chapter 12 Flashcards
irrecoverable debt
debt due from a customer that is expected will never be paid by them
reasons why irrecoverable debt may happen
the customer’s business may be in financial difficulties and unable to pay. some customers may be dishonest and may buy large amounts of goods with little intention of paying. if someone is trading with customers from another part of the world, there may be political or other events that mean that debts will not be paid
how to find trustworthy customers
If a business regularly sells goods on credit to a large number of customers, it is almost certain that some irrecoverable debts will happen even if the business has carried out checks-like using credit-rating systems or seeking references - to determine whether the customers are likely to be trustworthy. However, these checks only show whether someone has a history of payment problems. Even if someone has a perfect record of paying on time, there is no guarantee that they will not experience financial difficulties in the future.
impact of irrecoverable debt
an asset (trade receivable) is now worthless
a loss has been incurred
irrecoverable debts recovered
it is possible that money written off may actually be paid at a later date. if a business has failed it is possible that its assets will be sold off and there may be money to enable the trade payables to be paid off, either in full or in part
provision or allowance for irrecoverable debts
the amount of irrecoverable debts relating to this period’s sales and trade receivables figure that a business has estimated it will suffer during the next accounting year. .irrecoverable debts may only be written off many months after the sale.
how may firms attempt to get the customer to pay
many firms may attempt to get the customer to pay first, sending reminders, threatening legal action and then taking legal action to recover the money
problems of irrecoverable debts
the business may not be applying the matching principle
the trade receivables figure shown in the current assets part of the statement of financial position will be overstating the amount that we actually expect to get, which may not be applying the prudence concept.
allowance for irrecoverable debts account
the account used to account for possible irrecoverable debts that may not be seen until the next accounting year.
what happens when old provisions is lesser than the new provision
the difference is taken as expenses in the income statement.
SOPF=TR-NP
what happens when old provision is more than new provision
the difference is take as income in the income statement.
SOFP=TR+NP
types of calculating provision for irrecoverable debts
general
specific
specific and general
general way of calculating irrecoverable debts
calculated as a percentage of the total trade receivables. The average percentage of debts by amount that prove to be irrecoverable is used. Many businesses might adjust the percentage to reflect factors like the state of the economy, adjusting the percentage upwards if the economy is entering into a recession or reducing it during times of prosperity.
specific way of calculating irrecoverable debts
certain debts are selected from the sales ledger as doubtful. The provision will be equal to the total of those debts. The amount of the provision is based on specific knowledge the business owner has of each particular customer’s financial position.
specific and general way of calculating irrecoverable debts
made up of the debts that are thought to be doubtful plus a percentage of the remainder. specific provisions must always be deducted from trade receivables first, before the general provision is calculated
