Doubtful accounts receivable is Concept, types, general write-off rules

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

As part of doing business, companies often have to deal with transactions related to the emergence of receivables. The presence of a large number of nuances and subtleties, due to the peculiarities of recognizing this small trouble and reflecting it in documents, can often cause questions from accountants and reporting users. However, this problem will not present great difficulties if we consider in detail all the features associated with the recognition and reflection of debt in the framework of accounting. This article is devoted to these aspects.

What is accounts receivable and when does it arise?

In the course of a company's business activities, it is often necessary to interact with customers who purchase its products and services, and suppliers who provide materials and components for a fee. DZ (accounts receivable)occurs during this interaction in the following cases:

• The company has transferred goods to customers, but has not yet received the proceeds for these goods. It is assumed that the customer will pay for the goods later.
• The company has paid for the materials, but has not yet received them. The supplier is expected to deliver materials at a later date.

That is, we can say that if a company has a PD, then there are economic entities that owe it something. Accounts receivable should not be confused with accounts payable. The fact that the firm has the latter means that there are economic entities to which this company owes. However, receivables from one company are often accounts payable from another.

Impact of accounts receivable on business

The impact of having accounts receivable on doing business is controversial. On the one hand, it allows you to significantly expand business opportunities. The entities with which the company interacts do not always have enough funds to fully pay for goods and services. Then DM is one of the few means that makes interaction possible.

However, it must be remembered that receivables are the value of goods that were sold but not paid for, or materials that were bought but not received for use. Accordingly, it always causes the diversion of funds from circulation, their temporary deadening. Therefore, if the volume of accounts receivabletoo large, it does not contribute to the development of business, but rather, on the contrary, hinders its expansion. In addition, there is always a risk that the debt will not be returned, which inevitably leads to financial losses and may even lead to the bankruptcy of the company. For this reason, debt tolerance must be approached very carefully, carefully weighing all the risks and possible benefits.

Accounts receivable in company accounts

The amount of accounts receivable can be found by looking at the company's balance sheet. It is located in the current assets of the balance sheet. This category is presented without a reserve for doubtful debts, that is, without additional funds that the company may theoretically not recover from debtors.

Sale of the company's debts and liquidity of the company

Elements of the second section of the balance sheet are arranged in order of increasing degree of their liquidity. This concept is understood as its ability to transform into money in a relatively short period of time. The most illiquid part of the balance sheet is inventory, as selling them is the most difficult task. Selling DZ is also not an easy task, but a realizable one. The probability of a successful sale of debt depends on its conditions: term, reliability of the debtor, and so on. There are frequent cases of sale of remote control at a lower price, due to lack of demand or tight deadlines.

Doubtful debts

A doubtful receivable is an amount that a company may never get back. Forin order for it to be recognized as doubtful, it must meet the following conditions:

• Debt arose in the course of operating activities, that is, one that is the direct purpose of the company's existence.
• Debt is not returned within the period specified in the contract. If there is no term in it, then in order to determine it, it is necessary to refer to laws, regulations and other official sources of law.
• There should be no pledge or surety in relation to the debt, since otherwise it can be claimed from another person who is the guarantor, or obtained by selling the pledged item.

It is important to remember that a PD is dubious if it meets all three of these conditions. Accounting for doubtful receivables is characterized by the presence of some features that distinguish it from simple accounting.

The presence of such a problem does not mean that the funds are lost forever. Doubtful accounts receivable is an amount, the collection of which is still real. True, this happens extremely rarely, but if you act quickly and within the framework of the law, then everything can turn out in a very favorable way. Accounts receivable for doubtful debts are written off in case of their full repayment.

Bad accounts receivable

Doubtful accounts receivable should not be confused with bad debts. The latter is almost impossible to return. For a debt to be considered uncollectible,any of these conditions are met:

• The company cannot go to court to recover the amount from the debtor for legal reasons.
• The debtor company is liquidated. In this case, there is no economic entity that could return the debt, so its collection cannot be realized in any way.

Both of these conditions are equivalent, and to recognize the debt as uncollectible, it is enough to fulfill at least one of the conditions.

Doubtful accounts receivable on balance sheet

Let's consider some accounting features of this phenomenon. The share of doubtful receivables affects its total value. So, if the company failed to recognize the fact of doubtfulness, then the entire debt is reflected as receivable. If everything fully complies with the conditions specified earlier in the article, then a reserve for doubtful debts of receivables is calculated to the liability. This provision reduces the total amount shown in section 2 of the company's balance sheet.

Doubtful receivables are written off at the expense of the amount of the reserve, if, of course, it was created as part of the accounting policy. If the amount of the liability is greater than the amount of the provision, then the difference is written off to the company's expenses, reduces the amount of income tax and, therefore, increases the amount of net profit.

Why do you need a reserve for doubtful debts?

This reserve is necessary if there are serious reasons to believe that the debt will not be paid on time. Doubtful accounts receivableindebtedness is a factor that can harm the financial well-being of a company, and in order to reduce its impact on the business, the above reserve exists.

The scheme of work is as follows: firstly, the company must indicate in the accounting policy the fact of creating a reserve. Based on the accounting data for doubtful receivables, the organization calculates the amount of the provision. It is then deducted from profits, thereby reducing tax payments and increasing net income.

Features of creation

How to create a provision for doubtful accounts receivable? Its value depends on how long the debt is due. Establishing these deadlines is a fairly reasonable decision of the state, since doubtful receivables are debts that are not returned on time, and, of course, the likelihood that a liability will be returned, the delay for which is 10-15 days, is much higher than if this time was six months or a year. Accordingly, due to differences in the probability of repayment of debt, there is also a difference in the volume of recognized reserves.

So, if the counterparty does not repay the debt within a period of one to 45 days, this receivable cannot be recognized as doubtful, since this period is too short. Doing business is not always predictable, perhaps the counterparty does not return the debt due to the presence of an unforeseen cash gap, respectively, for this reason, such types of debts are not recognized as doubtful, notincrease the amount of the reserve and do not reduce the amount of income tax paid

If the term of the debt is from 45 to 90 days, then it is recognized in the amount of 50% of the total amount, increasing the amount of the provision by this amount.

Receivables over 90 days are recognized in full.

The debt inventory process and its importance

The determination of the above terms occurs in the process of inventory of doubtful receivables. After this transaction, the reserve is adjusted as follows:

• If the counterparty repays a debt that was previously considered doubtful, then the amount of the liability is restored, respectively, the volume of the reserve is reduced by this amount. In addition, the company will be required to pay income tax, the basis of which is the amount of debt received.
• If the counterparty does not return the debt, then its value is fully written off from the reserve. If it is formed, then the company does not have the right to write off the debt at the expense of other means.

Receivables management

Formation of a reserve is a frequently used, but far from the only tool for managing receivables. The main objective of this process is to reduce the time for repayment of debt and reduce the likelihood of losses due to dishonesty of counterparties. However, there are other ways to achieve this goal.

So, in case the DZmust be converted into cash, it can be sold. True, in this case, there is a possibility of losses.

In addition, it is possible to provide preferential terms of interaction for suppliers and customers who settle accounts with the company immediately or as soon as possible. These conditions may include discounts, reduced commissions, and so on.

In addition, at the moment there is an opportunity to check the integrity of debtors with the help of special services, which can also significantly reduce the likelihood of economic losses. There are special counterparty reliability factors compiled on the basis of a survey of its suppliers.

DZ is a unique tool that allows companies to carry out intercompany interaction, as well as cooperation with clients, even if counterparties do not have the amount of funds sufficient to implement various business operations.