Christian Debt Recovery

Bad Debt Expense Gaap

September 21st, 2010 |

Author: Gavin

The A/R side of Matching

GAAP defines the Matching Principle as a cornerstone of accrual based accounting in which expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, may cost be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue).

The Accrual basis of accounting is a method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service). Expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid at the time the expense was incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance

Accounts receivable (A/R) is an accouting transaction dealing with the billing of customers who owe money to an entity for goods and/or services that have been provided to the customers. On the balance sheet, accounts receivable is the amount that customers owe to that company. They are classified as current assets assuming that they are due within one year. To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account. When the customer pays off their accounts, one debits cash and credits the receivable in the journal entry. The ending balance on the trial balance sheet for accounts receivable is always debit.

There are two methods available to corporations for measuring the net value of account receivables: the direct write off method and the allowance method. The first method, the direct write-off method, is simpler than the allowance method. It allows for one simple entry to reduce accounts receivable to its net realizable value. The entry would consist of debiting a bad debt expense account and crediting the respective account receivable in the ledger. The allowance method establishes a liability account that has the effect of reducing the balance for accounts receivable. The amount of bad debt can be computed in two ways – either by reviewing each individual debt and deciding whether it is doubtful or by providing for a fixed percentage. The change in the bad debt provision from year to year is posted to the bad debt expense account in the income statement. These two methods are not mutually exclusive, although some businesses will have a provision for doubtful accounts and will also write off specific debts that they know to be bad.

For tax reporting purposes, a general provision for bad debts is not an allowable deduction from profit. However, to avoid overstating receivables in the balance sheet, companies may choose to have a general provision against bad debts which fall in line with their past experience of customer payments.

To remain financially sound, businesses must practice proper reporting consistently. And though there are fine lines when dealing with accounts receivables, the fundamentals are spelled out rather clearly.

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