Chapter 8 - Irrecoverable debts and the allowance for receivables Flashcards
What are Irrecoverable Debts?
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.
What can cause irrecoverable debt?
Bankrupcy or Liquidation
What is the journal entry for a irrecoverable debt
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
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?
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
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?
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
If irrecoverable debt is paid what is the journal?
How common is this?
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
What is an allowance receivables 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.
What ledger is a doubtful receivable posted to?
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
If we need to calculate the allowance for receivables how do we do this?
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
What type of account is Allowance for Receivables in DEADCLIC
What financial statement does this feed into?
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
What is the journal for allowance receivables?
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.
If my allowance for receivables needs to be adjusted so increased or decreased what is my journal?
This allowance may subsequently need to be adjusted for changes in our estimate of the level of doubtful debts.
If my allowance for receivables needs to be increased what is my journal?
INCREASE IN ALLOWANCE
Dr Irrecoverable debt expense £ the required increase
Cr Allowance for receivables £ the required increase
If my allowance for receivables needs to be decreased what is my journal?
DECREASE IN ALLOWANCE
Dr Allowance for receivables £ the required decrease
Cr Irrecoverable debt expense £ the required decrease
In the SOFP when once we calculate our trade rec (TR) allowance how do we calculate our final trade rec figure?
- 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
- 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
