Assignment – credit quality and allowance account Nora

Assignment
12-1:  Accounting Research and
Presentation

Topic:
Receivables – credit quality and allowance account

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Nora
Beth Hacker

Franklin
University

ACCT
310 Q1WW, Intermediate Accounting I

Professor
Sturgill

December
12, 2017

 

 

 

 

 

 

 

 

            Accounts receivable is an asset account used in the
accrual method of accounting that, for example, tracks the amount of credit a
business extends to its customers.  A
customer receives a product from a company,
and an invoice is given to the customer to pay later.  The total of the invoice is documented by the
company to indicate what is owed by the customer.  In this specific case, because these forms of
invoices are paid by the customer usually inside of one year, the accounts receivable
account is determined to be a short-term asset account.  FASB (FASB, 310-10-05-4) indicates that not
only credit sales are accounts receivables, but also loans and other
transactions, indicating accounts receivable,
depending on the length of time outstanding, may be long-term assets.  FASB 310-10-45-2 instructs that long-term receivable, such as a trade, a loan, or note
receivable, are to be indicated in a separate category on the balance sheet.
Furthermore, transactions may arise by the company itself or purchased from
another entity.

Continuing with the original example, companies
realize that some customers who receive credit will never pay their account
balances.  FASB (310-10-35-4) recognizes
the allowance and gives guidance for companies to fully analyze past events and
current conditions to conclude that a loss needs
to be recognized. If the analysis supports that a loss is going to
happen, appropriate adjustments are allowed. 
The analysis should be ongoing and consistent with each accounting cycle (FASB, 310-10-35-13).

With the allowance for losses, as in the original
example, companies have latitude on how to estimate the loss (FASB,
310-10-35-20). For example, the company can
assess a bad debt as a percentage of sales for the period, or as a percentage
of the accounts receivable balance.   The
method used is allowable if it reasonably estimated and reflects an adequate
estimate of future cash flows (FASB, 310-10-35-22).

An adjustment is made at
the end of each accounting period to approximate bad debts based on the company
activity during that accounting cycle.
Established companies rely on prior experience
to approximate unrealized bad debts, but new companies must rely on issued
industry averages until they have adequate experience to make their estimates
(FASB 310-10-35-10).  The adjusting entry
to approximate the expected worth of bad debts does not lower accounts
receivable directly. Accounts receivable is a control account that must have
the identical balance as the collective balance of every individual account in
the accounts receivable subsidiary ledger. When recording
the adjusting entry, the exact customer accounts that will become uncollectible
are not known.  Therefore the recorded
adjusting entry is made to the contra-asset account named allowance for bad
debts or allowance for doubtful accounts (FASB, 210-10-45-13).  The contra-asset account reduces the accounts
receivable account on the balance sheet to indicate the net realizable value of
accounts receivable. 

FASB (FASB, 310-10-50-11B) indicates a company
must disclose qualitative and quantitative information about the credit quality
of the accounts receivable.  Assessments
used in the allowance method are the responsibility of the management of a
company to advance the accuracy of the financial statements.  All methods require management to assess a
percentage approximation based on their perception of the industry, current
economic issues, and the customers’ payment history and creditworthiness. 

The ASU No. 2010-20 provides direction for a
company to separate new and present disclosures based on how it creates its
allowance for credit losses and how it oversees credit experiences.  Additional disclosures required under ASU
2010-20 for financing receivables include:

Aging of over-due
receivables,
Credit quality
signs, and
Changes in
financing receivables.

Short-term
accounts receivable, receivables calculated at fair value or lower of cost or
fair value, and debt securities are not included in the ASU No. 2010-20.

            The Accounting Standards Update (ASU
No. 2016-13) can provide further guidance to companies
that are required to measure expected credit losses for financial assets.
The ASU requires companies to provide more information in their disclosures
about the credit quality of their financing receivables and the credit reserves
held against them.  At the release of
this ASU, ASC Topic 326, Financial Instruments-Credit Loss was added to the US Generally
Accepted Accounting Principles.  This additional information provided
in disclosures would assist financial
statement users in assessing an entity’s credit risk exposures and evaluating
the adequacy of its allowance for credit losses. The ASU indicates that the
current elevated threshold for identification of credit impairments hinders
timely identification of losses.

            The GAAP Practice Manual (WG&L, 2017, 3.3.2) further
clarifies accounts receivable and the applicable measurement.  In the prior example of this paper, in measuring
accounts receivable, interest calculation is not applicable.  However, there are circumstances in which
calculating interest is relevant. 

            The GAAP Practice Manual (WG&L, 2017, 3.3.3) further
details the ASU No. 2016-13 and the FASB topic 326.   Beginning after December 15, 2019, public
business entities that qualify as SEC filers must
satisfy that both criteria of reasonable estimation of loss and
information must be present before the release
of financial statements.

In
the ASU No. 2016-13, a company duty is to consider all existing related
evidence when assessing foreseeable credit losses, including facts about past
actions, recent circumstances, and sound and justifiable predictions and
effects for foreseeable credit losses. That is, while the company can use past adjustments figures as a starting
point for determining foreseeable credit losses, it has to assess how
circumstances that existed during the past adjustment point may vary from its
present outlooks and appropriately adjust its estimate of foreseeable credit
losses. However, the company is not obligated to predict circumstances over the
agreed life of the asset.  Instead, for
the cycle beyond the cycle for which the company can make sound and justifiable
predictions, the company revisits to past credit loss knowledge.

Furthermore,
ASU No. 2016-13 does not advocate an element of account (e.g., an individual
asset or a set of financial assets) in the measuring of foreseeable credit
losses. However, a company is obligated to assess financial assets within the
range of the pattern on a group (i.e., pool) foundation when assets share like
risk traits. If a financial asset’s risk traits are not similar to the risk
traits of any of the company’s other financial assets, the company will assess the financial asset individually.  Companies are allowed to disregard presented
external data such as credit ratings and other credit loss statistics when
assessing the individual accounts receivable for the prediction of credit
losses.

            In conclusion of researching the topic of receivables,
credit quality and allowance, the International Accounting Financial Reporting
(B3.2.6) concurs with GAAP in that review is to be made at each accounting
cycle of receivables that could be impaired. 
However, it appears that the IAS requires objective measurement that is
stricter.  There must be significant
evidence that loss is probable.  For
example, even if a company, that has a current balance as accounts receivable
is no longer showing activity as being publicly traded, does not warrant a loss

Reference

Accounting Standards
Update (ASU) 2016-13, Financial Instruments — Credit Losses —

Measurement
of Credit Losses on Financial Instruments

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-05-4. Retrieved November

21, 2017, from FASB Accounting Standards Codification
database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-35-4. Retrieved November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-35-10. Retrieved
November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-35-13. Retrieved
November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-35-20. Retrieved
November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-35-22. Retrieved
November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-45-2. Retrieved November

28,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-45-13. Retrieved December

1,
2017, from FASB Accounting Standards Codification database.

FASB (Financial
Accounting Standards Board). (n.d.). ASC 310-10-50-11B. Retrieved

December
1, 2017, from FASB Accounting Standards Codification database.