Uncollectible accounts receivable refers to outstanding debts that a company does not expect to collect. Rather than keeping them on its books, the company may choose to write them down, recording this for financial purposes so tax authorities and shareholders are aware of the situation. This represents a loss for the company, because it provided products and services without being paid for them. Special procedures must be followed when writing down uncollectible accounts.
The authority to write down such accounts is usually limited to high-ranking officials in a company or government agency. This reduces the risk it will be abused, and creates a clear chain of command. Individual entities also have procedures in place for determining when accounts can be classified as uncollectible. Following policies makes it easier for companies to be consistent when dealing with uncollectible accounts receivable, to avoid charges of favoritism or poor business decisions.
In some cases, a collections agency tasked with getting the money reports back and informs the company that it cannot collect. This may be because someone is refusing to pay, has relocated and cannot be tracked down, or fraudulently obtained credit, making it impossible to figure out who is responsible. These types of uncollectible accounts receivable are pursued until it is clear the company will not be able to collect the funds.
If a debtor declares bankruptcy, this can lead to a decision to classify outstanding debt as uncollectible. Many forms of debt are erased in bankruptcy proceedings to provide an opportunity to reorganize finances and start again. Additionally, companies may determine that the cost of recovering money is not worth the expense, in which case they write down the debt. This allows them to operate more efficiently by eliminating expensive debt that is unlikely to resolve.
Other types of uncollectible accounts receivable include those subject to court cases where the company lost. A company may have sued for repayment, only to have a judge rule in favor of the respondent. In this situation, it has no court judgment to enforce to collect the balance, and doesn’t have a realistic chance of recovering the money. Writing the account down can allow the company to move forward and adjust accounting records to create a more accurate picture of outstanding accounts receivable.
Noting the presence of uncollectible accounts receivable is important. Normally, companies treat accounts receivable as anticipated income they can use for investment and other activities. If accounts are being carried on the books but are unlikely to pay out, this can create a false indicator of the amount of money a firm can expect to bring in over the course of coming months.