Chapter 8 - Irrecoverable debts and the allowance for receivables

Question 1

What are Irrecoverable Debts?

Answer 1

Irrecoverable debts are receivables that are not expected to be paid. They are therefore “written off”, that is, cancelled in the trade receivables ledger and charged against the profit or loss for the period.

Question 2

What can cause irrecoverable debt?

Answer 2

Bankrupcy or Liquidation

Question 3

What is the journal entry for a irrecoverable debt

Answer 3

Dr Irrecoverable debt expense (often included as part of other expenses - administrative expenses)

Cr Trade receivables
As they no longer owe us as we have moved it to the debt account -moved off memorandum (individual client) ledger

Question 4

What is the full process for a customers purchasing on credit, then they can’t pay so the debt become irrecoverable what are the journal entries?

Answer 4

Initial transaction for when customer purchases on credit
DR Trade Rec Asset
CR Sales Income

Becomes apparent they can’t pay the debt so we journal

Dr Irrecoverable debt expense (often included as part of other expenses - administrative expenses)

Cr Trade receivables
As they no longer owe us as we have moved it to the debt account -moved off memorandum (individual client) ledger

Question 5

When drawing out an Irrecoverable debt T account what does is a debit or a credit an increase/decrease?

Which financial statement does this impact?

Answer 5

DR Increases and irrecoverable debt as it is an EXPENSE

CR decreases it

Impacts the SOPL as it is an expense account

Reminder: Expenses and Incomes impacts the SOPL

Question 6

If irrecoverable debt is paid what is the journal?

How common is this?

Answer 6

Very uncommon

In the rare situation that an irrecoverable debt subsequently paid, the double entry is:
Dr Cash
Cr Irrecoverable debt expense

If we break it down
- The original writing off the debt is DR Irrecoverable debt expense and then CR Trade rec
- To reverse this we Dr Trade Rec and then Cr Irrecoverable debt
- Then to post the cash we DR cash and Cr Trade Rec

The positing in the trade rec account is a DR then CR so these balance each other out so instead what we do is

Dr Cash
Cr Irrecoverable debt expense

Question 7

What is an allowance receivables ledger?

Answer 7

If there is some doubt over a customer’s ability to pay, but the business still wishes to chase the debt, then a separate allowance can be made for these “doubtful receivables”.
In practice, a business will often use past experience regarding levels of irrecoverable debts to estimate the probability of non-payment from the receivables as a whole. This allowance for receivables represents the total potential amounts that may not be recovered from customers.

Question 8

What ledger is a doubtful receivable posted to?

Answer 8

Allowance Receivable ledger

If there is some doubt over a customer’s ability to pay, but the business still wishes to chase the debt, then a separate allowance can be made for these “doubtful receivables”.
In practice, a business will often use past experience regarding levels of irrecoverable debts to estimate the probability of non-payment from the receivables as a whole. This allowance for receivables represents the total potential amounts that may not be recovered from customers.

Dr Irrecoverable debt expense
Cr Allowance for receivables

Question 9

If we need to calculate the allowance for receivables how do we do this?

Answer 9

Calculate the required allowance for receivables based on a probability of non-payment which is applied to trade receivables AFTER any irrecoverable debts have been written off.

So allowance receivables = Trade Rec - Irrecoverable debt

Then we calculate the allowance from that figure

Dr Irrecoverable debt expense
Cr Allowance for receivables

Question 10

What type of account is Allowance for Receivables in DEADCLIC

What financial statement does this feed into?

Answer 10

CLASSED AS AN ASSET HOWEVER IT DOES NOT FOLLOW THE TRADITIONAL RULES
In our SOFP this would be a negative asset as we would always minus it

If we want to make it bigger we credit it
CREDIT Increases Allowance for Receivables
DEBIT Decreases Allowance for Receivables

Affects my statement of financial position SOFP

Question 11

What is the journal for allowance receivables?

Answer 11

Dr Irrecoverable debt expense
Cr Allowance for receivables

We Dr Irrecoverable debt expense due to accounting concept of prudence - we want to recognise cost up front of customers not paying

WE NEVER TOUCH TRADE REC - AS WE DON’T WANT TO REDUCE THIS AS WE ARE DOUBTFUL THEY WILL PAY SO WE ARE NOT CERTAIN

Note that we have not credited trade receivables directly, but this allowance will be offset against receivables in our final financial statements.

Question 12

If my allowance for receivables needs to be adjusted so increased or decreased what is my journal?

Answer 12

This allowance may subsequently need to be adjusted for changes in our estimate of the level of doubtful debts.

Question 13

If my allowance for receivables needs to be increased what is my journal?

Answer 13

INCREASE IN ALLOWANCE
Dr Irrecoverable debt expense £ the required increase

Cr Allowance for receivables £ the required increase

Question 14

If my allowance for receivables needs to be decreased what is my journal?

Answer 14

DECREASE IN ALLOWANCE

Dr Allowance for receivables £ the required decrease

Cr Irrecoverable debt expense £ the required decrease

Question 15

In the SOFP when once we calculate our trade rec (TR) allowance how do we calculate our final trade rec figure?

Answer 15

1. To calculate our TR allowance we first need to do TR - irrecoverable debt = then calculate the percentage of that i.e. allowance is 2% so 2% of that value which is my figure for allowance TR
2. Then to get the final TR we do

TR- Allowance TR = Amount to be shown on SOFP (NET FIGURE) = this is my current asset

FINAL FORMULA
TR = TR total at year end - irrecoverable debt written off then PLUS OR MINUS Allowance for Rec

Question 16

SOFP - Irrecoverable debt expense formula

Answer 16

We will be asked to find the Irrecoverable debt expense in the statement of profit or loss. This can be quickly found with the following:

(1) Irrecoverable debts written off in period - DR
(2) Increase/(decrease) in allowance - IF INCREASE ITS A DR, if DECREASE ITS A CR (negative)
(3) Old irrecoverable debts that pay in the period - CR (negative)

This will give us the overall expense Dr (positive) or other income Cr (negative)

Question 17

What Is the relationship between irrecoverable debt expense and allowance?

Answer 17

Increase in allowance = Increases in the expense

Decrease in allowance = Decreases in the expense

Question 18

How do we calculate

a) Allowance Receivable

b) Trade Receivable

c) Net Trade Receivable

Answer 18

a) So allowance receivables = Trade Rec - Irrecoverable debt
Then we calculate the allowance from that figure

b) Trade Receivable initial figure - Written off debts

c) Net Trade Receivable = TR (AFTER WRITING OFF DEBTS) - Allowance for Rec

Question 19

If we decrease my allowance what effect does this have on my profit?

Answer 19

Decrease allowance (DR) = Decrease Irrecoverable debt (CR) = INCREASE PROFIT

Question 20

If we increase my allowance what effect does this have on my profit?

Answer 20

Increase allowance (CR) = Increase Irrecoverable debt (DR) = DECREASE PROFIT

Question 21

Enigma plc has reduced its allowance for receivables by £600. Indicate whether each of the following statements are true or false.

QUESTION
The reduction in the allowance for receivables will increase gross profit by £600.
A True
B False

The reduction in the allowance for receivables will increase net profit by £600.
C True
D False

Answer 21

Let’s break down each statement carefully and think through the effects:

1. “The reduction in the allowance for receivables will increase gross profit by £600.”
   Gross profit is calculated as Revenue - Cost of Goods Sold (COGS). It doesn’t include operating expenses like bad debt allowances or changes in the allowance for receivables.
   Since the allowance for receivables is an expense that impacts net profit, not gross profit, this reduction will not affect gross profit.
   Answer: B. False
2. “The reduction in the allowance for receivables will increase net profit by £600.”
   Net profit includes all revenues and expenses, including operating expenses like bad debts.
   Since the reduction in the allowance means fewer expenses for bad debts, this would increase net profit by £600. The money not set aside for bad debts stays within the business, raising net profit.
   Answer: C. True

So, the answers are:

Gross profit: B. False
Net profit: C. True

Question 22

What effect do discounts given, irrecoverable debts, and cash receipts have on the trade receivables?

Answer 22

Discounts, bad debts, and cash receipts reduce the amount of trade receivables (hence they are credits).