Question

Chapter 8 - overview with Kimmel : How should companies report receivables in the financial statements? Does it prove to be problematic for companies to determine the amount to report in the financial statements?

Answer 1

How should companies report receivables in the financial statements?  

Companies should report receivables in the financial statements at NET REALIZABLE VALUE as on the reporting date. Net realizable value is the proceeds that the firm can expect to be collected from the total receivables as on reporting date. Usually, gross receivables shall be reduced by allowance for doubtful accounts so as to estimate the net realizable value. Some companies will directly deduct the estimated doubtful accounts from receivables and report receivables after deducting such estimated doubtful accounts related figure. Former is called as ALLOWANCE METHOD and the later is called as DIRECT WRITE-OFF METHOD.

Does it prove to be problematic for companies to determine the amount to report in the financial statements?

Yes, it proves to be problematic for companies to determine the amount to report in the financial statements because estimation of doubtful accounts is based on companies past collection trend and management personnel's judgements which may not be accurate always. As market and customer trends are unpredictable and estimates are just estimates and not certain, the amount of net realizable value reported as on a particular reporting date by the management will be problematic if such estimate goes wrong. Sometimes, the estimated doubtful accounts may be higher than the actual doubtful debts that turn around during the reporting period. In such case, management will be on safe boat so that they can write-off the excess allowance created to current year's income statement. Suppose, if the estimated doubtful accounts is lesser than the actual doubtful debts that turn around during the reporting period, management violates the matching principle which states that the expenses related to generating current reporting period's revenues shall be reported during the current period and only those expenditures shall be reported as expenditures for the current period. Because of lesser allowance created during previous period in later case, expenditures related to previous reporting period are deferred to current period. As a result, previous year's net income would have been reported high and current year's net income will be lesser due to excess doubtful debts written off during current period though related to previous period. Hence, it proves to be problematic for companies to determine the amount to report in the financial statements.