense).

The allowance for doubtful accounts (ADA or AFDA) is also known as a bad debt reserve (BDR).