When is a Bad Debt Reserve Necessary?
If you’re using the Cash Method of accounting, income is only recorded when the payment is actually received, so there is no need for a reserve account to offset future bad debt. However, under GAAP (Generally Accepted Accounting Principles) requirements and for SOX compliance, the Accrual Method of accounting must be used. This accounting method recognizes income when the credit sale is made (before it is paid). Accrual accounting also requires that bad debts be recognized as an expense in the same period as the revenue was generated. Without a crystal ball, credit analysts have no way of knowing at the outset which accounts are going to go bad. Therefore, it’s necessary to have a means of forecasting (or estimating) the amount of bad debt that will occur.
Related Questions
- If a Covered Institution does not have any sweep accounts or automated credit accounts, is it necessary to generate a Sweep/Automated Credit Account file?
- What Is The Difference Between Provision For Bad Debt And Reserve For Doubtful Debts And Their Accounting Implications?
- When is a Bad Debt Reserve Necessary?
