Lesson 19 of 33 · Free
Contents
- 1 Accounts Receivable & Bad Debts
- 1.1 What accounts receivable really is
- 1.2 When does AR get recorded?
- 1.3 The aging analysis
- 1.4 Bad debt provision (Allowance for Doubtful Debts)
- 1.5 When a specific customer is confirmed uncollectible
- 1.6 Two methods for estimating bad debts
- 1.7 Three AR KPIs every CFO watches
- 1.8 Lesson recap
- 1.9 Practical Indian Application
- 1.10 Worked Example — Royal Furnishings ECL Computation
- 1.11 Common Receivable Management Mistakes
- 1.12 Frequently Asked Questions
- 1.13 Credit Control Best Practices
Accounts Receivable & Bad Debts
Customers who owe you. Aging analysis, bad-debt provisions, write-offs, and the three KPIs every CFO watches.
What accounts receivable really is
Accounts receivable (AR) is money customers owe you for goods or services already delivered. When you sell on credit — issue an invoice with payment terms like “Net 30” — AR is born. It’s an asset because you expect to collect the cash. But it’s a risky asset, because some customers don’t pay. Managing AR well is one of the biggest determinants of working-capital health.
When does AR get recorded?
The moment you’ve earned the revenue. Under accrual accounting, that’s when the goods are delivered or the service is performed — not when the invoice is mailed and not when payment arrives. The entry:
Dr. Accounts Receivable ₹1,00,000
Cr. Sales Revenue ₹1,00,000
When the customer pays:
Dr. Cash / Bank ₹1,00,000
Cr. Accounts Receivable ₹1,00,000
The aging analysis
Not all receivables are equal. A bill that’s 5 days old is very likely to be paid; one that’s 200 days old, much less so. The aging schedule buckets receivables by how overdue they are:
- Current (0-30 days) — within terms. Provision: 1-2%.
- 31-60 days — recently overdue. Provision: 5%.
- 61-90 days — escalation needed. Provision: 15%.
- 91-180 days — collection action. Provision: 40%.
- Over 180 days — likely write-off. Provision: 100%.
Provision percentages vary by industry and customer mix. The above is illustrative; a SaaS company with auto-debit might use much lower numbers, a B2B trader much higher.
Bad debt provision (Allowance for Doubtful Debts)
Conservatism principle: you must estimate uncollectible AR and book it as an expense in the same period as the related sale, not when the customer eventually defaults.
The journal entry uses a contra-asset:
Dr. Bad Debt Expense ₹25,000
Cr. Allowance for Doubtful Debts ₹25,000
The allowance is a contra-asset — it sits next to AR but with a credit balance. On the balance sheet:
| Accounts Receivable (gross) | 6,77,000 |
| Less: Allowance for Doubtful Debts | (25,000) |
| Net AR (realisable value) | 6,52,000 |
When a specific customer is confirmed uncollectible
The receivable gets written off against the allowance — no new expense, because the expense was already booked when the allowance was created.
Dr. Allowance for Doubtful Debts ₹12,000
Cr. Accounts Receivable — Customer Z ₹12,000
If the customer surprises you and later pays after the write-off, you reverse the write-off then record the receipt.
Two methods for estimating bad debts
- Percentage of credit sales (income-statement approach). “Assume 2% of credit sales will go bad.” Simple, focuses on the P&L expense.
- Aging analysis (balance-sheet approach). Apply different percentages to each age bucket. Focuses on the realistic AR realisable value. More accurate; required under Ind AS / IFRS for material AR balances.
Three AR KPIs every CFO watches
- Days Sales Outstanding (DSO) = AR ÷ Daily revenue. Lower is better.
- Collection efficiency = Cash collected ÷ Total receivables. Higher is better.
- Bad debt ratio = Bad debt expense ÷ Revenue. Should track stably across periods.
Lesson recap
- AR is born when revenue is earned, not when the invoice is paid.
- Aging analysis buckets AR by overdue period; older = riskier.
- Bad debt provision is a contra-asset; reduces AR to realisable value.
- Write-offs reduce the allowance, not the P&L (the expense was booked earlier).
- Watch DSO, collection efficiency, and bad-debt ratio every month.
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Practical Indian Application
Tools and references: Tally Prime ageing report; TReDS (RBI-licensed receivable discounting platforms — RXIL, M1xchange, Invoicemart); CIBIL Commercial credit score for customer evaluation; Section 36 of the Income-tax Act for bad-debt deduction rules; ICAI Guidance Note on Expected Credit Loss methodology.
Worked Example — Royal Furnishings ECL Computation
Imagine Royal Furnishings, Kolkata, has total Sundry Debtors of ₹50,00,000 on 31 March 2026. Ageing: 0–30 days ₹25,00,000, 31–60 ₹12,00,000, 61–90 ₹6,00,000, 91–180 ₹4,00,000, above 180 ₹3,00,000. Under Ind AS 109 ECL, the firm applies historical default rates: 0.5% on current, 2% on 31–60, 5% on 61–90, 25% on 91–180, 100% on above 180. ECL = 12,500 + 24,000 + 30,000 + 1,00,000 + 3,00,000 = ₹4,66,500. The journal: Dr Impairment Loss ₹4,66,500, Cr Allowance for Expected Credit Loss ₹4,66,500. If a specific ₹1,50,000 debt is later confirmed uncollectable, it is written off against the allowance, leaving the rest as buffer for future losses.
Common Receivable Management Mistakes
- Not setting credit limits per customer — leads to concentration risk
- Failing to age receivables in proper buckets
- Treating provision and write-off identically for tax — only write-off is deductible under Section 36(1)(vii)
- Ignoring economic indicators in ECL modelling — Ind AS 109 requires forward-looking adjustments
Frequently Asked Questions
What is the difference between provision and write-off?
Provision is a buffer based on expected loss; write-off is the actual removal of a receivable from books when recovery is judged impossible.
Is provision for doubtful debts tax-deductible?
Generally no, except for specified banks/NBFCs under Section 36(1)(viia). Actual write-off under Section 36(1)(vii) is deductible.
How long can a debt remain on Indian books?
No statutory limit, but the Limitation Act, 1963 typically bars suits beyond 3 years from the cause of action — though the right to receive is not extinguished.
Credit Control Best Practices
A robust credit policy includes: (a) customer credit limits set based on CIBIL Commercial score, GST compliance score, and recent payment behaviour; (b) terms and conditions printed on every invoice (interest @ 18% p.a. on overdue); (c) ageing review every 15 days with collection calls at 30/60/90 day buckets; (d) escalation to legal notices and arbitration for accounts beyond 180 days; (e) periodic write-off of confirmed bad debts with documentation under Section 36(1)(vii). A firm with receivables ₹50 lakh, average daily sales ₹2 lakh, collection days 25 against industry benchmark 18 has ₹14 lakh excess working capital tied up — ₹1.68 lakh annual interest cost.
Closing Discipline
Build a weekly receivable review meeting with sales and finance teams. Combine ageing reports with customer credit scores and recent payment patterns. The best Indian SMEs run with Receivable Days under 25 — chase that benchmark relentlessly. Every day of delay is a day of working capital cost; compounded over a year, this single discipline can boost profitability by 1-2%.
The Indian Debtor Recovery Toolkit
When standard collection calls fail, Indian businesses have several escalation tools:
- Demand Notice under MSMED Act: For MSME suppliers, statutory demand triggers interest at 3× bank rate
- Legal Notice via Lawyer: ~₹5,000-15,000 cost; often prompts settlement
- Suit under Order 37 CPC (Summary Suit): Faster track for commercial dues; 6-12 month resolution
- Section 138 Negotiable Instruments Act: Criminal action for cheque bounce; powerful deterrent
- Insolvency under IBC 2016: For dues above ₹1 crore; can trigger corporate insolvency resolution
- Arbitration: If contract has arbitration clause; faster than civil suits, binding award
The right tool depends on debt size, debtor’s financial health, and your relationship horizon. Most Indian SMEs use a graduated approach — gentle reminders → demand notice → legal notice → suit only when other options exhausted.