The deterioration of the debtor’s financial position may leave an “imprint” in the creditor’s accounting. Therefore, accounting standards contain, in particular, the procedure for forming an account for doubtful debts. The allowance method is a system for estimating the amount of a cash loan that must be repaid by the client. Current accounts receivable, a monetary asset, is included in the balance sheet total at net realizable value (Suwantari et al., 2020). The allowance for doubtful debts is created concerning current accounts receivable, in the repayment of which there is uncertainty. It is necessary to form such a reserve even before doubtful debts become bad debts.
There are two alternative allowance methods: the absolute amount of doubtful debts and the use of the coefficient of doubtfulness. The absolute amount method is that the amount of the reserve is determined based on the analysis of the solvency of individual debtors. The way of the absolute amount of doubtful debts provides for a personal approach to the calculation of the reserve. The fact of recognizing certain receivables as uncertain by creating an account of doubtful debts regarding it is proposed to be formalized by order of the head of the enterprise (Suwantari et al., 2020). To calculate the reserve for doubtful debts using the coefficient of doubtfulness, it is necessary to multiply the amount of the balance of receivables at the beginning of the period by the coefficient of doubtfulness, which can be calculated in several ways. These include determining the share of bad debts in net income and the definition from the classification of receivables by maturity (Suwantari et al., 2020). It is possible to decide on the average share written off during the period of receivables for the number of receivables at the beginning of the corresponding period.
Companies can apply different methods of determining the reserve to various receivables. The approach chosen should be specified in the accounting policy of the firm. Most likely, the value of the account for doubtful debts, determined by the method of the absolute amount of doubtful debts, will be closer to the truth. However, this method requires additional labor costs if the enterprise has many debtors. Therefore, economic feasibility will be the key to choosing a method for calculating reserves for doubtful debts.
Suwantari, N. P., Ariana, I. M., & Suprapto, P. A. (2020). Accounting analysis in accounts receivable management to minimize the risk of uncollectible receivables at ALS hotel and resort. Journal of Applied Sciences in Accounting, Finance, and Tax, 3(2), 117-124.