In accrual-based accounting, revenue and expenses are reported at the time of transactions, regardless of whether your payment has been received. Although this practice may seem strange at first, many Americans use it every day without thinking about it. Consider credit cards. If someone is using a credit card, there is no cash change, only understanding that if everything goes smoothly, the buyer pays to the credit card company, who in turn reimburses the seller. This is a kind of accrual accounting.
Another form of accrual accounting is claims. When retailers sell credit products (think of the many ads that "have no money, there is no payout for the next year"), this is an example of the claims. In this case, the retailer accepts that the payments are accepted in good time in exchange for a good or service return. For example, if a customer buys a $ 1,000 television from the TV Shack loan, it is agreed that they will pay the shop for monthly payments up to $ 1,000. This is a $ 1,000 account worthy of payment.
The business is able to report $ 1,000 in sales in the current period, even though it will not be paid until later. The net realizable value, in this case $ 1000, is the store's feedback from the customer if the customer pays the debts as agreed. He claims to have sold $ 1,000 in sales, assuming he finally got cash. But what if the customer can not repay the loan in time? What if the customer is unable to fully repay the debt? Or at all? This would mean that the company reported $ 1000 in revenue has never been realized. In other words, the company has $ 1,000 to tell investors what it is. This phenomenon is bad debt
Businesses know that in some cases they will not repay what they have lent, but instead of resigning from lending, these companies are taking precautionary measures against bad debt. In some cases, businesses provide assistance only to the most skilled customers. In others, companies simply pay a higher advance and raise higher interest rates for less qualified customers. Anyone who bought a home is familiar with the strategies that businesses lose from default. Many people have heard about subprime mortgages, they are less aware that this is simply an example of offering mortgages with higher interest rates to customers who have a higher chance of default. These are simply methods that companies use to improve their chances of obtaining repayable loans.
Another method used by companies to cover bad loans is a bad debt ratio. It is also known as an indefinite debt ratio, companies are able to calculate, with some degree of precision, the amount of money they need to separate if their credit is not repaid. In some cases, companies simply assume that a percentage of their credit is considered as default and drags out the full percentage of total loans. In others, businesses are tracking which credits are likely to be defaulted to determine the cost of bad debts. This setback is classified as a loan guarantee reserve
There is concern that corporate credit reserves are inadequate for the economic downturn. Using the above-mentioned percentage model, these companies only keep some of their money lending in case of default. This is no different from the partial reserve systems used by banks. And like a bank, if for some reason debtors do not pay their credit, then the company does not have enough money to describe these costs. Due to this vulnerability, there are concerns that many companies are not as healthy as it may seem
Recall the example where TV Shack borrowed $ 1000 for a television purchase and then made a $ 1,000 gain before the customer started paying. This may be good in good economic times and the client will probably be able to pay off his debt. But if the economy declines, the customer can not pay the debt due to unforeseen circumstances. TV Shack feels they have an impact because they do not get their full amount or not. That's why TV Shack is weaker than paper. Investors in TV Shack were intentionally misled by reading the TV Shack declarations, which represent a $ 1,000 gain, which never comes. It is therefore a concern that the current methods of bad debt management related to Accrual Accounting are inadequate
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