How to treat overdue receivables in bookkeeping?
A frequent occurrence in business dealings are receivables which remain unpaid long after they have fallen due. The possible reasons are varied: from the debtor's sheer inability to pay to willful non-payment, to disputes over the amount of the invoice. However, the consequence is always the same: the creditor is stuck with an account receivable on their balance sheet which is apt to distort the true and fair view provided by the company's accounting.
For this reason, companies should consider, at the very least when drawing up their financial statements, whether or not to create a value adjustment item to receivables which have been due but unpaid for several months, so as to reduce their book value. This value reduction is a temporary state, given that there is still hope that the receivable may be settled before the limitation period lapses.
Such value adjustment items may be created in two different ways: statutory (taxable) allowances, or book allowances.
Statutory, or taxable, allowances are governed by the Act on Provisions which clearly states the amount in which value adjustment items may be created, and the conditions under which this may take place, for them to be tax deductible and to be claimed in one's tax return. By comparison, only a minimum of restrictions applies to book allowances for receivables, precisely because they have no impact on the tax base. They are being created by companies upon learning that their debtor has become insolvent. Creating them is obligatory, as they prevent the distortion of the fair and true view of the company's assets and financial position which its books are supposed to provide. The key distinction between statutory and book allowances lies in the fact that the former are tax deductible but the latter are not.
Before allowances may be created with respect to accounts receivable, the following conditions must be met:
• the receivables must be past their due date
• the receivables must not have become statute-barred (whereas during litigation, the limitation period is stayed),
• the receivables must be accounted for in the company's books,
• the receivables must not be subject to book depreciation,
• upon their origination, the receivables must represent taxable revenues.
Such allowances are reported on the profit and loss statement, on the balance sheet, and in the notes on the financial statement. Micro and small enterprises who are subject to mandatory auditing, as well as all medium and large enterprises, shall specify the amount of allowances at the beginning and at the end of the fiscal year (including any fluctuations throughout the year) in the notes.
Once the circumstances have ceased to exist which justify the existence of the value adjustment item, it must be (fully or partly) reversed. Once the company has become aware that the value reduction is permanent, it shall replace the allowance with a one-time writedown.
Source: Act No. 593/1992 Coll. (Income Tax Act); Act No. 563/1991 Coll. (Accounting Act)