What Is the Cash-Realizable Value of the Accounts Receivable After the Write-off?
Most accounting uses either a cash basis or an accrual basis. Cash basis accounting records revenues when cash and cash equivalents are received and expenses when cash is paid out. Accrual basis accounting records transactions at the times of their occurrence. Sometimes, sales made on credit and recorded under accrual basis accounting cannot be collected. In these circumstances, cash realizable value is the sum expected to be collectible from these debts.
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Cash and Accrual Bases
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Accrual basis accounting is much more popular than cash basis accounting because it produces more useful and faithful financial statements, albeit at the cost of some reliability in its figures. To compensate for this, accrual basis accountants often take the unreliability of their figures into account when compiling financial statements.
Revenue Recognition Under Accrual Basis
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Revenue is recorded under accrual basis accounting so long as it is earned and realizable. Earned means that the transaction that produced the revenue is complete and all obligations of the business to its customer have been met. Realizable means that there is no reasonable cause to doubt that the revenue can be collected and that the revenue's amount is measurable.
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Direct Write-Off Method
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One method businesses use to account for accounts receivable that can no longer be collected is the direct write-off method. Using this method, the business directly writes off bad debts whenever they occur. For example, if a business learns that a customer that owed them $200 cannot pay, the business records $200 as bad debt expense and makes a corresponding deduction from its accounts receivable. Under this method, the cash realizable value is the present value of the business's accounts receivable.
Allowance Method
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Another method that businesses use for account for bad debt is the allowance method. Under this method, the business estimates the portion of current accounts receivable that is likely to be uncollectable and records this amount as allowance for bad debts, adjusting it in each period as need arises. For example, if a business estimates that it likely has $5,000 in bad debts and it already has $4,000 in allowance for bad debts, it records $1,000 in bad debt expense and a corresponding increase to allowance for bad debts. Once a specific account is deemed to be uncollectable, the business writes off the amount owed and writes off a corresponding amount from its allowance for bad debts. Under allowance method, the cash realizable value of accounts receivable is net accounts receivable or accounts receivable minus allowance for bad debts.
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