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Regulatory influence on bad debt estimation

Fri, March 14, 10:30am to 12:00pm, Sheraton Dallas Hotel, TBA

Abstract

This paper examines the difference between two methods of managing the allowance for doubtful accounts and bad debt expense. We compare firms that extend credit to businesses (trade credit) and firms that extend credit to consumers (consumer credit). We ask the question: How does the degree of conservatism in the allowance for doubtful accounts differ between trade credit and consumer credit firms? We find that trade credit and consumer credit firms differ significantly. Consistent with prior research, trade credit firms exhibit significant conservatism in estimating bad debt expense, creating reserves that allow firms to manage earnings to meet benchmarks, even recognizing income increasing bad debt accruals. In contrast, consumer credit firms estimate uncollectible accounts that are close to write-offs in the subsequent period showing no signs of earnings management. We attribute differences between groups to the additional detailed disclosures and estimation procedures required of consumer credit firms. The additional detail required of consumer credit firms limits their ability to make opportunistic accruals.

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