Let's say a debtor declared bankruptcy and defaulted on $100. That would be then considered bad debt, and then creditor could write it off, correct? How would that write-off flow through the 3 statements, what will it affect? Thank you.
I understand it will be an expense on the IS, right? Will it be an add (+) on the IS, and then a less (-) (non-cash expense?) on the Cash Flow from Operations section of CFS?
Also would like to know if the write-off is considered a cash expense or non-cash expense. Thanks in advance for everyone's help!
Also, would you subtract the write-down from the existing debt balance to get a new debt balance?
bump -- would you?
it's a plus on the is. because you do't have to pay that debt.
basically, +100 pretaax, assuming 40% tax, +60 after tax basis.
cfs: +60-100 (because noncash) = -40
bs = -40 cash, -100 debt, +60 ni and it balances.
Thanks a lot. Makes sense. Just want to clarify, why doesn't anything happen to AR? wouldn't it go down?
I think kidflash is commenting from the debtor's perspective.
I'm no accountant, but I would think from the creditor's perspective it would look like this:
IS
Bad debt expense +100 => EBT -100 => Tax -40 => Net Income -60
CF
NI -60 and AR -100 => Cash Flow From Operations +40
BS
Assets: Cash +40, AR -100, and Shareholders' Equity: RE -60 => Balance sheet balances
AR is affected by the writeoff amount. Whatever specific AR account that's affected is going to be reduced, as will the allowance for doubtful accounts account. However, the net affect means no change over the aggregate AR balance (AR less allowance for doubtful accounts).
So, say you had $50,000 for AR and $2,000 for Allowance for Doubtful Accounts (AFDA). The net balance comes out the be $48,000. If you write off $1,000, AR will go down by $1,000, but AFDA will too. So overall AR in total stays the same ($48,000).
Per GAAP bad debts are estimated and expensed upon that estimation, not when the actual writeoff occurs.
Right, but at one point you had 50k aggregate (2k of which is for allowance right?), and then after the write off you only have 49k aggregate, correct?
On the B/S, you'll either see one line for AR with AFDA taken into affect (there should be a note), or two lines showing AR and AFDA separate, with a net affect to the right. So, in my example all of the AR balances would be $50,000, and separately the AFDA would be $2,000 giving you a net balance of $48,000 for AR. If you write off $1,000 of an account, AR will go down by $1,000 (to $49,000), and AFDA will go down by $1,000 (to $1,000). Therefore, if we were to net out the new amounts it would still be $48,000 total.
As to your other question, from an accounting standpoint, this is what I see. You don't expense the bad debts when you write them off, so if you're talking about the affect ONLY from the writeoff, there is no effect to the I/S (because the expense will be when you estimate your bad debts, no when you write stuff off). There will be no effect on the on the net balance for AR, but both the AR (before figuring in the AFDA) and the AFDA are going to decrease. Essentially there is no change to your assets. As for cash flows, since you're netting the A/R change with the AFDA change, there is no change in the net A/R level (which you would use for cash flows). Assuming there is no other change in your A/R amounts outside of the writeoff, there would be no Statement of Cash Flow effect as well.
Again, this is assuming you're talking specifically about the writeoff itself, not the estimation of the bad debts for your books (which would have affects to all three statements).
Whos correct in the 3 statement flow, value or kid? I am looking for the creditors side (the firm that has to write off, since the debtor defaulted). Thanks everyone!
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Sorry. I didn't read the problem too carefully. II was looking at it from debtor perspective.
Value's example IS appears accurate to me. IS is going to less the BDE estimated amount (say 100 in his example) plus the tax savings (40) for a net decrease to NI of 60.
However, I'm not sure about the statement of cash flows, mainly due to the nature of the transaction (BTW this is 100% speculation on my part after this, as I've never come across this). BDE acts more like a pre-paid expense than anything else. So, I'm thinking A/R would go down (do to the BDE becoming an increase AFDA), which would be classified as a positive cash flow, but the BDE would also be listed as a pre-paid expense (an increase and this a reduction to cash), thus netting the effect of the A/R out. If you think about it, in future years the AFDA will keep your overall A/R from decreasing, even though writing off the A/R amount means you are forgoing collecting cash. My logic may be flawed but I think that's what would happen. The tax would only have an impact to the CFS if you did not pay it (thus increasing your cash at the end of the year).
Therefore on the balance sheet (assuming you did not pay the tax liability), your A/R would be $X lower (in other words your AFDA would be $X greater than before). You'd have an $X tax liability, and probably effects to Cash and possibly R/E as well.
Probably the best thing you can do is rough out pro-forma income statements and see what the affects look like on paper. It would probably make more sense if you do than my explanation.
accounts receivable goes down by 100, therefore change in net working capital goes down by 100. However, EBIT will go down by 100, so there will be no net change
Explain please...
Don't you watch Suze Orman? If you did, you would know that all debt is bad.
If A/R goes down on balance sheet, shouldn't the change in WC on CFS be positive, as cash flow goes up?
Ahh, im so confused now but THANK YOU EVERYONE FOR YOUR HELP AND TIME! Really appreciate the help!
bump
Dude, you need to exercise your brain here too, or are we just doing your homework for you?
Think about it: writing off a receivable - is that a cash expense? Does any cash change hands...? No. (It only has a cash impact if there is a tax saving since EBT is reduced.)
So, how is this reflected in the cash flow statement? Ignoring taxes, net income decreases by 100. Does that mean cash flow decreases 100...? No. Cash doesn't change hands when you write off a debt. So, why doesn't cash flow decrease? Because when you debit your write off expense, you credit accounts receivable. And when accounts receivable decreases, net working capital decreases - and that equates to... a cash inflow.
So, your total net cash flow is unchanged because you have two offsetting items of 100 each: a net income decrease of 100 and a decrease in working capital of 100.
Is that clear?
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