The management of accounts receivable is essential in the cash flow of any company, since it is the amount expected to be received from customers for the products or services provided (net realizable value). Accounts receivable are classified as current and non-current assets. These transactions are recorded on the balance sheet. Current accounts receivable are cash and other assets that a business expects to receive from customers and use within one year or depending on the operating cycle, whichever is longer. Accounts receivable are collected as bad debts or discounted for prompt payment. Non-current assets are long-term, which means that the company holds them for more than one year. Aside from well-known non-current assets, banks and other mortgage lenders have a mortgage receivable that is recorded as a non-current asset.
Bad debts, also known as bad expenses, are considered a contra asset (subtracted from an asset on the balance sheet). The against asset increases with the credit entries and decreases with the debit entries and will have a credit balance. Bad debt is an expense account that represents accounts receivable that a business is not expected to collect. A prompt payment discount is offered to the customer to attract timely payment. When a customer pays an invoice within a stipulated time, which is normally 10 days, a cash discount is offered noted as 2/10, which means that if the account is paid within 10 days, the customer gets a 2 percent discount. The other credit terms offered could be n30, which means the full amount: must be paid within 30 days. Cash discounts are recorded in the income statement as a deduction from sales income.
Banks and other financial institutions that provide lending expertise or expect to incur losses on loans they lend to clients. As the country witnessed during the credit crisis, banks issued mortgages to clients who, due to job losses or other events related to their circumstances at the time, were unable to pay their mortgages. As a result, mortgages were defaulted, causing a foreclosure crisis and banks repossessed homes and lost money. For better loss recovery, banks ensured accounting procedures to help bankers report accurate loan transactions at the end of each month or based on the bank’s mortgage cycle. Among these credit risk management systems, banks created a reserve account for credit losses and provisions for mortgage losses. Mortgage lenders also have a mortgage credit account (non-current asset). By definition, a mortgage is a loan (a slow sum of money to interest) that a borrower uses to buy a property such as a house, land or building and there is an agreement that the borrower will pay the loan monthly and in installments. they are amortized over a few stipulated years.
To record the mortgage transaction, the accountant debits the mortgage receivable and credits the cash account. By crediting cash it reduces the account balance. If the borrower defaults on his mortgage, the accountant debits the bad debt expenses and credits the mortgage accounts receivable account. Mortgage accounts receivable are recorded as long-term assets on the balance sheet. The bad debt expense is recorded in the income statement. Having a bad debt expense in the same year that the mortgage is recognized is an application of the principle of matching.
To safeguard losses on defaulted mortgage loans, banks created a reserve account for credit losses, which is a counter-asset account (a deduction of an asset on the balance sheet) that represents the amount estimated to cover the losses in the entire portfolio. of loans. The credit loss reserve account is reported on the balance sheet and represents the amount of outstanding loans that are not expected to be repaid by borrowers (a credit loss reserve estimated by mortgage lending financial institutions). This account is adjusted on a quarterly basis based on the interest loss on both outstanding and delinquent mortgage loans (not accumulated and restricted). The provision for bad loans is an expense that increases (or decreases) the reserve for bad loans. Bad loan expense is recorded in the income statement. It is designed to adjust the loan reserve so that the loan reserve reflects the risk of default in the loan portfolio. In my opinion, the loan loss reserve estimation methodology based on all loan accounts in the portfolio does not provide a good measure of the losses that could be incurred. There is still the risk of exaggerating or underestimating the loss. Therefore, there is still the possibility of banks operating at a loss, and that defeats the purpose of having the reserve and provision for credit losses. If loans were categorized and then estimated accordingly, more credit losses would be eliminated.