Allowance for Doubtful Debts: Economic Essence

Anatolii Vladimirovich Kholkin

and Svetlana Pavlovna Goryachikh

Vyatka State University, Moskovskaya Street, 36, Kirov, Russia

Keywords: Allowance for doubtful debts, essence, financial accounting, financial report, management.

Abstract: The purpose of this article is to clarify the description of the economic essence of the doubtful debt reserve,

based on studying its nature. The objectives of the research are to study regulations, scientific sources,

literature, to identify and describe the nature of the reserve, to substantiate the economic essence of doubtful

debt reserve. The authors use the following methods: analysis and synthesis, deduction and induction,

abstraction. As a result, they clarify the description of the nature and economic essence of the reserve for

doubtful debts. The research is scientifically significant as the revised description allows more fully to identify

and substantiate problems of the reserve accounting and develop a set of measures to resolve them.

1 INTRODUCTION

The doubtful debt reserve is one of the most difficult

accounting objects. Its recognition and reflection in

accounting and disclosure in financial statements

raises a large number of questions and problems.

The reason for this problem is the lack of

understanding by accounting employees and the

management of an economic entity, users and other

people interested in information about the enterprise,

the economic nature of the doubtful debt reserve. In

addition, this problem is caused in Russia by the lack

of desire among the accounting employees and the

management to form a reserve and take the initial

action to form it - to check doubtful debts.

It determines the relevance of the study and is the

prerequisite for its implementation.

Theoretical basis for the study were works by

Kulikova L.I., Garyncev A.G., Goshunova A.V.

(Kulikova LI, Garyncev AG, Goshunova AV, 2015),

Scott B. Jackson, Xiaotao Kelvin Liu (Scott B.

Jackson, Xiaotao Kelvin Liu, 2010), Catherine A.

Finger (Catherine A. Finger, 2010), Nizar

Mohammad Alsharari , Rasha Abousamra (Nizar

Mohammad Alsharari, Rasha Abousamra, 2019),

Kuznetsova O.N. (Kuznetsova O.N., 2019), Alloy

Silverstein (Alloy Silverstein, 2019), Hyun Ah Lee,

Won Wook Choi (Hyun Ah Lee, Won Wook Choi,

2016), Goryachikh S.P. (Goryachikh S.P., 2016)

http://orcid.org/0000-0002-2790-1314

https://orcid.org/0000-0003-0186-5308

Kholkin A.V. (Kholkin A.V., 2019); and other

sources, in particular, accounting textbooks by Jerry

J. Weygandt, Paul D. Kimmel, Donald E. Kieso (Jerry

J. Weygandt, Paul D. Kimmel, Donald E. Kieso ,

2018).

Researchers define the doubtful debt reserve as a

certain regulatory value formed in accounting with

the aim of adjusting the amount of accounts

receivable to determine the amount of receipts from

debtors, which is likely to be received.

But, this definition of the economic essence of the

reserve does not quite correspond to the nature of the

reserve. It leads to misunderstanding of the necessity

of its formation. Accounting workers and the

management of economic entities are not interested in

understanding the importance of this reserve as an

economic indicator characterizing the enterprise

management system.

Therefore, the hypothesis of the research is that

the doubtful debt reserve as an accounting object and

an indicator that affects the formation of data

reflected in the accounting (financial) statements, is

of a more complex nature than it is described in

scientific sources.

The scientific novelty of the study is the

clarification of the nature of the doubtful debt reserve

formed in accounting and disclosed in reports.

Therefore, the purpose of this study is to clarify

the description of the economic essence of the

Kholkin, A. and Goryachikh, S.

Allowance for Doubtful Debts: Economic Essence.

DOI: 10.5220/0010697700003169

In Proceedings of the International Scientiﬁc-Practical Conference "Ensuring the Stability and Security of Socio-Economic Systems: Overcoming the Threats of the Crisis Space" (SES 2021),

pages 237-240

ISBN: 978-989-758-546-3

237

doubtful debt reserve on the basis of studying the

nature.

This goal requires solving the following tasks:

1. To identify and describe the nature of the

doubtful debt reserve based on scientific sources,

accounting standards and recommendations.

2. To establish and describe the economic essence

of the doubtful debt reserve based on the description

of its nature.

3. To substantiate the description of the economic

nature of the reserve.

An object of research is the doubtful debt reserve

formed in accounting. The subject of the research is

its nature and economic essence.

2 MATERIALS AND METHODS

The tasks were solved using the following methods:

analysis and synthesis, deduction and induction,

abstraction.

Analysis is a method that involves dividing a

single object into its separate parts and examining

them in the totality of connections and dependencies.

The use of this method made it possible to reveal the

nature of the reserve and to study its description.

Synthesis is the union of separate parts or

elements into a whole. The use of this method made

it possible to determine and describe the economic

essence of the provision for doubtful debts.

Deduction is the formulation of an inference

based on the transition from general facts and

provisions to specific conclusions and

generalizations, reasoning from the general to the

particular. The application of this method made it

possible to describe specific features and elements of

the economic essence of the reserve.

Induction is the process of obtaining logical

conclusions based on the transition from particular

provisions to the general. The use of this method

made it possible to generalize and formulate a general

conclusion about the economic essence of the reserve.

Abstraction is a mental selection, isolation of

some elements from a certain set and separating them

from other elements of a given set. It is used to

separate unnecessary, irrelevant, unusual features

when describing the nature of the reserve.

3 RESULTS AND DISCUSSION

When solving the tasks, the authors have obtained the

following results:

1. described the nature of the provision for

doubtful debts;

2. determined the economic essence of the

doubtful debt reserve, which is different from its

essence given in the literature;

3. gave the substantiation of the description of the

economic nature of the reserve.

Investigating the nature of the doubtful debt

reserve, it is necessary to study provisions of

accounting standards, recommendations, regulations

and literary sources.

The provisions of the IAS were investigated as

standards and prescriptions (regulations).

The works of the above authors were studied as

literary sources.

Literary sources define the doubtful debt reserve

as a kind of regulatory value created for adjusting the

amount of accounts receivable, due to the need to

reflect in the accounting (financial) statements the

amount which, with a high degree of probability, the

debtor will fulfill its obligation fully and on time. It is

considered the nature and essence of the debt reserve.

This position cannot be considered complete,

since it does not describe the nature of the reserve in

the following aspects.

1. The reserve is a virtual value. This conclusion

is made due to the fact that the reserve is an

accounting object, its formation is not associated with

the real movement of resources and real economic

processes. All operations carried out with the reserve

exist only in the system of accounting accounts and

cannot exist independently.

2. A reserve is an opinion expressed in monetary

form that any obligation to an economic entity will

not be fulfilled by its debtor fully within the specified

time period, which will lead to economic losses in the

future. However, based on the requirement of

prudence, these losses are recognized as expenses and

reduce the financial result when the enterprise obtains

obvious and sufficient evidence that in the future the

debtor will not fulfill its obligations fully and on time.

Opinion has no material form, it is not associated with

the emergence of a duty. Therefore, it cannot really

exist.

3. The reserve has a dual nature, it fully

corresponds to the application of the double entry

method. The dual nature of the reserve is manifested

in the following. On the one hand, this is a value used

to adjust accounts receivable, to determine and reflect

in the accounting (financial) statements the amounts

actually receivable from debtors. On the other hand,

this is a value that characterizes possible financial

losses, including lost profits, arising as a result of the

wrong choice of counterparties, their failure to fulfill

SES 2021 - INTERNATIONAL SCIENTIFIC-PRACTICAL CONFERENCE "ENSURING THE STABILITY AND SECURITY OF

SOCIO - ECONOMIC SYSTEMS: OVERCOMING THE THREATS OF THE CRISIS SPACE"

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their obligations, and shortcomings in claims. This

characterizes the risk management system.

4. The need to form a reserve is due to the

requirements of regulatory enactments governing

accounting, to ensure the reliability and reality of the

data in the accounting (financial) statements. That is,

the requirements for the formation of a reserve, as a

rule, are normatively fixed and do not aim to

somehow distort the actual state of affairs. Therefore,

the management of an economic entity may have no

incentive to ensure the organization of a reliable

reflection in the accounting of the reserve. Moreover,

there is a motive for refusing to form a reserve due to

compliance with the requirement of rationality of

accounting.

5. The value of the reserve has not been

determined in terms of the risk management system.

Considering the nature of the reserve from the

standpoint of risk management, it is necessary to

explain the following.

Entrepreneurship is based on risk. One of the

significant risks is the risk of default by the debtor of

his obligations under the contract, legislation, and

customs. Of course, there are various mechanisms to

reduce the negative effects of the debtor's failure to

fulfill his obligations, but for their application it is

necessary to create appropriate conditions, without

them the application of these mechanisms is not

possible. Therefore, the simplest and most effective is

the implementation of a set of measures aimed to

prevent the occurrence of the situation, when adverse

consequences are possible. It presupposes the

creation of a risk management system and ensuring

its effective functioning. Therefore, the creation of a

risk management system, in terms of managing

accounts receivable, is a prerequisite for preventing

the negative consequences of default by debtors, their

default or bankruptcy.

Any management system, including the risk

management system, must function effectively.

Therefore, the key point in the functioning of the

management system is the assessment and control of

efficiency. Control is possible if there is a

quantitatively measurable indicator. The value of the

created reserve for doubtful debts should be used as

an indicator.

Therefore, the economic essence of the reserve

should also provide the fact that the doubtful debt

reserve should be considered as a certain estimated

indicator, which can help to assess the effectiveness

of accounts receivable management from the

standpoint of an adequate preliminary selection of the

counterparty (due diligence), current work with a

counterparty, the choice of forms and methods of

settlements between counterparties, the use of

methods to ensure the fulfillment of obligations. Of

course, this indicator is not exclusive and should be

supplemented by other indicators characterizing the

claim work, but the formation of these indicators

should be the topic of independent scientific research.

Since this indicator characterizes the risk

management system in terms of receivables, the

management of an economic entity may have a

motive to veil the reporting data by distorting the

amount of the reserve, or completely abandoning the

formation of a reserve by refusing to qualify the

receivables as doubtful. Disclosing the amount of the

actually required to create a reserve, the management

of an economic entity unwittingly discloses an

indicator of possible ineffective work to prevent

doubtful and bad accounts receivable.

Considering the nature of the doubtful debt

reserve, it is necessary to investigate the reason of

forming the reserve. The reason can be the

assumption of temporary certainty of the facts of

economic life, which requires the recognition of

proceeds from sales in the absence of full certainty,

that is, in conditions of risk. Therefore, accounting

and financial reporting do not reflect revenue in the

amount of actually received assets or other benefits,

but a certain amount of potential revenue that can be

received, taking into account the probable risk of non-

receipt.

However, based on the requirement of reality, the

accounting (financial) statements should reflect the

amount of obligations for which the creditor

organization will be able to obtain performance

without resorting to additional expenditures of time

and resources. Since the adjustment of proceeds when

identifying signs and recognizing receivables as

doubtful is not possible, it becomes necessary to

change the value of the financial result indirectly, by

creating a reserve of doubtful debts. And in the

balance sheet, the amount of receivables is adjusted

by the amount of the created reserve.

However, it should be noted that the recognition

of a debt as doubtful or hopeless does not mean the

termination of the existence of the obligation itself, or

the right to receive performance under this obligation.

It is connected precisely with the opinion that in the

current circumstances or formed conditions, the

voluntary performance of the obligation by the

debtor, or the implementation enforcement can be

difficult and hardly possible. It also implies the need

to apply an indirect adjustment to the amount of the

financial result, and not a direct recalculation of both

the amount of receivables and recognized revenue or

other income (if the fact of occurrence and

Allowance for Doubtful Debts: Economic Essence

239

recognition of receivables is related to the recognition

of revenue or other income).

Thus, the economic essence of the doubtful debt

reserve can be defined as follows. The reserve is a

virtual value that has a dual nature: on the one hand,

it is a value that adjusts the amount of receivables to

determine the real amount receivable from debtors.

On the other hand, it is the amount of possible losses,

including lost profits, arising from default by debtors

of their obligations. The value of the reserve as a

reporting indicator for management purposes is a

characteristic of the state of the risk management

system in terms of the risk of default by debtors.

To substantiate the described economic nature of

the reserve for doubtful debts, the authors have

analyzed the reasons for the reserve formation and the

role of the reserve as an estimated indicator in risk

management.

4 CONCLUSIONS

The article explores and describes the nature and

economic essence of the doubtful debt reserve from

the standpoint of risk management of an economic

entity. The authors have reveled the incompleteness

of the description of the nature and essence of the

reserve in normative acts and literary sources,

namely:

1. The dual nature of the reserve has not been

investigated.

2. It has not been underlined that the reserve is a

virtual object.

3. The reserve is expressed in monetary terms, and

not as a consequence of the real movement of

resources.

4. Formation of the reserve in general and, in

particular, in Russian accounting practice, is

compliance with the requirements of regulations

governing accounting, and is not conditioned by the

subjective desires of the management of an economic

entity. Therefore, the reserve, as an accounting object,

is imposed from the outside, its reflection is an

objective external established obligation.

5. The nature of the reserve is not disclosed as an

indicator characterizing the risk management system

from the standpoint of preventing the risk of default

by debtors.

Therefore, the authors of the article have made an

attempt to eliminate these shortcomings in describing

the economic essence and nature of the reserve for

doubtful debts.

The results of this study can be used further to

identify and substantiate problems in the organization

and accounting of this object, to develop measures to

solve them.

Moreover, the results of the study can be used as

working hypotheses in substantiating the reasons for

refusing to form a doubtful debt reserve, which can

be carried out using the methods of sociological

research.

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SOCIO - ECONOMIC SYSTEMS: OVERCOMING THE THREATS OF THE CRISIS SPACE"

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