Question

1) Underwood Company believes that by establishing an allowance for uncollectible receivables, a company recognizes losses that have occurred in the past. What does the authoritative literature say about this belief? If possible with codification references

Answer 1

By establishing an allowance for uncollectible receivables, a company provides for future losses in terms of receivables which will ultimately get uncollectible. The authoritative literature i.e., the GAAPs principles which contain accounting concepts and conventions provide for a concept called as conservatism or prudence which suggests that provisions or allowances shall be made for expected or possible losses but should not be made for anticipated gains.

In the given statement it isn't mentioned correctly that allowance for uncollectible receivables is recognition of a loss that occurred in the past

The correct point is it is a provision for future losses.

Refer below notes for more detailed explanation:

An allowance for doubtful accounts is a contra-asset account that nets against the total receivables presented on the balance sheet to reflect only the amounts expected to be paid. The allowance for doubtful accounts is only an estimate of the amount of accounts receivable which are expected to not be collectible. The actual payment behavior of customers may differ substantially from the estimate.

Understanding the Allowance For Doubtful Accounts

The allowance is established by recognizing bad debt expense on the income statement in the same period as the associated sale is reported. Only entities that extend credit to their customers use an allowance for doubtful accounts. Regardless of company policies and procedures for credit collections, the risk of the failure to receive payment is always present in a transaction utilizing credit. Thus, a company is required to realize this risk through the establishment of the allowance account and offsetting bad debt expense. In accordance with the matching principle of accounting, this ensures that expenses related to the sale are recorded in the same accounting period as the revenue is earned.

Because the allowance for doubtful accounts is established in the same accounting period as the original sale, an entity does not know for certain which exact receivables will be paid and which will default. Therefore, generally accepted accounting principles (GAAP) dictate that the allowance must still be established in the same accounting period as the sale but can be based on an anticipated and estimated figure. The allowance can accumulate across accounting periods and may be adjusted based on the balance in the account. Two primary methods exist for estimating the dollar amount of accounts receivables not expected to be collected.