1. Irrecoverable Debts Flashcards
Define irrecoverable debts.
An irrecoverable debt is a debt which is not expected to be paid.
Define writing off.
Writing off is the charging of the cost of the irrecoverable debt against the profit for the period.
How are irrecoverable debts written off presented in the financial statements?
When a business decides that a particular debt will not be paid, the whole amount of the receivable in question is ‘written off’ as an expense in the statement of profit or loss.
Irrecoverable debts are presented as follows:
1. Revenue is recorded in the statement of profit or loss at the amount expected to be received from the customer, which in most cases is the invoice amount.
The sale has been made, an expense has been incurred in making that sale and the gross profit should be recognised. The subsequent failure to collect the debt is a separate administrative matter and does not require revenue to be adjusted.
2. Irrecoverable debts expense is shown as an administrative expense.
3. The receivable is removed from trade receivables.
What is the journal entry for writing off an irrecoverable debt?
Debit - Irrecoverable debts expense (statement of profit or loss)
Credit - Trade receivables (statement of financial position)
What is the overall affect of irrecoverable debt on the business? (2)
- Overall, a loss is made on the transaction since the entity has incurred costs in rendering the service, and these will not be recovered.
- The business has also forgone the profit it could have made on the transaction in selling the good or service to a different customer.
How does the writing off of a debt affect receivables?
When a debt is written off, the value of the receivable as a current asset is zero. It is no longer recognised as an asset because it no longer has the potential to produce economic benefits for the business and therefore does not meet the Conceptual Framework definition of an asset.
What is a professional accountant’s role in determining whether a debt is irrecoverable?
An accountant must use information about its credit customer to determine whether a debt is irrecoverable.
This information may be formally provided by the credit customers liquidator or administrator or may be more generally confirmed by a public notice that the credit customer has entered into administration.
What is the journal entry for an irrecoverable debt which is written off and then subsequently paid?
Debit - Cash at bank account
Credit - Irrecoverable debts expense
There is no need to credit trade receivables as this has already been done when the debt was initially written off.
How would the payment of a debt which had been previously written off cause an issue for the computerised accounting system?
Receiving a payment in respect of a debt previously written off is likely to result in a problem for the computerised accounting system as it will be unable to match the payment to a known transaction.
The unmatched payment would be reported on an exception report, the details of which may be presented to you in an exam question.
You need to know how to resolve the problem by recording the transaction manually using a journal entry.
What is the accounting treatment for the situation where a customer makes a payment that is not honoured by its bank?
If a customer makes a payment that is not honoured by its bank, we must reinstate the debt and remove the receipt of cash: debit trade receivables (reinstating the debt) and credit cash at bank (removing the ‘receipt’).
This may occur if the customer has paid by cheque which is dishonoured or if the electronic transfer of funds is not processed as expected.
Should a dishonoured payment be treated as irrecoverable debt?
Dishonoured payments should not be treated as an irrecoverable debt. Payments may not be processed or cheques be dishonoured for administrative reasons that have nothing to do with a customer’s actual inability to pay its debt, so do not presume that it will never be paid.
