Irrecoverable And Doubtful Debts

Question 1

What’s the difference between an irrecoverable debt and a doubtful debt?

Answer 1

• ID: customer definitely will not pay
• DD: customer might not pay us

Question 2

Describe irrecoverable debts

Answer 2

• An irrecoverable debt is one that definitely won’t be recovered, i.e., the customer is not going to pay us any cash.
• They may because the customer has ceased trading or has become bankrupt.
• Also called ‘bad debts’ in the workplace.

Question 3

What’s the double entry you make when you know a customer will not pay you?

Answer 3

Dr Irrecoverable debts expense (P/L)
Cr Receivables (SFP)

Question 4

Do you reverse the original sale when creating a journal for a bed/irrecoverable debt?

Answer 4

• No, the sale has still been made and the cost of the purchase still exist is in our cost of sales account as the goods have been sent to our customer.
• So we leave that where it is but now include irrecoverable debts as part of out list of expenses in our profit and loss account.
• The expense will reduce our profit for the period; our customer not paying us has cost the business the amount the customer owes but has not paid.

Question 5

Describe a doubtful debt

Answer 5

• If a debt is possibly recoverable then it will be a doubtful debt.
• This may be because we are still trying to collect the debt although getting payment is proving hard.
• We don’t therefore want to remove the receivables from our books, we want to show we are still owed money from the customer (to continue chasing payment) but it wouldn’t be fair to show the full value of the debt as an asset.
• So we show an allowance for doubtful debt on the SFP.

Question 6

Why do we show an allowance for doubtful debt on the SFP?

Answer 6

The allowance can be offset against the receivables figure so we don’t show the full value of the receivables as an asset

Question 7

What’s the double entry for creating an allowance four doubtful debts?

Answer 7

• Dr Allowance for doubtful debts adjustment (P/L) (also called the doubtful debts expense in the workplace, this is sometimes combined with the irrecoverable debts expense account).
• Cr Allowance for doubtful debit (SFP)

Question 8

Define irrecoverable debts

Answer 8

The expense in the SPL account that we use for debts that will definitely not be recovered

Question 9

Define allowance dour doubtful debts

Answer 9

The allowance account on the SFP that we set against the receivables figure

Question 10

Define allowance for doubtful debt adjustment

Answer 10

The expense in the SPL that we use for doubtful debts

Question 11

In the workplace, you may refer to allowance for doubtful debt adjustment as…

Answer 11

Doubtful debt expense which is sometimes combined with the irrecoverable debt expense account

Question 12

What are the two types of allowances we may need to make?

Answer 12

1. Specific allowance
2. General allowance

Question 13

Describe the difference between a specific allowance and a general allowance

Answer 13

A specific allowance is an allowance made against a particular customer and made against a specific debt whereas a general allowance is one that is made against all debts, it is not allocated to any particular customer or debt.

Question 14

Describe a general allowance

Answer 14

The general allowance would be based upon historical knowledge of our business.
- We may know from past experiences that when we get to the year end a % of our customers will not pay.
- We will make an additional adjustment to make allowance for that % of our debts.

Question 15

What is the double entry for a general allowance

Answer 15

It is identical to a specific allowance so still…
Dr Allowance for doubtful debt adjustment (P/L)
Cr Allowance for doubtful debts (SFP)

Question 16

What are the 3 steps when making a general allowance?

Answer 16

1. Write of any irrecoverable debts
2. Make any specific allowances
3. Calculate any general allowances

Question 17

Describe what happens in subsequent periods for irrecoverable debts

Answer 17

• If a debt has been written off there are no further accounting adjustments to be made unless the customer does end up paying (which barely happens in real life).
• If the customer does end up paying we would needs to account for the cash being received. If we posted a normal journal for receiving cash from a credit customer this would result in a credit to receivables/RCLA, but if we have written off a debt as irrecoverable it has been removed from our receivables balance so we annoy credit RCLA. Therefore we have to post a journal to for it.

Question 18

What double entry do you make when a credit customer does end up paying firstly?

Answer 18

Dr Cash (SFP)
Cr Irrecoverable debt expense
- This is because we need to account for the cash being received, and the other side will be a negative expense so will be like additional income in the SPL.
- This counteracts the expense which had been posted for the irrecoverable debt in a previous period.

Question 19

Describe what happens in subsequent periods for specific allowances

Answer 19

• We may discover in the next period that the debt we made a specific allowance has gone bad.
• So far the entries we made are…
  — Dr Receivables (SFP), Cr Sales (P/L) when sale was made
  — Dr Allowance for doubtful debt adjustment (P/L), Cr Allowance for doubtful debt (SFP) when we made specific allowances.
• If debt has gone bad we need to remove the receivable from our books.

Question 20

What is the adjustment to make when a debt has gone bad (from specific allowance)

Answer 20

• Dr Allowance for doubtful debt (SFP) as this removes the allowance from our book
• Cr Receivables (SFP) as this removes the receivables from our books.

No entry needs to be made to P/L because we already adjusted it when we initially set up the allowance in a previous year.

Question 21

Describe what 2 steps you have to take when a customer pays us after we created a specific allowances

Answer 21

1. Post the cash that has been received
   — Dr Cash (SFP)
   — Cr Receivables (SFP)
2. Now the customer has paid us, we no longer need the allowance we made previously so we reverse that entry.
   — Dr Allowance for doubtful debt (SFP)
   — Cr Allowance for doubtful debt expense (P/L) (negative expense)

Question 22

We adjust the general allowance at…

Answer 22

The end of each period

Question 23

Describe how a general allowance is dealt with

Answer 23

• As it is never allocated to a particular customer or debt it can never be recovered or go bad.
• Thus we should calculate a new general allowance at the end of each period and post the difference between the opening balance and the closing balance.

Question 24

Is the allowance a doubtful debts as debit or credit balance?

Answer 24

Credit so

Question 25

What’s the double entry to make a general allowance bigger?

Answer 25

Dr Doubtful debts expense (P/L)
Cr Allowance for doubtful debts (SFP)

Question 26

What’s the double entry to make a general allowance smaller?

Answer 26

Dr Allowance for doubtful debt (SFP)
Cr Doubtful debt expense (P/L)

Question 27

Remember for a general allowance it is just the…

Answer 27

Difference we post to increase or decrease the balance from the start to the end of the year.

Question 28

Describe irrecoverable debts and accounting manipulation

Answer 28

• Writing off an irrecoverable debt puts an expense in the P/L
• There is a danger that to make the results look better than they are, irrecoverable debts don’t get written off.
• This increases profits as no expense is charged and the asset value is overstated making the company look more liquid than it really is.