Technical definition
A contra-asset estimate that reduces receivables to the amount expected to be collected.
How it works
Expected credit losses are estimated before specific customers necessarily default. The estimate records bad-debt expense and a credit allowance; later write-offs use the allowance rather than creating the full expense at that later date.
Everyday example
Receivables of $40,000 with expected losses of 3% require an allowance of $1,200 and net receivables of $38,800.
Common pitfall
The allowance is an estimate of portfolio losses, not a separate cash reserve.