An allowance is a reserve that is set aside in the expectation of expenses that will be incurred at a future date. The creation of a reserve essentially accelerates the recognition of an expense into the current period from the later period in which it would otherwise have been recognized. The intent of a reserve is to match expenses with the sales transactions with which they are associated. For example:
- An allowance is created for bad debts that are expected to arise from invoices sent to customers.
- An allowance is created for sales returns that are expected from current shipments to customers.
- An allowance is created for warranty claims expected from current shipments to customers.
The "allowance" term can also be used from the perspective of a customer order, where the sales staff gives an allowance that is essentially a price reduction, perhaps based on year-to-date order volume, or because an order is being placed within a time period designated as being subject to a discount.
The allowance concept can also apply to per diem travel and entertainment arrangements, where employees are paid a certain amount per day for their travel expenses, irrespective of the actual amount incurred. This practice can give rise to extreme frugality by employees, in order to earn a profit on the per diem amounts paid to them.