The notion of account manipulation, which encompasses
"earnings management", is mainly attached to the items of
income statements. For example, Copeland (1968) focused on income
statements and observed that management influence the size of net income
purposefully. By constructing the three concepts of "income
minimizers", "income maximizers" and "income
smoothers" he put earnings management at the centre of research
focus. Notably, the concept of earnings management denotes a particular
type of accounting practices that draw the attention only on the income
statements. However, accounts manipulation may have classificatory
practices, those related to the balance sheets and income statements
classifications. These types of manipulations are not described in the
literature. Perhaps, a reason for this shortcoming should be related to
the complexity of the accounting techniques that are applied to promote
A study carried out by Richardson et al. (2002) showed that
earnings management are chiefly based on revenue recognition that
includes AR. He did not show that in which way AR are used to manipulate
the accounts. Observations of the accounting irregularity and accounting
errors make authorities to ask for restatements or correction of the
annual reports. The reason for AR-related restatements should be related
to the desired "earnings management" that encompasses
manipulations of both balance sheets and income statements.
It seems like that "earnings management" is on the way to
be replaced by the concept of "managed accounts". This new
concept reconstructs the old concept of earning management and
communicates a more neutral and fashionable view of management
influences in accounting (see, e.g., Financial Times June 8, year 2009).
By definition, earnings management communicates a set of ways in which
management artificially manages to meet some pre-established level of
expected earnings, e.g., the analysts' forecasts. By keeping pace
with some earnings trend, estimated by analysts, it is a priori assumed
that the investors' perceptions of risk can be affected
(Riahi-Belkaoui 2005; Mathews and Perera 1996). Essentially, this type
of accounts manipulation is based on a common functional fixation view
of share price determination in the sense that accounting numbers
determine share prices (Mathews and Perera 1996). In any case, earnings
management denote practices that may affect income statements and items
such as cash flow, net income, or risks perceived by analysts.
On the one side, the term "managed accounts" was invented
to indicate transparency in practices of return strategies such as hedge
fund management. Institutional investors have asked disclosures about
those accounts that "managed" by management to increase the
return. Hedge accounting is one account by which managers attempt to
increase the net income. In this sense, the meaning attributions of
"managed accounts" are in contrast with the meaning
attributions of "earnings management". On the other side, the
term "managed accounts" indicates a full spectrum of
accounting related service platforms to improve profitability of the
firms. This means that management tend to use this concept as a touted
panacea to repair the bad reputation attached to the term "earnings
management". Management can present some service platforms, such as
hedging or to increase the net sale by credits in order to show higher
profitability. As we see, the concept of managed accounts is confusing.
This study focuses on the technical aspects of AR in order to show how
AR can be "managed". A report issued by the United State
General Accounting Office (GAO) shows that almost 38% of
"accounting irregularities"- which required restatement--were
related to the improper recognition of revenues based on AR.
According to GAO, the major reasons of restatements between 1977
and 2002 (sample periods) are:
AR is one of the key accounting tools that has increasingly used as
a service platform, e.g., to enhance profitability and at the same time,
construct a favourable image of risk. AR is used both for the purposes
of "earnings management" and restructuring of balance sheets
to portrait the financial positions less risky.
The accounting techniques and procedures that can be used for the
reporting of AR are not presented and analyzed by researchers. This
study applies an inductive method in order to show how the growth of AR
has motivated innovation of a set of methods to account for AR. It
illustrates the estimates applied for the valuation of AR and by this it
contributes to the understanding of a new form of desired accounting
2. MANAGEMENT OF AR IN A THEORETICAL LIGHT
According to Paton (1922) accounting should be changed continuously
in order to keep pace with the entities economic growth and changes. One
of the key factors underlying the recent concept of economic growth is
the development of management policy for credit sale. Credit sale is now
a management service platform by which profitability can be increased.
However, an increase in credit sale may create space for influencing a
favourable classification in the balance sheets. From the standpoint of
accounting the economic growth by credit is paradoxical; that is, an
increase in credit sale creates a set of balance sheet-related problems,
particularly for the application of principles such as prudence,
materiality and objectivity. Thus, management policy of credit sale
impacts the process of accounting for AR and as a consequence the
operational value of AR becomes ambiguous. An increase in the credit
sale enlarges the material size of AR, increase the size of the
inventory, and (assumingly) the cash-flow. Beside these changes, the
distributions of value between the categories of current and non-current
assets will be affected. For example, an increase in AR causes a
decrease in cash, and a need to increase inventory which is, in return,
related to the proportional increase in sale. We can stress that a
change in AR causes a chain of effects on the categories of assets at
the balance sheet and rules of valuation and estimates.
In spite of these balance sheet-related influences, the key
influence factor should be related to the impact of AR on income
statement. By means of AR revenue will be increased. Beside this, the
gap between realizable revenue and sale will be increased. We may say
that the simple concept of "economic growth" by credit turns
to become a "nightmare" for accountants and accounting of
growth in a reliable way.
When management importance of AR has increased, standard setters
became curious about the scope of uncertainty that surrounds AR. The
trend toward credit sale increased the risk of credit losses. When
accountants will eliminate the risk, they should make a reference to the
principles of prudence (conservatism), objectivity (and materiality),
substance over form, and matching. An emphasis on prudence means to
resolve the problem of overstating of value. The concept of prudence
suggests that the value of AR should be reduced to an adequate level. On
the other side, the principle of objectivity suggests that accounting of
AR should be based on the "realizable value". This further
suggests that book-value needs to be reduced to reach a realistic level.
And finally, the concept of matching principle suggests that any
reduction in the value of asset, here AR, should be expensed in regards
with the year in which this reduction arises. This latter idea is
directly associated with the diverse meaning attributions that we
normally attach to the principle of "substance over form".
Here it is meant that, uncollectable accounts (bad debts) should not
affect the expenses (and hence the profit) of the year in which they
legally proved to be uncollectable (or bad). Instead, the bad debts
should be matched as an expense in the year they arise. Paradoxically,
too much emphasis on matching (a means to reach fair value and also a
means to reach substance over form) provides a space for managerial
interpretations and ad hoc accounting. For variety of reasons, firms
move towards matching and fair value accounting of AR because it is
required by IASB (International Accounting Standards Board). The
analysis of the underlying factors that affect accounting of AR attests
to the shift in the application of AR by small and big firms. Firms of
varied size attempt to apply AR as a managerial service platform, for
example, in dealing with customers or to improve the operational and
financial performances, market share, growth and profitability (Needls
et al., 1996). These management choices or platforms provide spaces for
the firms to adopt a set of flexible techniques in accounting of AR. It
is not surprising that Lin et al. (2003) expressed their concerns about
assessing the risk of fraudulent financial reporting.
In the following sections the major focus is directed on the
standards and the related techniques used for the accounting of AR. The
aim is to show how the options of different techniques and arbitrary
nature of the accounting estimates can influence accounting
3. AR AND PROBLEM OF CLASSIFICATION
In modern accounting to make lines of division between tangible and
intangible items is of special importance. One major problem is that
standard setters cannot always follow the logic of the accounting
theories (Puxy1993). Classification of AR has some meaning for valuation
of AR. A question that we can be addressed is that is AR a tangible or
According to Paton (1922), "The most logical view is to
consider as intangibles all immaterial properties, such as patent,
leaseholds, goodwill, trade-marks, copyrights, royalty rights, etc., and
all other rights or claims, such as securities and open customer
accounts. Accounts receivable are certainly as fully immaterial in
nature as patent rights (p. 213)".
It is reasonable to assume that AR are not a cash or cash
equivalents, rather they are rights to cash a kind of legal right.
Arguably, legal rights should be classified as intangible assets. Clark
(1930) is perhaps the first writers who focused on AR from the customer
credit point of view. He emphasized that AR is an intangible asset that
is structured by involvement of management.
In spite of this early theoretical recommendation, the work of
classifying AR in terms of tangible/intangible asset is not fully
completed. An immaterial asset like accounts receivable which is
classified as none-intangible is not theoretically sound. It seems like
that IASB wishes to treat as intangibles only those assets that have
somewhat dubious nature. As mentioned by Paton, by creation of a
separate classification for AR, the intangibles are portraits as dubious
and non-important items in the (ownership) traditional accounting. It is
paradoxical that the test of tangibility is not related to the
immaterial nature of an asset. This means that classification is not
being used to designate the nonphysical or immaterial assets as a group.
In the following sections, we consider AR as an intangible asset that
lacks physical substance. It is classified as entity's
"right" to future customer payments. Further, it is assumed
that the book-value of this asset is not the same as its realizable
value. As the volume of this assets increases, it is materially
reasonable that realizable value to be estimated.
3.1 International Standards for Accounting of AR
The Swedish accounting lacks sufficient standards aimed at
estimating the realizable value of the AR. Thus, we need to refer to IAS
(International Accounting Standards) standards. Concepts and rules for
recognition and accounting treatment of AR are initially developed in
IAS 1. In order to prevent misleading, cash that is not available for
immediate use (e.g. AR) should be disclosed separately. In the revised
IAS 1 (effective 2005), cash which restricted and not available for use
within one year of the balance sheet date should be included in
non-current assets. Considering this rule, AR can be defined both as a
current and non-current asset. A portion of AR can take more than one
year to be converted into the cash and thus cannot be classified as a
current asset. This problem is not solved by IAS.
IAS 7 brings forward the concept of cash equivalent. By definition,
cash equivalent is short-term (limit of three month) and risky
investment. There is also a possibility that the concept of cash
equivalent be applied in order to create a separate caption for AR. AR
is a risky concept and view of "service platform" makes this
concept to be more risky than ever. The interpretation is that the
concept of cash equivalent may confuse the classification one step
further. That is to say that, it is possible that AR to be classified as
the categories of current, non-current and cash-equivalent.
For some companies that sell to consumers, instalment accounts
receivable, note receivables and trade receivables constitute a
significant portion of AR (see appendix 1).
Although instalment accounts receivable allow the customers to use
a payment periods which may be 24 months or more, they are (often)
classified as current assets. If instalment policy is customary in an
industry, the instalment accounts receivable should be classified as
current accounts in the balance sheet and be treated as AR.
Another technical problem is how to delimit caption of AR as an
object of classification. As the volume of AR increases the riskiness
increases and this change in risk should affect the goal of
classification. For example as the grade of riskiness increases, it is
reasonable that the principle of prudence to be more emphasized. An
emphasis on prudence requires precision in estimates and a change in
recognition procedures. How AR should be defined? Receivables include
trade receivable, note receivables, trade acceptances, third-party
instruments (for example loan to employees, affiliated companies etc.)
and interests receivable. Sometimes acquisitions and sales of
subsidiaries cause charges--movement charges- which are related to the
basis of customers. Practically, accountants insist on the various
classes as a separate and distinguishable post. Considering this, IAS
provides no guides for the classification of AR.
IAS 39 and IAS 18 provide some guide lines for the reporting
structure of AR. IAS 39 addresses recognition, de-recognition and
measurement of receivables as if it is a financial asset. In the revised
version of IAS 39 and IAS 32 (which treats financial instruments) a
commitment to a strict "substance over form" approach is
recommended. This requires, in return, a focus on good matching and fair
value accounting for the treatment of AR.
It should be argued that in regards with the determinant of
"substance over form" or fair value accounting, practitioners
have developed a range of procedures for the recognition, valuation,
measurement, and reporting of the uncollectable receivables. None of
these practical techniques are included in IAS guide-lines. In the
following sections these technical approaches will be presented.
3.2 Accounting Valuation of AR
In the previous section, it was argued that standard setters have a
difficulty to classify AR. The classification problem has its root in
recognition and measurement of AR. Basically, the accounting treatment
of AR is not similar to those applied for the accounting of current and
noncurrent assets. Instead, it is more similar with recognition rules
used for the accounting of intangible assets. The reason for this should
be related to the notion of "contra accounts" and the need of
particular procedure for evaluation of risks. Notably, the book-value of
accounts receivable is often under the "recovering value"
because of the following economic situations:
1. It is difficult to assess the creditworthiness of the customer,
particularly in periods of economic recession.
2. The customer may refuse to accept the price charged. As the
volume of credit sale increases, the probability for the refuse of
products will be increased.
3. The customer may refuse to accept some of the products because
they were faulty.
In current accounting, AR is categorized as current assets, usually
converting into cash within 30 to 60 days. Therefore, AR appears in the
balance sheet immediately after cash and short term investment in
marketing securities. This type of classification creates problem for
calculation of cash-flow.
There are many reasons indicating that the book value (carrying
amount) of the AR is higher than its recovering amount (net realizable
value), and as such, the AR should be impaired. The accounting
adjustment of AR is the most commonly occurring accounting issues and
problems that accountants need to deal with. The principles of prudence,
fair value, objectivity, and matching are key concepts that accountants
apply to recognize, measure, and valuate the AR. The relationships
between these principles and measurement are promulgated in IAS in the
"When an uncertainty arises about the collectability of an
amount already included in revenue, the uncollectible amount, or the
amount in respect of which recovery has ceased to be probable, is
recognized as an expense, rather than an adjustment of the amount of
revenue originally recognized" (IAS 18, IASC 1993: [section] 22).
This standard implicates the requirements of the two key accounting
procedures, (1) uncollectible amount should be valued objectively, (2)
and be expensed as they arise. This standard ensures that the bad debts
do not affect the expenses of the year in which they prove to be bad
(legally approved), but rather the year in which the credit transaction
is taken place. The position of IAS 18 is accounting by
"substance" rather than by "form".
If loans or sales are not made for the regular costumers, and made
to employees, officers of corporation, or owners they should be shown
separately. Such a separation is not specified in IAS, meaning that
standard setters neglected to provide guidelines for an important
classification. A further technical notion worth mentioning is that
accounts receivable have debit balance. Sometimes customers overpay
their accounts e.g. by mistake or in anticipation of future purchase.
The overpaid accounts should be classified as a current liability.
In sum, the problems attached to the accounting of AR are many.
Some of these problems concern management- how to increase, control and
account the cash-flow and receivables or to delimit the risk of
uncollectability; other problems should be related to the notion of
reporting or task of accountants in regards with matching principles,
materiality and reliance.
3.3 Accounting Models for Reporting of AR
Accounts cannot wait for standard setters. Like any other
practitioners they develop their techniques and they expect that these
technique to be "legitimized" by standard setters and law
makers. In recent years two types of methods has been developed to deal
with the problem of accounting of AR. These methods are not clearly
defined in the current textbooks.
Broadly speaking, there are four techniques for the recognition and
measurement of AR. These four techniques shape two distinctive methods.
We name here one of them as an individual method of treatment and the
other one as a collective method of treatment. Disregarding the size of
the companies, if the numbers of credit sale are limited, an individual
methods, and if the numbers of credit sale is high the collective
methods are applied. For example, a car dealer firm that sells less than
100 cars per year uses an individual method; while a dentists that serve
more than 1 000 patients per year needs to use a collective method. When
the prices of goods/services are materially high, risk of the credit
should be treated individually. On the contrary, when the number of the
items sold is high and prices are materially low a collective treatment
is advisable. Individual methods are based on judgement and collective
methods on estimates. In the following sections both methods will be
3.3.1 Individual Methods
The individual treatments have two frameworks, a legal and an
economic. In both methods the economic situations of the credit accounts
should be judged. In the legal form a direct writ-off method is used.
This means that allowance is not allowed and AR is reduced (or
uncollectable customers are removed from the accounting) when the legal
authorities have determined that a customer is insolvent. It takes more
than several months or sometimes several years that the legal
authorities to determine the insolvency of an individual customer. The
use of legal guide lines puts the matching principle out of work. This
means that the fair value accounting is not possible.
The economic model allows allowance meaning that on the basis of
risk evaluation, a portion of the amount of AR can be adjusted per year.
The final adjustment and reduction has been down when the authority has
confirmed that customer is insolvent. The legal method is more reliable
but less relevant; while the economic method is more relevant or is more
close to fair value accounting, but less reliable. The economic model
allows ad hoc accounting of the type "earnings management".
Here a practical model for risk evaluation is presented. The idea is to
describe how accountants can deviate from the correct procedures without
being revealed by auditors or individuals who are located
"outside" of accounting.
A practical approach to the risk evaluation of AR on the individual
basis begins with the interpretation of the economic situations that
underlies AR. The following table (2) illustrates the nature of AR and
its relationships with legal and economic models of treatments.
The nature of AR can be djuged in considerations of four
situations: ordinary, doubtful, disputed and unocallectible. A reliable
accounting needs thre types of documents that describe the risk
situations. IAS did not develop procedural rules for the identifications
of the risk situations. A practical way of making distinctions between
different risk situations and account for these situations is to use
different "documents". The use of documents helps accountants
to arrive closer to the principle of "objectivity".
In ordinary situation, it is judged that collection is certain, and
there will be no foreseeable loss when collecting AR. This means that
there are no evidences that indicate the failure of collections. Here,
the portion of receivables that is qualified for the ordinary situation
can be equated as realizable cash.
In interpreting the doubtful situation a legal document is not
available. It is sufficient that accountants have some information about
the payment inability of the debtor. In the doubtful situations
documentation should contain two criteria; (1) claim is accepted by an
uncontested customer; (2) the economic situation of the customer
(debtor) is considered. For example, accountant by means of telephone or
e-mail ask a customer about the time and portion of the debts that the
customer can pay. Customer's answer is a ground for
"documentation". The legal model of accounting refuses to
accept adjustments. The economic model allows that the balance of AR to
be reduced by estimated per cent of uncollectabilities. The net income
can be reduced by the same estimate.
In disputed situations, claim is contested by customer and there is
uncertainty considering the amount and probability of the
uncollectibility. In this situation, a document--not necessarily a legal
one--is involved. Customer sends a message (telephone or e-mail) in
which price, quality, quantity etc. are questioned. In disputed
situations, the provision of documents is initiated by customers rather
than accountants. Accounting of doubtful and disputed situations is
In uncollectible situations, claims are not collectible, debtor is
insolvent and a legal document should support an uncollectible
situation. At this stage, accounts should be both adjusted and reduced,
that is, the customers should be eliminated from the bookkeeping
accounts. A deviance from the above specified accounting procedures will
lead to a type of ad hoc accounting that favour interest of individuals
involved in accounting communication.
3.3.2 Evaluations by Collective Method
An evaluation credit risk by collective methods is carried out when
the volume of credits is material and numbers of credit sales are high.
Here, evaluation should be calculated by means of an estimate rather
than judgement of situation. There are two methods by which the risk of
AR can be estimated. These methods are "global estimation" and
"aging of accounts".
The global estimation is even called percentage of net sale method;
the aging method is even called percentage of gross receivable method.
Theoretically, the global estimation is considered as income
statement and aging method as balance sheet approaches to AR. The reason
for such as a theoretical distinction has a deep historical background
that the description of which is out of the scope of this study.
A distinctive characteristic of the global method is that the
historical data from the income statements of the previous years should
be used for calculation of the estimate. In a simple way, the following
table shows how estimate is calculated.
The table shows that a-three-years net sales results in 2 percent
bad depth in average per year. This 2 percent can be used as an estimate
for the assessment of the bad depth of the current annual revenues (or
By means of aging method, AR of a company can be analyzed by
consideration of past due and clusters of customers. As it is shown in
the following table, based on the previous experiences, a company may
use 1% rate for "not yet due" 2% for 1-30. ... etc.
The function of aging method is different compared with global
method. For example, the global method helps estimating the bad depth,
whereas the aging method helps estimating the target balance of
allowance in order to adjust the amount of AR. We may say that aging
method is good for estimating the realizable amount of AR. On the other
side, the global method is good for the estimation of bad depth. When
the economic situations behind the historical data of a firm keep pace
with the current economic situation the differences between the two
methods are not so dramatic. But, if the economic situations are
changed, e.g., credit sales are increased, the use of estimate that is
based on the old data is misleading. In the situation of change the
aging method is preferable.
The aging method is often supported by a data program.
Computer-based registering of customers provides a possibility for the
treatment of uncollectible accounts in regards with the receivables past
due (outstanding times). It means that the aging technique can aid
cash-management, budgeting, and customer analysis. Accounting of bad
depth and realizable value of AR requires a complicated procedure which
is not shown here.
4. ANALYSIS AND CONCLUSIONS
By means of an inductive approach, the study could present four
different valuation procedures for the accounting of AR. First a
distinction made between the individual and collective treatment of AR.
It was suggested that when the number of credits are increased firms
account by collective methods. On the other side, when the number of
customer are limited the individual methods are applied.
The study developed the key procedures needed for judging the four
different economic situations that indicate the riskiness of AR. By
means of a model these economic situations are related to a framework of
accounting objectivity. It was showed that when a legal method for the
recognition of bad depth is used practices of earnings management cannot
easily be accomplished. In contrast to this, when economic situations
were used as criteria of recognition, fair value accounting is allowed,
and at the same time, a space for earnings management was created. That
is to say that in order to match the estimated bad depths in the years
they arise, management can influence the volume of estimate by
interpreting doubtful situations in a desired way.
Further, the study could show two different methods of collective
treatments that firms apply in situations where the numbers of credits
have increased. Illustrations 3 and 4 show the features of the methods.
It was argued that when the collective methods are at the issue,
management has an option to choose an estimate that gives a favourable
result. The two methods can rarely produce the same estimate and
managers usually choose the favourable one. Another problem is that the
estimate itself can be influenced. By changing the rules of recognition
or by ignoring the impact of economic circumstances of the current
accounting year, management can practice earnings management. For
example, when the volume of AR increases the riskiness will be also
increased. A correct accounting practice requires that the estimates to
be changed in response to the economic situations. By ignoring such a
change the value of AR is not correctly accounted.
The study concludes that by exploiting the flexibility allowed by
standards, managers can bolster the earnings or portrait the key ratios
in a less risky fashion. A lack of proper categories for recognition,
definition of AR alongside with alternative treatments at the practical
level makes accounting of AR to appear troublesome in the future time.
Additionally, the language style of standards allows management to
project earnings path and avoid true and fair value accounting. The
conclusion is that increasing development of "managed
accounts" and inclusion of AR as part of managerial service
platform creates a fear for witnessing an erosion in the quality of
income statements and balance sheets. Finally by drawing on Epstein
& Jermakowicz (2007); and Mathews (1993), the study concludes that
the use of estimate increases problem of disclosure in accounting. A
fair value accounting requires that valuation of AR to be carried out by
means of estimate. The question that can be raised is that: how the use
of estimate affects users' interpretation of accounts in decision
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Table 1: Source: United States General Accounting Office: Financial
Statement Restatements: Trends, Market Impacts, Regulatory
Responses, and Remaining Challenges (October 2002).
Major reasons Percents
Revenue recognition 37,9
Illustration 2: the procedures of judging the economic situations of
Procedures of judging uncertainties of AR
Nature of AR Sources of Legal treatments
Ordinary AR No indication of risk No adjustments and
Doubtful AR Accountants' own No adjustments and
Disputed AR Customers' information No adjustments and
Uncollectible AR Legal authorities' AR and net income are
Nature of AR Economic treatments
Ordinary AR No adjustments and
Doubtful AR Balance of AR and net
income are adjusted
Disputed AR Balance of AR and net
income are adjusted
Uncollectible AR AR and net income are
reduced and adjusted
Illustration 3: calculation of estimate by global method
Years Net sale (SWED) Bad depth percentage
X1 520 000 10200 1, 96
X2 595 000 13900 1, 34
X3 585 000 9 900 1, 69
Total 1 700 000 34 000 2, 00
Illustration 4: presentation of aging method
Customers Total Not 1-30 days
yet due past due
Customer a 150 150
Customer b 400
Customer c 1 000 900 100
Customer d 250
Others 42 600 21 000 1 4000
Total 44 400 21 900 14 250
Estimate % 1.0 2.0
Total allowance 2 459 219 285
Customers 31-60 days 61-90 days Over 90
past due past due days past
Customer b 400
Customer d 250
Others 3 800 2200 1 600
Total 4 200 2 450 1 600
Estimate % 10.0 30.0 50.0
Total allowance 420 735 800