Cash realizable value definition
/How to Determine Cash Realizable Value in Accounting
Cash realizable value is the cash remaining after the uncollectable amount has been subtracted from an account receivable. This net amount can be found by combining the receivable balance and the allowance for doubtful accounts on a company’s balance sheet. Depending on the problems a firm is having with customer discounts and non-payments, the cash realizable value can be substantially lower than the gross amount of accounts receivable.
Reporting of the cash realizable balance is required under the accrual basis of accounting, since a reporting business must report a reserve for its estimated uncollectible receivables. This is not the case under the cash basis of accounting, where a determination of uncollectability does not need to be made in advance of the collection of cash. Instead, the accountant merely writes off a receivable when it is clear that the customer will not pay it (known as the direct write-off method). This means that the receivable balance presented under the accrual basis of accounting is more realistic than one reported under the cash basis of accounting.
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Calculation of Cash Realizable Value
The key factor in calculating cash realizable value is the determination of the uncollectible amount. This determination is usually based on a historical analysis of uncollectible amounts in prior periods, adjusted for current conditions. A more precise approach is to review open receivables based on their age, and adjust for the risk of nonpayment associated with each customer. A less precise approach, but a more common one, is to apply a standard percentage to the amount of sales generated in order to estimate the probable uncollectible amount. Since this latter approach is quite high-level, it may require further adjustment over time, as more detailed information becomes available.
As an example of the percentage of sales method, a company has historically experienced 2% bad debts, and sold $1,000,000 on credit in the last month. Therefore, it records an allowance for doubtful accounts of $20,000.