Unclaimed Property Compliance: Accounts Receivable Credits

May 4, 2021

Accounts receivable credits (A/R credits) are often overlooked when it comes to unclaimed property compliance. This is problematic because A/R credits, if treated incorrectly, can create a substantial amount of unclaimed property, and can become a key focus in unclaimed property audits. Consequently, any effective escheat program should include formal policies and procedures for reviewing and including accounts receivable credits in the reporting process.

How Do A/R Credits Become Unclaimed Property?

A/R credits become an unclaimed property issue when credit balances occur that go unresolved and age beyond the statutory dormancy period (typically 3 to 5 years). Typically, unclaimed credit balances will show on a company’s books and records in three forms:

1. On Account Customer Credit Balances

On account customer credit balances can become unclaimed property when activity with the customer ceases and the credit balance ages beyond the statutory dormancy period, which varies by jurisdiction. Customer credit balances can result from a variety of reasons including, but not limited to, returned products, overpayments, and invoice adjustments. It is important that an organization understand the specific causes for credit balances and have standard procedures in place to regularly review and resolve them before they age and become unclaimed property.

As is the case with any unclaimed property type, including A/R credits, it is vital to maintain documentation sufficient to substantiate the resolution of any credit balance. Procedures should include standardized documentation requirements for resolved credit balances to ensure the final disposition (e.g., credit balance reissued via check) can be substantiated under the scrutiny of an unclaimed property audit.

2. Unidentified or Unapplied Receipts

Unidentified or unapplied receipts typically occur when a payment is received that cannot be applied to an invoice or a customer account. If a payment cannot be applied to a customer within the dormancy period it becomes unclaimed property and should be reported to the respective state or jurisdiction.

These payments may sit in generic “clearing” or “suspense” accounts while they are researched for application purposes. All general ledger or sub-ledger accounts that hold unidentified or unapplied payments should be reviewed and reconciled on a regular basis. Payments that cannot be applied or otherwise resolved should be returned to the payor. If this cannot be accomplished, they should be analyzed for inclusion in the regular unclaimed property reporting process.

3. Write-Offs

Write-offs can be a complicated area when it comes to unclaimed property and should not be overlooked. This is the area that gets companies in the most trouble when under audit. Credit amounts that are written-off, even small amounts, can accumulate over time and become relatively large amounts. To make matters worse, due to the passage of time and bad record keeping, it can be very difficult to differentiate between credit write-offs that represent actual amounts that are due and owing, and basic accounting adjustments. Considering that the states may use methods like extrapolation and may also impose penalty and/or interest assessments, something as simple as a write-off policy can put even relatively compliant companies at risk for an unclaimed property audit.

Most unclaimed property audits will include a review of common general ledger accounts where accounts receivable credits and debits are typically written-off to. Auditors will review activity in these accounts to identify any credit amounts that have the potential to be unclaimed property. Most states do not have a minimum threshold for unclaimed property reporting, so even a small credit write-off policy can result in fairly large amounts of past due unclaimed property liability, especially for companies with high transaction volumes or large customer bases.

Once an amount is written-off the balance sheet, the information necessary to research and resolve the credits may no longer be retained or linked within the accounting system. This can put an otherwise compliant company at risk for an audit as items that may not truly be due and owing can be misconstrued as unclaimed property by the auditors. It may simply be the case that the information to research the credit balance is unavailable or that the supporting documentation was not retained.

The best way to ensure that credit write-offs do not become a source of potential unclaimed property exposure is to analyze all credit balances and move unresolved items to the general ledger account that maintains future due unclaimed property. It is important to ensure that all supporting information (e.g., system coding, notes, and other support) is retained for unclaimed amounts as well as for resolved items. In addition, a netting exercise should be performed to confirm whether the credit is truly owed to the customer or if the credit represents a valid offset such as a bad debt or other recovery, a volume discount accrual, or an invoice adjustment.

Finally, organizations should regularly review their accounts receivable write-off policy to ensure that they are compliant with the escheat statutes and provide for the retention of documentation that support any credit write-offs that are not due and owing.

Recommendations to Manage A/R Credits

Accounts receivable credits are not a property type that can be ignored. Use the points above to start a discussion and review of current policies and procedures around A/R credit balances. Consider engaging an outside advisor who has expertise and can assist in the creation of best practices and procedures. This will help ensure compliance and keep A/R credits from becoming an issue and prevent any surprises coming to light in the event of an audit.

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*Content contained in this article is considered accurate as of the publish date.

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