Accounts uncollectible are the receivables that most probably won't be paid. They also can be loans or other debts. The reason to this can be bankruptcy of borrower, death of borrower, fraud on the part of the debtor, not being able to prove the debt or an inability to find the debtor. Portion of credit sales in accounts receivables that company does not expect to collect from customer is named uncollectible accounts receivable. Uncollectible accounts appear in the valuation of receivables, in company’s balance sheet (Jackson, S. B., & Liu, X. 2010).
The vendor can sell good for cash or on credit. If the vendor has confidence in customer, he/she can sell on credit. If before paying debt, customer goes bankrupt, the receivable won't be paid. The account becomes uncollectible. The value should be taken away from accounts receivable and in result decrease income.
Balances of open accounts must have a reserve for bad debts because not all revenues from sale of product or services will be collected. The company must estimate how much money it will receive and how much it will not receive. Under generally acconting principles, we should establishing a write-off for uncollectible accounts receivables which creates a reserve. We get a more realistic value of the asset through reducing net of total accounts receivable by the reserve balance.
How to protect from accounts uncollectible
Uncollectible Accounts are almost in every company. Companies try to protect themselves against uncollectible accounts. To avoid or minimize it the company should check the solvency of the customer before he decides to cooperate with that customer. They should check standing of customers, limit sales on credit to only the most loyal ones, etc. This can protect the company from uncollectible accounts. That however only decreases possibility of occurrence. Other way can be insurance, which decreases consequences of that risk (Ezawa, K. J. & T. Schuermann 1995, p. 157).
It is difficult to determine whether a receivable is uncollectible. Usually the company may not analyze each account, instead they can specify a percentage of sales or accounts receivable or they may use a historical trend. It is clear that each company is aim to keep accounts uncollectible as low as possible.
- Cecchini, M., S. Jackson, X. Liu (2012). Do Initial Public Offering Firms Manage Accruals? Evidence from Individual Accounts. Review of Accounting Studies, 17(1), 22 - 40.
- Ezawa, K. J. & T. Schuermann (1995). Fraud/uncollectable debt detection using a Bayesian network based learning system: A rare binary outcome with mixed data structures. In P. Besnard & S. Hanks (Eds.), Proceedings of the Eleventh Conference on Uncertainty in Artificial Intelligence (pp. 157–166). San Francisco, CA: Morgan Kaufmann.
- Jackson, S. B., & Liu, X. (2010). The allowance for uncollectible accounts, conservatism, and earnings management. Journal of Accounting Research, 48(3), 565 - 601.
Author: Iwona Tuleja