Consider: average mortgage debt is about 50 percent of home value; consumer debt is 34 percent of personal income; and available credit limits on credit cards sums to $2.4 trillion (figures from Business Week). In addition to these numbers, most economic observers acknowledge that the U.S. economy is in a slowdown, if not in an actual recession. Weekly we hear about such things as new layoffs, declines in consumer confidence, or decreases in sales.

As I read these reports, I wonder what corporate America will do with these facts. In particular, accountants are required to examine the balance in accounts receivable and assess their viability. If the firm cannot collect the receivable, then it ought to write off the receivable, for it is no longer an asset of the firm.

Of course, in practice companies often cannot predict which customers will pay and which will not. If they could forecast like that, then they wouldn't extend credit to the deadbeats in the first place. But they can estimate the aggregate numbers fairly well. In other words, business enterprises can observe the receivables in total and make such estimates about how many of them can be collected and then write off the rest as uncolletible.

As an economy tanks, the number of defaults and bankruptcies increase. During these times, fewer accounts receivable will materialize as cash inflows from customers.

So here is my question. Will corporate America adjust their allowance estimates to reflect the worsening economy and the consequent increase in defaults? If firms act as they have in the past, they won't adjust the bad debts expense at all. They will assume that the default rate is the same in bad times as it is in good times. Such a presumption is silly, but in the past entities underadjusted for increases in credit risk, and I see no reason to think that it will be any better this time around.

I shall be reading the annual reports to see who wants to tell it like it is instead of how they want it to be. I fully expect not to see the increase in credit risk displayed in annual reports.

More by J. Edward Ketz