Accrual Accounting

Question: This company holds $100,000 in accounts receivable but only expects to collect $93,000 based on the

available evidence. The $7,000 reduction in the asset is an expense. When should the expense be recognized?

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These sales were made in Year One but the identity of the specific customers who fail to pay and the exact amounts

to be removed will not be determined until Year Two. Should bad debt expense be recognized in the same year as

the sales by relying on an estimate or delayed until the actual results are eventually finalized?

Answer: This situation illustrates how accrual accounting plays such a key role within U.S. GAAP. As discussed

previously, the timing of expense recognition according to accrual accounting is based on the matching principle.

Where possible, expenses are recorded in the same period as the revenues they helped generate. That guidance

is clear. Thus, every company should handle uncollectible accounts in the same manner. The expected expense is

the result of making sales to customers who ultimately will never pay. Because the revenue was reported at the

time of sale in Year One, the related expense must also be recognized in that year. This handling is appropriate

according to accrual accounting even though the $7,000 is only an estimated figure.

Based on U.S. GAAP, when the company produces financial statements at the end of Year One, an adjusting entry

is made to (1) reduce the receivables balance to its net realizable value and (2) recognize an expense in the same

period as the related revenue.