Definition
The allowance for credit losses is a contra-asset that brings amortized cost down to the net amount expected to be collected. Under ASC 326-20, it reflects lifetime expected credit losses based on past events, current conditions, and reasonable and supportable forecasts, and is recognized when the asset is first recorded. Changes flow through credit loss expense, and write-offs reduce the allowance.
Why it matters in an audit or review
It is an estimate, so AU-C 540 applies. Auditors test the pooling of similar receivables, the loss rates, adjustments for current and forecast conditions, and the aging data. Under ASU 2025-05 (fiscal years beginning after December 15, 2025), entities may use a practical expedient that assumes current conditions persist for current receivables and contract assets, and a nonpublic entity may also elect, as an accounting policy, to consider collections after the balance sheet date.
Example
(Illustrative) An aging matrix applies 0.5% to current balances of $600,000, 3% to 1-30 days past due of $120,000, and 10% to 31-60 days of $50,000. Allowance equals 3,000 + 3,600 + 5,000 = $11,600. If the existing allowance is $8,000:
Dr Credit loss expense 3,600 Cr Allowance for credit losses 3,600
Common mistakes
- Applying historical rates without a forecast adjustment.
- Not pooling by risk characteristics.
Sources
- FASB ASC 326-20, Financial Instruments, Credit Losses, Measured at Amortized Cost
- FASB ASU 2025-05, Measurement of Credit Losses for Accounts Receivable and Contract Assets (annual periods beginning after December 15, 2025)
- AICPA, AU-C Section 540, Auditing Accounting Estimates and Related Disclosures
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error