We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.

What Is a Valuation Allowance?

By Osmand Vitez
Updated May 16, 2024
Our promise to you
SmartCapitalMind is dedicated to creating trustworthy, high-quality content that always prioritizes transparency, integrity, and inclusivity above all else. Our ensure that our content creation and review process includes rigorous fact-checking, evidence-based, and continual updates to ensure accuracy and reliability.

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

Editorial Standards

At SmartCapitalMind, we are committed to creating content that you can trust. Our editorial process is designed to ensure that every piece of content we publish is accurate, reliable, and informative.

Our team of experienced writers and editors follows a strict set of guidelines to ensure the highest quality content. We conduct thorough research, fact-check all information, and rely on credible sources to back up our claims. Our content is reviewed by subject-matter experts to ensure accuracy and clarity.

We believe in transparency and maintain editorial independence from our advertisers. Our team does not receive direct compensation from advertisers, allowing us to create unbiased content that prioritizes your interests.

A valuation allowance represents funds set aside for a specific purpose. Among the most common reasons for this allowance include a loss on investments, estimated amounts for uncollectible accounts, and depreciation for fixed assets. Accountants typically post a valuation allowance into a contra account. A contra account falls in the asset account group and resides on a company’s balance sheet. The difference with a contra account is that it has a natural credit balance, which is opposite from regular asset accounts.

Companies make a valuation allowance to adjust an item’s historical value as recorded in the company’s ledger. A contra account relates to an asset account and usually has an account number close to the original. Taken together, the original asset account with a debit balance will net against the contra account with a credit balance. The difference represents the actual value of the item in a current fair value estimate. Each asset item has its own contra account for this process.

Accounts receivable is a common example of a valuation allowance. A company sells goods or services on credit, allowing customers to pay bills over time. Many companies allow customers 30 days to pay off their open accounts receivable balance. Accountants estimate how many open receivables will go uncollected from customers who do not pay their bills. Accountants make an allowance using one of two methods to create this figure.

The percent of sales or percent of receivables are two common valuation allowance methods used for accounts receivable. The former method requires accountants to review previous credit sales to determine how many of them were written off. The percent of receivables method is similar; accountants look at previous receivables written off and create a percentage to apply to current receivables. The bad debt percentage, applied to current open accounts receivables, indicates the valuation allowance for bad debts. Accountants post this figure into a bad debt allowance account, which is a contra asset that nets against current accounts receivable.

Valuation methods for other items, particularly assets, work in a very similar method. Accountants must find the current value of items through estimates or looking at the current market price for items. In most cases, items lose value and need adjustment so a company represents its true financial value. National accounting standards often call this method mark-to-market accounting or fair value accounting. Accountants must stay within these guidelines to ensure they make the proper valuation allowance for assets.

SmartCapitalMind is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Discussion Comments
SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.

SmartCapitalMind, in your inbox

Our latest articles, guides, and more, delivered daily.