Doubtful Debt Clients: Accounting and Tax Criteria

Although dubious collection clients are proliferating in the recession, they are a common problem. You can’t avoid provisioning them when things go wrong. You can’ t abuse their accountment when things are going well either.  Then, when should you account them?

In accounting terms, the term clients refers to those persons (individuals and companies) who acquire goods or services from an entrepreneur. Customers, in contrast to debtors, acquire goods and services that come from the main activity of the employer.

When an entrepreneur sells a good or provides a service, he issues an invoice and accounts for a claim. This receivable is recorded in the accounts under the “Customers” heading.

Therefore, customer balances are assets from which the entrepreneur expects to obtain an economic return. The value of these balances must match the amount of the invoice delivered for the sale. In other words, it must express the value expected to be received.

However, on some occasions this value may change due to events beyond the control of the entrepreneur. For example, the so-called insolvency risks.

An insolvency risk is the circumstance that leads the employer to believe that he will not collect customer debts. However, the General Accounting Plan does not define these circumstances. It only establishes that the employer will be obliged to make the appropriate value adjustments to the recorded assets on an annual basis.

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When is a client considered doubtful or insolvent?

The qualification of a client as dubious in term of collection depends on the bussinesman. It is the intuition that leads him to deduce that he will not receive a credit, at its due date. As soon as the entrepreneur foresees the dissatisfaction of the credit, he must classify the customer as dubious.

Consequently, a customer must be classified as dubious before the due date of the credit.

The fact that a customer is classified as dubious is not a loss of credit. The loss will be the consequence of the customer’s expectations of collection of the debt balance being completely unsatisfied.

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Rigth to honor and credit blacklists

The credit blacklists are records that include people, that have incurred in default of a debt.

When should the loss due to insolvency (or dubious collection) be paid?

As we said, the businessman will qualify a client as dubious when (before the expiration date) he foresees that such client will not satisfy the amount owed.

When the due date arrives, it may happen that the entrepreneur will collect or not collect at all. If the company does not collect, it may reflect an actual loss, and the credit will be cancelled.

Accounting regulations do not determine the circumstances to consider an insolvency or a loss. The businessman must always be guided by the principle of prudence, in order to show the true image of his patrimony.

However, tax regulations can be enlightening.

Article 13 of the Corporate Tax Law establishes four requirements for deducting a loss due to client insolvency: (any of them enables the tax loss)

• That a period of 6 months from the expiration of the payment obligation has elapsed;
• That the debtor has been declared bankrupt;
• If the debtor is prosecuted for the crime of property seizure;
• If the obligations have been claimed in court.

This tax regulation excludes from deduction the credits of credit institutions or parties related to the employer. With the exception in this last case of the declaration of insolvency proceedings.

Therefore, it seems reasonable to take these requirements as a reference, to provide or not the risks for insolvencies.

How do I register an insolvency?

The General Accounting Plan requires all entrepreneurs to verify the value of their assets at least once a year.

Therefore, the entrepreneur must evaluate, annually, if there is evidence to modify the value of his credit rights. In this respect, the circumstances set out in the aforementioned tax regulations may serve as a reference.

That said, once the entrepreneur assumes that it is difficult to collect a customer’s balance, he will be classified as a dubious customer. The accounting record involves changing a customer account into one of dubious collection.

Once the customer has been registered as dubious, if it is not recoverable, the corresponding loss may be recorded due to insolvency. This loss will be reflected in the profit and loss account.

Conclusions

Expectations concerning collection from customers should be reflected in the accounting.

When an entrepreneur foresees that it will be difficult to collect a loan before its due date, he must classify it as doubtful.

If the loan is uncollectible on its due date, it can be charged with the corresponding loss due to customer impairment.

Such loss will be tax deductible when the requirements established by the Corporate Income Tax Law are met.

If this article has been of interest, we also suggest you to read the following article published on our website: Non-payment of debts as direct damage according to the Supreme Court