Question

Historically, your company has calculated bad debts using an aging of accounts receivable. Near the end of the fiscal year, the company is in a cash crunch and needs to borrow money from the bank, using accounts receivable as collateral. The owner of the company knows that many of the accounts receivable are more than 90 days past due, resulting in net receivables equal to only 80% of total receivables.

Respond to the following in a minimum of 175 words:

• The owner asks you to change the method of estimating bad debts to a flat 3% of receivables. What should you do?

Answer 1

Late payments from customers are one of the top reasons why companies get into cash flow problems.One of the best ways to keep track of late payments and make sure they aren’t getting out of hand is to calculate the accounts receivable turnover ratio for your business.We calculate it by dividing total net sales by average accounts receivable.

Following up with late-paying customers can be stressful and time-consuming, but tackling the problem early can save you loads of trouble down the road. Here’s what you can do to encourage customers to pay you on time.

If the costs of collecting the debt start approaching the total value of the debt itself, it might be time to start thinking about writing the debt off as bad debt—that is, debt that is no longer of value to you. Bad debt can also result from a customer going bankrupt and being financially incapable of paying back their debts.

Now in case of the above the company has receivable outstanding of more than 90 days and out of which 80% seems to be recoverable. The company owner asking for change in the bad debt assessment to 3% shall be deeply analyzed based on the past trend of recoverability of debts.

Bad debts assessed at flat 3% cannot be concluded upfront without certain surety or past trend data.The bad debts shall be taken into consideration based on the estimates and the same shall be supported by some specific reason.

Apart from bad debts the provision for the bad debts of 20% shall be made in order to be safe side. The provision made shall also be assessed.

Thus we can consider the provision and 3% bad debt based on the recoverability assessment.