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The Corporate Finance Institute
Accounting
Risks associated with Accounts Receivable 
1.
Uncollected debt – High A/R that goes uncollected for a long time
is written off as bad debt. This situation occurs when customers
who purchase on credit go bankrupt, or otherwise shirk the invoice
without reason.
2.
Cash flow deficiencies – A business needs cash flow for its
operations. Selling on credit may boost revenue and income, but
present no actual cash inflow. In the short-term this is acceptable,
but in the long run can cause the company to run short on cash and
have to take on other liabilities to fund its operations.
Measurement of Bad Debts in Accounts Receivable 
There are two ways to account for balances in accounts receivable 
that are predicted to not be collected, which is also known as bad debt 
expense. To account for this expense, the percentage of sales method 
(income statement approach) or the aging of accounts method (balance 
sheet approach) can be used. 
Percentage of Sales Method:
•
This method uses the idea that some fraction of sales will be
uncollectible. Therefore, to match expenses with revenues, the bad
debts expense is a certain percentage of sales.
•
This method focuses on the computation of the expense, hence, an
income statement approach.
•
For example, if 2% of sales is considered bad debt expense and sales
were $100,000, the bad debt expense is $2,000.
•
Bad debt expense is debited while the allowance for doubtful
accounts (a contra AR account) is credited.