this excludes items from reported revenue and accounts receivable. An increase in this account reduces the discretionary accrual related to the change in accounts receivable. can anyone explain this?
Conservative accounting: If you think you’re going to have more payment problems with customers , recognize the revenue but also set aside a higher amount for bad debt. If companies did this explicitly instead of analysts having to figure out from footnotes and such , they would not have so many accrual problems ( and potentially CFA’s would not be needed to sniff them out)
Accounts receivable is what you expect to receive because you sold items on credit. If 100 were your AR and you had an allowance for doubtful accounts of 10 - because you expected not to collect 100 -> you AR balance net of Allowances would be 90. The AR account is no longer as inflated as before. You have removed discretionary accrual related to AR. From another point of view: Cash Collected from Customers = Revenues - Change in AR + Change in Unearned Revenue. Change in AR is smaller - because it now includes the doubtful accounts. Assuming Change in Unearned Revenue=0 -> Your cash collected from customers would be a higher number. Accruals thus is reduced.
You can also use the allowance for doubtful accounts in lieu of reducing the value of the investments in financial assets, if they are impaired.
But, if the allowance account reduces A/R and cash collections increases…problem is that cash collections did not actually increase; more cash is expected to NOT be collected.
the cash not expected to be collected has already been removed. you are more certain that the cash will be collected…
Cash collected from customers is: Revenue + decrease in A/R (minus increase) + increase in deferred revenue (minus decrease)