What it is:
How it works (Example):
Let's assume Company XYZ sells $1 million of goods to 10 different customers. Accordingly, Company XYZ increases itsaccount by $1 million and increases its account by $1 million (we are assuming the customers have 60 days to pay). One of those customers is Company ABC, which purchases $100,000 of those goods.
If Company ABC suddenly declares bankruptcy or just incurs cash flow problems and becomes very overdue in paying Company XYZ, Company XYZ may determine that all or some of the $100,000 Company ABC owes is uncollectible. Company XYZ's balance sheet would then be adjusted to show $1 million of accounts receivable and $100,000 in an allowance for doubtful accounts, for a net accounts receivable of $900,000.
Note that accounts uncollectible is for amounts Company XYZ suspects income statement as bad debt expense (note that this reduces profits) and reduce the balance sheet's allowance for doubtful accounts by the same amount.not be collected. When Company XYZ in fact cannot collect the $100,000 (because Company ABC is liquidated, for example), Company XYZ record $100,000 on the
How Company XYZ determines that a receivable is uncollectible is a matter of judgment and negotiation. In the real world, companies may not analyze the collectibility of every single account when determining how much to record in their allowance for accounts uncollectible. Instead, they may simply use a percentage of or accounts receivable, or they may use a historical trend percentage.
Why it Matters:
Almost every company records accounts uncollectible because invariably some customersfail to pay. However, changes in accounts uncollectible can indicate other trends in a company.
For example, if accounts uncollectible has increased, the company may beto riskier customers, which jeopardizes the reliability of the company's . However, the company may be padding the allowance in order to make things look worse than they are -- because that can make future performance look better.