Question

What does impairment on Accounts Receivable refer to and how is it different from bad/doubtful debts and its allowance?

Answer 1

As per US GAAP, trade receivables qualify as financial assets and would be considered impaired if its carrying amounts exceeds its recoverable amount. An impaired asset is a company's asset that has a market price less than the value listed on the company's balance sheet. Accounts that are likely to be written down are the company's goodwill, accounts receivable and long-term assets because the carrying value has a longer span of time for impairment. Upon adjusting an impaired asset’s carrying value, the loss is recognized on the company’s income statement.

The term bad debts usually refers to accounts receivable (or trade accounts receivable) that will not be collected.

The bad debts associated with accounts receivable is reported on the income statement as Bad Debts Expense or Uncollectible Accounts Expense.

When the allowance method is used, the journal entry to Bad Debts Expense will include a credit to Allowance for Doubtful Accounts, a contra account and valuation account to the asset Accounts Receivable. The allowance method anticipates the losses and therefore requires the use of estimates.

Under the direct write-off method, the Allowance for Doubtful Accounts is not used. Rather, Bad Debts Expense will be debited when an account receivable is actually written off. The credit in this entry will be to the asset Accounts Receivable.