When a company's Allowance for Doubtful Accounts is understated, the credit balance in this account is too small. This indicates that the company has reported too little of Bad Debts Expense and therefore too much net income.
Having a credit balance in the Allowance for Doubtful Accounts that is too small also means that the company is reporting too much for the following balance sheet items: net receivables, total current assets, working capital, total assets, and owner's equity.
