Accounting Flow Of Purchasing And The Accounts It Hits Matching Principle in Accounts Receivable

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Matching Principle in Accounts Receivable

The matching principle is the foundation of accrual accounting and revenue recognition. In principle, all expenses incurred in generating revenue must be deducted from the revenue earned in the same period. This principle allows for a better evaluation of actual profitability and performance and reduces discrepancies between when expenses are incurred and when revenues are recognized. The application of the matching principle is to provide for bad debt expense in the same year in which the related sales revenue is recognized.

Accounts receivable represent amounts due from customers for the purchase of goods, services, or goods on credit. On the balance sheet, they are classified as current or non-current assets based on the expected period of time required to collect them. Most receivables are trade receivables, which arise from the sale of products or services to customers.

To help increase their sales revenue, the company offers credit to its customers. Credit limits attract its customers to buy. But when a company extends credit to a customer, there is also a risk that the customer will not repay them. The company sets certain guidelines and policies for extending credit to its customers to eliminate risks. They conduct credit checks to assess the creditworthiness of the customer. They created a collection policy to ensure they received payments on time and reduce the risk of non-payment. Unfortunately, there are still sales on account that may not be collected. It is either the customer is broke, unhappy with the service provided or simply refuses to pay them. The company has legal ways to try to collect their money but they often fail and are expensive. These uncollectible accounts are a loss in revenue recognized by recording bad debt expense. As a result, it is necessary to establish accounting procedures to measure and report these uncollectible accounts.

There are two methods for recording bad debt expense. The first method is ‘Direct write-off method’ and the second is ‘Allowance method’.

The direct write-off method is a very weak method and does not apply the matching principle of recording expenses and revenues in the same period. This method records bad debt expense when a company has made every effort to collect money owed and ultimately declares it uncollectible. It has no effect on income because it is simply reducing accounts receivable to its net realizable value.

This is a simple method but it is acceptable only in cases where the company has no accurate means of estimating the value of bad dents during the year or the bad debts are insignificant. In accounting, an item is considered material if it is significant enough to affect the judgment of its economic users. With the direct write-off method, several accounting periods have already elapsed before it is finally determined to be uncollectible and written off. Revenue from credit sales is recognized in one period but the cost of accounts receivable unrelated to that sale is not recognized until the next accounting period. This leads to a mismatch between revenue and expenditure.

The allowance method is the preferred method of recording bad debt expense. This method is consistent with generally accepted accounting principles. Accounts receivable are recorded in the financial statements at net realizable value. Net realizable value is equal to the gross amount receivable minus the estimate of uncollectible accounts. This is often called allowance for bad debts. It is treated as a contra asset account in the balance sheet. This contra asset account has a normal credit balance instead of a debit balance because it is a deduction from accounts receivable. Allowance for bad debt accounts informs its financial user that a portion of accounts receivable is expected to be uncollectible. Under the allowance method, you can estimate bad debt based on each period’s credit sales or accounts receivable.

Estimating bad debt as a percentage of sales is consistent with the matching concept because bad debt expense is recorded in the same period as the related revenue. It is calculated by providing a fixed percentage of loan provision during the period to account for bad debt expense in the income statement. Previous year trends or patterns of credit sales and associated bad loans provide a basis for a reasonable estimate or estimate of bad debt expense for the current year.

While estimating bad debts based on receivables, a company can estimate the allowance from an aging schedule or by making a single calculation based on total accounts receivable. When using estimates based on receivables, the journal entry for bad debt expense must take into account the current balance in the allowance account. The entry amount is the amount required to bring the allowance account balance up to the desired closing balance.

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