What Is the Nonaccrual Experience (NAE) Method?
The Nonaccrual Experience (NAE) Method is an accounting procedure allowed by the Internal Revenue Code (IRC) for handling bad debts. This method can be applied exclusively to services performed in fields such as accounting, actuarial science, architecture, consulting, engineering, health, law, or the performing arts. To qualify, a company must have average annual gross receipts of less than $5 million for any three prior tax years. For more details, refer to IRS Publication 535: Business Expenses.
Key Takeaways
- The Nonaccrual Experience (NAE) Method is an accounting approach for managing bad or delinquent debts.
- This method permits firms to avoid accruing income that is not expected to be collected based on past experience.
- Bad debts likely to remain uncollected can be written off using this method.
Understanding the Nonaccrual Experience (NAE) Method
A company incurs a bad debt when it cannot collect the money it is owed. Bad debts that cannot be claimed using the NAE method may be reported using the more common specific charge-off method. Under NAE, the firm can estimate the level of bad debt based on past experiences with customers and vendors.
A nonaccrual experience method as outlined by SEC rule 448(d)(5) allows certain service providers to exclude from accrual the portion of revenue deemed uncollectible based on their experience and formula authorized by this regulation. These service categories include:
- Accounting
- Actuarial Science
- Architecture
- Consulting
- Engineering
- Health
- Law
- Performing Arts
Eligibility to use the NAE method of accounting requires that the taxpayer employs an accrual method for service-related revenues, is part of one of the aforementioned service sectors, and earns less than $5 million in gross receipts in any of the past three tax years. The matching principle mandates that expenses align with related revenues during the same accounting period. To comply with GAAP tax rules, bad debt expenses must be estimated using the allowance method in the same period as the sale.
Using the Nonaccrual Experience Method
There are several ways to employ NAE. For instance, a taxpayer can request IRS consent to switch to a formula that aptly reflects their experience. This pertains explicitly when adopting or changing to safe harbor NAE methods. Safe harbor represents an accounting technique that circumvents complex tax or legal regulations and simplifies tax determinations.
In September 2011, the IRS introduced a modified rule for computing uncollectible revenues under NAE using a 95% factor applied to the allowance for doubtful accounts based on the taxpayer’s relevant financial statements.
Related Terms: Bad Debts, Accrual Accounting, Charge-off Method, Financial Statements, Safe Harbor Method.
References
- Internal Revenue Service. “Publication 535: Business Expenses”, Pages 41-42.
