Accounting for bad debts is necessary yet not always straight forward. Both the income statements and the balance sheet are affected. To shareholders reviewing a company’s annual report, it is crucial to investigate the company’s bad debt standing.
On the income statement: The estimate of bad debts appears.
On the balance sheet: The estimate of uncollectible accounts appears as a subtraction from accounts receivable in the current assets section.
Two Aims in Accounting for Bad Debt
- To match the cost of bad debts to the sales revenue incurred for that time period. Some credit sales will result in being uncollectible along with other uncollected sales. An estimation is necessary because not all accounts will be proved uncollectible even at the year ‘s end. Therefore, to ensure the annual report reflects this year’s sales as accurately as possible an estimate of the uncollectible amount must be made if the company is to charge this year’s profits with bad-debts expense as accurately as possible.
- To place the correct value on the amount of accounts receivable recorded in the current assets section of the balance sheet. This is also just an estimation. The accounts remain listed in accounts receivable. Therefore, the company has not yet finalized them as bad debt.
These estimates can result in some conflicts between the income statement and the balance sheet. The estimates may be too high or too low, especially on quarterly reports. The annual report tends to be more accurate in its estimations and is therefore, more reliable overall.