Chapter 7 - Irrecoverable Debts And Allowance For Doubtful Receivables Flashcards
Irrecoverable debts
Debts owing to a business which it considers will never be paid
Allowance for doubtful receivables
Also called provision for bad debts is when the business uses an estimate of the likely percentage of its trade receivables which may become irrecoverable.
Calculating trade receivables after irrecoverable debts and allowance for doubtful receivables
A business with trade receivables of £10,0000 has £200 as irrecoverable debts.
The £200 is written off as irrecoverable debts. An allowance for doubtful receivables is to be made totalling to 2% of remaining trade receivables after the £200 has been written off.
£10000 - £200 = £9800
£9800 x 2% = £196
£9800 - £196 = £9604
So the net trade receivables would be £9604
General and specific allowances
A general allowance for doubtful receivables is an allowance applied to the total trade receivables after writing off irrecoverable debts
A specific allowance for doubtful receivables is an allowance applied to one or more specific doubtful receivables where the risk of default is thought to be higher.
Treatment of irrecoverable debts in bookkeeping
In terms of double entry bookkeeping, the transactions are:
Debit irrecoverable debts
Credit trade receivables account
At the end of the financial year irrecoverable debts account is transferred to the statement of profit or loss as an expense:
Debit statement of profit or loss
Credit irrecoverable debts
Treatment of irrecoverable debts in financial statements
If the figure for irrecoverable debts is shown on the trial balance on the debit side simply record the amount as an expense in the statement of profit or loss and the trade receivables figure has been reduced already.
If the figure for irrecoverable debts is not already shown in the trial balance and a note tells you to write off an account as irrecoverable you need to list the amount as an expense in the statement of profit or loss and reduce the trade receivables figure for the statement of financial position. In the extende trial balance use the adjustments columns - debit irrecoverable debts and credit receivables figure
Recovery of a debt
Recovery of a debt is when a former trade receivable whose account has been written off as irrecoverable makes a payment. This can be voluntarily or from debit collection procedure.
The bookkeeping transactions are:
Debit cash/bank account
Credit irrecoverable debts account
At the end of the financial year, the net balance of irrecoverable debts account is transferred to the statement of profit or loss:
When the amount of debts written off is more than debts recovered irrecoverable debts account will have a debit balance which will be recorded in the debit column of profit or loss
When the amount of debts written off is less than debts recovered irrecoverable debts account will have a credit balance which will be recorded in the credit column of profit or loss
Treatment of allowance for doubtful receivables in bookkeeping and financial statements
The usual procedure is to have two accounts in the general ledger:
Allowance for doubtful receivables: adjustment account - records the amount to create, increase or decrease the allowance each year
Allowance for doubtful receivables account - records the accumulated total of the allowance
The allowance which is calculated after writing off irrecoverable debts is recorded in the double entry system as:
Debit allowance for doubtful receivables: adjustment
Credit allowance for doubtful receivables
Debit statement of profit or loss
Credit allowance for doubtful receivables: adjustment
The allowance for doubtful receivables: adjustment account acts as a holding account which transfers to and from the statement of profit or loss are made. The allowance for doubtful receivables account holds the accumulated total of the allowance which is shown on the opposite side from the receivables ledger control in the statement of financial position.
In financial statements on the extended trial balance the amount of the allowance for doubtful receivables is shown as:
A debit in the statement of profit or loss columns
A credit in the statement of financial position columns
Adjustments to allowance for doubtful receivables
A policy change in the allowance. Eg increase in the fixed percentage
An arithmetical adjustment in the allowance as a result of a change in the total trade receivables. Eg increase of £5000 trade receivables will require a proportionally higher allowance
Increasing the allowance
Recorded in the double entry as follows:
Debit allowance for doubtful receivables: adjustment account
Credit allowance for doubtful receivables account
Debit statement of profit or loss
Credit allowance for doubtful receivables: adjustment account
Decreasing the allowance
Recorded in the double entry as:
Debit allowance for doubtful receivables account
Credit allowance for doubtful receivables: adjustment account
Debit allowance for doubtful receivables: adjustment account
Credit statement of profit or loss
Irrecoverable debts in the extended trial balance
If the irrecoverable debt already appears in the trial balance simply show the amount in the debit column of profit or loss. Do not alter the figure for receivables ledger control as it will have been reduced already by the amount written off.
If a note to the trial balance tells you to write off the irrecoverable debt then you will need to include a row in the extended trial balance for irrecoverable debts. In the adjustments column show a debit for this row and credit the receivables ledger control row.
Recovery of a debt in the extended trial balance
If a trial balance shows a credit balance for either irrecoverable debts account or debts recovered account simply show the amount in the statement of profit or loss credit column which will increase profit for the year
Allowance for doubtful receivables
In the extended trial balance there is a row for allowance for doubtful receivables: adjustment. Use this for the holding account to create, increase or decrease the allowance.
For example to increase an existing allowance of £500 by £250 record the following in the extended trial balance:
In the adjustments column - debit allowance for doubtful receivables: adjustment, credit allowance for doubtful receivables
In profit or loss record £250 of the allowance for doubtful receivables: adjustment as an expense in the debit column
In the statement of financial position record the allowance for doubtful receivables as £750 ie trial balance figure of £500 and the amount of £250 shown in the adjustments column
