Bad debt disciussion
1. Identify the parties likely to be affected by this proposed action.
The parties that are likely to be affected include the company itself, shareholders, financial auditors, financial analysts, potential investors.
2. How will reducing the provision for uncollectible accounts affect the income statement and the balance sheet?
Balance Sheet: When the Allowance for Uncollectible Accounts, a contra asset account, is reported on the balance sheet, the company expects that some of its accounts receivable will not be collected. It will debit Bad Debt Expense and credit Allowance for Uncollectible Accounts. This will result in reduction of “Current Assets” on balance sheet.
Income Statement: This will also result in an expense on the income statement (Earlier than it would have been under direct write-off). This will reduce the Net Income by the Bad Debt Allowance Amount.
If the Bad Debt allowance is not in line with the actual write-offs trend in previous periods, this gives company an advantage of Net Income not being reduced by the amount it actually should have been. So the EPS might appear to be higher than what it actually is.
3. How will reducing the provision for uncollectible accounts in the current period affect the income statement and the balance sheet in a future period?
In the future period – If there is an Allowance balance from previous period – It will be carried on as Beginning Allowance Balance. The Bad Debt Allowance to be allocated for future period will be less by this balance.
If in the future, if the Actual Write-off happens, it will be considered as an “Expense” . It will not change Account Receivables in future period unless another Bad Deb Allowance is allocated.
4. What argument might the CFO use to convince the company's internal auditors that this action is justified?
If recorded cumulative bad debt allowance was higher than actual write-offs over the few years, CFO can justify this reduction of bad debt allowance action by citing that
The parties that are likely to be affected include the company itself, shareholders, financial auditors, financial analysts, potential investors.
2. How will reducing the provision for uncollectible accounts affect the income statement and the balance sheet?
Balance Sheet: When the Allowance for Uncollectible Accounts, a contra asset account, is reported on the balance sheet, the company expects that some of its accounts receivable will not be collected. It will debit Bad Debt Expense and credit Allowance for Uncollectible Accounts. This will result in reduction of “Current Assets” on balance sheet.
Income Statement: This will also result in an expense on the income statement (Earlier than it would have been under direct write-off). This will reduce the Net Income by the Bad Debt Allowance Amount.
If the Bad Debt allowance is not in line with the actual write-offs trend in previous periods, this gives company an advantage of Net Income not being reduced by the amount it actually should have been. So the EPS might appear to be higher than what it actually is.
3. How will reducing the provision for uncollectible accounts in the current period affect the income statement and the balance sheet in a future period?
In the future period – If there is an Allowance balance from previous period – It will be carried on as Beginning Allowance Balance. The Bad Debt Allowance to be allocated for future period will be less by this balance.
If in the future, if the Actual Write-off happens, it will be considered as an “Expense” . It will not change Account Receivables in future period unless another Bad Deb Allowance is allocated.
4. What argument might the CFO use to convince the company's internal auditors that this action is justified?
If recorded cumulative bad debt allowance was higher than actual write-offs over the few years, CFO can justify this reduction of bad debt allowance action by citing that