ACCOUNTS RECEIVABLE VALUATION: Allowances, Write-Offs, and Aging Analysis

Accounts receivable represent amounts owed by customers from credit sales. Valuation of receivables must reflect the expected collectable amount, requiring estimates for bad debts and other adjustments.

1. What Are Accounts Receivable?

Accounts receivable (AR) are recorded when a business delivers goods or services on credit.

They are initially recognized at invoice amount and later adjusted to reflect collectibility risks.

AR are reported as current assets, usually due within 30–90 days.

2. Gross vs Net Realizable Value

Term	Definition
Gross AR	Full amount billed to customers
Allowance for Doubtful Accounts	Estimate of uncollectible amounts
Net Realizable Value (NRV)	Amount expected to be collected = Gross AR – Allowance

Example:Gross AR = €80,000

Allowance = €6,000→ Net AR = €74,000 (shown on balance sheet)

3. Estimating Bad Debts

Two common methods under GAAP and IFRS:

A. Percentage of Sales Method

Estimate bad debts as a % of credit sales

• Focuses on income statement matching

B. Aging of Receivables Method

Analyze receivables by age and assign risk-based rates

• Focuses on balance sheet valuation

Aging schedule example:

Age Bucket	Balance (€)	Estimated Uncollectible %	Allowance (€)
0–30 days	40,000	1%	400
31–60 days	20,000	5%	1,000
61–90 days	10,000	15%	1,500
Over 90 days	5,000	40%	2,000
Total	75,000		4,900

4. Journal Entries

To record estimated bad debts (allowance method):

• debit Bad Debt Expense

• credit Allowance for Doubtful Accounts

Example:

• debit Bad Debt Expense .................................. 4,900

• credit Allowance for Doubtful Accounts .......... 4,900

To write off a specific receivable:

• debit Allowance for Doubtful Accounts

• credit Accounts Receivable

If a written-off amount is recovered later:

• debit Accounts Receivable

• credit Allowance for Doubtful Accounts

• debit Cash

• credit Accounts Receivable

5. Direct Write-Off Method (Not GAAP-Compliant)

This method records bad debts only when they are confirmed uncollectible.

• debit Bad Debt Expense

• credit Accounts Receivable

Downside:

Violates the matching principle and overstates assets. Allowed only for small businesses or tax purposes.

6. Presentation on Financial Statements

• Balance Sheet:

  • Net Accounts Receivable = Gross AR – Allowance

• Income Statement:

  • Bad Debt Expense under selling/general expenses

• Cash Flow Statement:

  • Changes in AR affect operating cash flows (indirect method)

7. Internal Controls and Monitoring

Best practices include:

• Customer credit checks and limits

• Prompt invoicing and collection follow-ups

• Regular aging analysis and provision reviews

• Segregation of duties in billing and collections

• Automated alerts for overdue accounts

Key take-aways

• Accounts receivable must be adjusted for expected credit losses.

• Estimations are made using sales-based or aging-based approaches.

• Allowance for doubtful accounts ensures receivables are not overstated.

• Proper monitoring protects liquidity and ensures accurate reporting.

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