Difference between Expense and Allowance

The account Bad Debts Expense reports the credit losses that occur during the period of time covered by the income statement. Bad Debts Expense is a temporary account on the income statement, meaning it is closed at the end of each accounting year. (Closed means the account balance is transferred to retained earnings, perhaps through an income summary account.) By closing Bad Debts Expense and resetting its balance to zero, the account is ready to receive and tally the credit losses for the next accounting year.

The Allowance for Doubtful Accounts reports on the balance sheet the estimated amount of uncollectible accounts that are included in Accounts Receivable. Balance sheet accounts are almost always permanent accounts, meaning their balances carry forward to the next accounting period. In other words, they are not closed and their balances are not reset to zero.

Because the Bad Debts Expense account is closed each year, while the Allowance for Doubtful Accounts is not, these two balances will most likely not be equal after the company's first year of operations.

For example, let's assume that at the end of its first year of operations a company's Bad Debts Expense had a debit balance of $14,000 and its Allowance for Doubtful Accounts had a credit balance of $14,000. Because the income statement account balances are closed at the end of the year, the company's opening balance in Bad Debts Expense for the second year of operations is $0. The credit balance of $14,000 in Allowance for Doubtful Accounts, however, carries forward to the second year. If an adjusting entry of $3,000 is made during year 2, Bad Debts Expense will report a $3,000 debit balance, while Allowance for Doubtful Accounts might report a credit balance of $17,000.

Again, the reasons for the account balance differences are 1) Bad Debts Expense is a temporary account that reports credit losses only for the period shown on the income statement, and 2) Allowance for Doubtful Accounts is a permanent account that reports an estimated amount for all of the uncollectible receivables reported in the asset Accounts Receivable as of the balance sheet date.