Accounting: The Language of Business (Part 43)

If there was a tax difference, my accountants have paid everything off. 

Unknown

Receivables (Part B)

by

Charles Lamson

Uncollectible Receivables

In prior posts, we described and illustrated the accounting for transactions involving sales of merchandise or services on credit. A major issue that we have not yet discussed is uncollectible receivables from these transactions.

Businesses attempt to limit the number and amount of uncollectible receivables by using various controls. The primary controls in this area involve the credit-granting function. These controls normally involve investigating customer creditworthiness, using references and background checks. For example, most of us have completed credit application forms requiring such information. Companies may also impose credit limits on new customers. For example, you may have been limited to a maximum of $500 or $1,000 when your credit card was first issued to you.

Once a receivable is past due, companies should use procedures to maximize the collection of an account. After repeated attempts at collection, such procedures may include turning an account over to a collection agency.

Retail businesses often attempt to shift the risk of uncontrollable receivables to other companies. For example, some retailers do not accept sales on account but will only accept cash or credit cards. Such policies effectively shift the risk to the credit card companies. Other retailers, however, have issued their own credit cards.

Companies often sell their receivables to other companies. This transaction is called factoring the receivables, and the buyer of the receivables is called a factor. An advantage of factoring is that the company selling its receivables receives immediate cash for operating and other needs. In addition, depending upon the factoring agreement, some of the risk of uncollectible accounts may be shifted to the factor.

Regardless of the care used in granting credit and the collection procedures used, a part of the credit sales will not be collectible. The operating expense incurred because of the failure to collect receivables is called uncollectible accounts expense, bad debts expense, or doubtful accounts expense.

When does an account or a note become uncollectible? There is no general rule for determining when an account becomes uncollectible. The fact that a debtor fails to pay an account according to a sales contract or fails to pay a note on the due date does not necessarily mean that the account will be uncollectible. The debtor's bankruptcy is one of the most significant indications of partial or complete uncollectability. Other indications include the closing of the customer's business and the failure of repeated attempts to collect.

There are two methods of accounting for receivables that appear to be uncollectible. The allowance method provides an expense for uncollectible receivables in advance of their write-off. The other procedure, called the direct write-off method, recognizes the expense only when accounts are judged to be worthless. We will discuss each of these methods in the next couple posts. 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 320-321*

end