An estimation of the debt that a company is unlikely to recover. The allowance for credit losses is from the perspective of the selling company that extended credit to its buyers. A certain amount of credit losses can be anticipated, and these expected losses are included as a contra asset and as an expense in the company's balance sheet and income statement respectively.
The line item is usually "Allowance For Credit Losses" or "Allowance For Doubtful Accounts" or a "Bad Debt Expense" entry. A company can use statistical modeling such as default probability to determine its expected losses to delinquent and bad debt. The statistical calculations can utilize historical data from the institution as well as from the industry as a whole.
A certain percentage of loans are expected to become delinquent. The allowance for credit losses is an accounting technique that allows companies to take these anticipated losses into consideration in its financial statements to limit overstatement of potential income. Companies regularly make changes to the allowance for credit losses entry to correlate with the current statistical modeling allowances. Companies may have a bad debt reserve to offset these credit losses.