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  Trade Receivables Problems

Introduction to Trade Receivables Problems

As described earlier that when businesses sell goods or services on credit, revenue will generally be recognised before the customer pays the amounts owing. Recording the double aspect of a credit sale will include increasing sales revenue and increasing trade receivables through the amount of the revenue from the credit sale. Through this type of sale there is all the time risk that the customer will not pay the amount that is due; though reliable they might have appeared to be at the time of the sale. While it becomes reasonably sure that the customer will never pay, the debt owed is referred to be a bad debt and this have to be taken into account while preparing the financial statements.

To give a more practical picture of financial position and performance, the bad debt must be 'written off'. This will include decreasing the trade receivables and rising expenses (through creating an expense termed as 'bad debts written off') through the amount of the bad debt.

The matching convention needs that the bad debt is written off in similar period like the sale that provided rise to the debt is recognised.

Note:  while a debt is bad, the accounting response is not just to cancel the original sale. If this were made, the income statement would not be very informative. Reporting the bad debts as an expense can be very helpful in assessing management performance.

It might not be feasible to identify with reasonable assurance all the bad debts which have been acquired throughout the period, at the end of the accounting period. It might be that some trade receivables come out doubtful, but only at some point in time will the true position become clear. The doubt which is available does not mean that, while preparing the financial statements, we should ignore the probability that some of the trade receivables outstanding will ultimately prove to be bad. It would not be prudent to do so, nor would it conform with the requirement to match expenses to the period in which the related sale is recognised. Therefore, the business will generally try to recognize all those trade receivables that, at the end of the period can be classified like doubtful (i.e. there is a probability that they may ultimately prove to be bad). This can be done through examining individual trade receivables accounts or through taking a proportion of the total trade receivables outstanding rely on past experience.

One time a figure has been derived, an expense termed as an allowance for trade receivables can be created. This will be displayed as an expense in the income statement and subtracted from the total trade receivables figure in the statement of financial position. For doing this, full account is taken, in the suitable accounting period, of those trade receivables in which there is a risk of non-payment. In addition, this accounting treatment of these trade receivables will be to the treatment of bad debts that is explained above.

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