If you compare the amounts Instructure reported for its 2016 bad debt expense and accounts written off in its 2016 financial statements to amounts that should be the same in its 2017 financial statements, you’ll find that they differ. The amounts reported in 2017 are over 50% less than the ones reported in 2016. We asked for clarification from Instructure’s Investor Relations Department. They provided the following explanation:
In our analysis of the AR allowance during 2017 it came to our attention that there was an inappropriate accrual. This improperly inflated the bad debt expense and write-off amounts shown in our 2016 disclosure. The 2016 number is inappropriately too high and does not represent true write-off activity or bad debt expense. Thus, we appropriately trued up these amounts in the 2017 10-K filing. The new numbers represented in 2017 filing (for 2016) are the accurate amounts.
However, this explanation doesn’t make sense because there is no accrual that would affect only one account; in this case, allowance for doubtful accounts. To understand why we need to understand what an accrual is. An accrual is an accounting entry that a company makes because of timing differences between when it earns revenue or incurs an expense and it receives or pays cash.
In the case of allowance for doubtful accounts, a company accrues a bad debt expense because it does not know which accounts receivable will not be collected but wants the estimate in the allowance account to reflect the part of accounts receivable it does not expect to collect.
The bad debt expense accrual would not just affect the allowance for doubtful accounts, but would also affect an expense and net income. In this case none of the balances on the financial statements were affected, only the amounts in the notes. Let’s take a look at the details.
Reported in 2016 Statements
Reported in 2017 Statements
Note that the bad debt expense for 2016 was 600 in the 2016 statements. We expect it to be 600 in the 2017 statements but is 262. The net write-offs also decreased by the same amount so the ending balance remained the same.
Additional details are provided in the video: