In accounting, "allowance for doubtful debts" refers to a technique used to account for potential Receivables that may not be collected in the future. It is a contra-asset account that reduces the Accounts Receivable balance on the Balance Sheet. This allowance is estimated based on historical data, customer payment behaviors, and other relevant factors to prepare for anticipated losses due to uncollectible debts. Companies create this allowance to show a realistic and fair perspective of their financial position. For instance, if a business expects that 2% of its credit sales might not be collected, it will record an allowance for doubtful debts for that estimated amount to reflect the potential loss realistically.

Consider an example: Enterprise A has accounts receivable of $100,000 at the end of the year. From past experiences, they anticipate that 5% of these receivables, or $5,000, may not be recoverable. They create or adjust an allowance for doubtful debts to show $95,000 as the net accounts receivable, providing a realistic value of collectible accounts.

This practice aligns with the Accrual Accounting principle, helping companies achieve a true and fair view of their financial statements and preparing for potential write-offs in future periods. Adjustments to this allowance may also be made during the Month End or Year End close procedures.