Question

Discuss the reasons why we need to have methods of anticipating the amount customers will fail to pay of Accounts Receivable. (Allowance method and Percent of Sales method)

Answer 1

Answer is as under :

Due to the following reasons we need to have methods of anticipating the amount customers will fail to pay of account receivables :

1) When seller sales goods on credit there is always a risk that the buyer will not the pay the full or part amount to seller due to various reasons. Due to this, seller is considered unsecured creditor who don’t have rights on goods sold nor he have any certainty of receiving payment. Hence seller will keep a provision of amount which he estimates that the buyer will not able to pay

2) Account receivables comes under current assets. Current assets should not be overstated because overstated assets shows incorrect financial position. Also it should result in cash inflow with in one year. If sellers have anticipated certain percentage of account receivable as uncollectable , he should keep allowances for doubtful debt in advance. Hence it will help to avoid the overstated asset in balance sheet

3) It helps to avoid the recording of all loss on receivable in a particular financial year and accounting principles also states that all losses should be recorded in a year to which it belongs.

Estimating of loss depends on total credit sales and estimated percentages of doubtful receivables