Question

When sales are made on credit, businesses typically will incur some amount of bad debt when not all customers pay their debt owed. These losses become operating expenses. Under accrual accounting, the expense is recorded in the same period as the sale but how do companies do this when the actual amount of uncollected accounts is not known until later?

*** Can you explain this to me in a way a non accounting person can understand. Thank you**

Answer 1

sales can either be made in cash or on credit. The credit period generally depends upon the creditibility of the debtor and can generally range from 15 days to 6 months.

in case of comapnies as per there prior experience on collectiblity of the debtors they make a provision i.e provision for doubtful debts

henever a seller decides to offer its goods or services on credit, two things happen: (1) the seller boosts its potential to increase revenues since many buyers appreciate the convenience and efficiency of making purchases on credit, and (2) the seller opens itself up to potential losses if its customers do not pay the sales invoice amount when it becomes due.

Under the accrual basis of accounting a sale on credit will:

1. Increase sales or sales revenues, which are reported on the income statement, and
2. Increase the amount due from customers, which is reported as accounts receivable—an asset reported on the balance sheet.

If a buyer does not pay the amount it owes, the seller will report:

1. A credit loss or bad debts expense on its income statement, and
2. A reduction of accounts receivable on its balance sheet.

With respect to financial statements, the seller should report its estimated credit losses as soon as possible using the allowance method. For income tax purposes, however, losses are reported at a later date through the use of the direct write-off method.