Question

Discuss the effects of uncollectible accounts on a business either from the business’s point of view or from the consumer's point of view, using specific examples. Specifically, what impact do uncollectible accounts have on a business? Do you think a customer understands this impact?

Answer 1

Impact on Uncollectible Accounts on Business (Business Perspective):

Uncollectible Accounts refers to the accounts that will not be likely to be collected or realised and are also known as Bad debts. However, it can also be referred as Notes Receivable that will not be collected.

In a short way, we can say that the impact of Bad debts on Business as the “Loss to the Business”.

If it is to be explained, it can be said as follows:

Bad debt expense is money that you are not able to collect from outstanding customer invoices. When an invoice is overdue for more than specified collectability period (say 90 days) businesses typically write it off as uncollectible bad debt. This will increase expenses on the profit and loss statement and decrease accounts receivable on the balance sheet by the same amount.

The amount of time that you allow customer invoices to remain unpaid before you write it off altogether is up to you. What’s most important is that you set payment terms that are in line with your industry, communicate these terms to customers who you extend credit to, and then follow-up to enforce them. And other thing to consider while extending the credit is Credibility of the Customer. You can ask the customer to give a Letter of Credit from the Bank to support his credibility etc., to check the credibility and design payment terms in accordance with the same.

The reason why you write off a collectible account is that it gives more accurate picture of the financial position and as a result you do not overstate your assets and financial position.

When you write off an outstanding invoice / Collectible Account as bad debt, you need to record a bad debt expense and also adjust the accounts receivable balance so it reflects the actual amount “collectible” from customers. If not, your accounts receivables will be overstated.

Impact of Bad debts on Financial Performance and Position:

Particulars	Impact
Bad debts Expense	Increase, which will result in decrease in Profits.
Accounts Receivable	Decrease, which say that you cannot collect the amount from the customer and decrease in Asset.

Example:

For Eg: Business has sold goods worth $ 1,000,000 to a customer on credit under the payment terms to repay full within 90 Days.

Accounts Receivable A/c. Dr.

To Sales A/c.

Customer has paid $ 500,000 within 50 Days.

Cash / Bank A/c. Dr.

To Accounts Receivable A/c.

Credit Period of 90 Days has been expired and customer has not made a payment and not traceable.

This is an indication of Customer not paying the Balance amount of $ 500,000. Now, this has to be treated as Uncollectible Accounts and following treatment should be done.

Bad Debts A/c. Dr. (Expense) – (Debited to Statement of Profit & Loss)

To Accounts Receivable A/c. (Loss of an Asset) – (Credited to Asset A/c.)

Statement of Profit & Loss A/c. Dr.

To Bad Debts Expense A/c.

Debiting the Statement of Profit & Loss with the Expense, thereby decreasing the Profit.

Do you think Customer understands this impact?

Customer may have the knowledge of this impact because whoever may have some knowledge of the financial impact of not receiving the money given on credit. Even though he may have the understanding (or) not, it does not change the fact of non-collectability because it may be remained unpaid due to the bad financial condition of the customer (or) other reasons which may contain intentional avoidance of payment due to which he may not make the payment.