Question: When financial statements are prepared, an expense must be recognized and the receivable balance
reduced to net realizable value. However, in the above adjusting entry, why was the accounts receivable account
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not directly decreased by $7,000 to the anticipated balance of $93,000? This approach is simpler as well as easier
to understand. Why was the $7,000 added to an allowance account?
In reporting receivables, why go to the trouble of setting up a separate allowance?
Answer: When the company prepares this adjustment at the end of Year One, it does not yet know which accounts
will fail to be collected. Officials are only guessing that $7,000 will prove worthless. Plus, on the date of the
balance sheet, the company actually does hold $100,000 in accounts receivable. That figure cannot be reduced
directly until the specific identity of the accounts to be written off has been determined. Utilizing a separate
allowance allows the company to communicate the expected amount of cash while still maintaining a record of
all balances in the accounts receivable T-account.