Irrecoverable Debts And Provision For Doubtful Debts

Question 1

What is irrecoverable debts

Answer 1

An amount owing to a business which will not be paid by the credit customer

Question 2

Explain how writing off irrecoverable debts is an application of the principle of prudence

Answer 2

Writing off irrecoverable debts is an application of the principle of prudence as it ensures that both the assets and the profit for the year are not overstated.

Question 3

List ways in which possibility of irrecoverable debts may be reduced

Answer 3

-obtaining credit references from new customers
-fixing a credit limit for each customer
-monitoring the debtors accounts (credit control)
-issuing invoices and month-end statement promptly
-taking legal action
-use of factoring and invoice discounting

Question 4

Define provision for doubtful debts

Answer 4

An estimate of the amount which a business will lose in a financial year because of irrecoverable debts

Question 5

Explain how maintaining a provision for doubtful debts is an application of both the principle of matching and the principle of prudence

Answer 5

Maintaining a provision for doubtful debts is an application of the matching principle because the amount of sales for which a business is unlikely to be paid is regarded as an expense of the year in which those sales are made (rather than an expense of the year in which the debt is written off).
Maintaining a provision for doubtful debts is an application of the principle of prudence as it ensures that both the profit for the year and the trade receivables are not overstated.

Question 6

Why should we maintain a provision for doubtful debts

Answer 6

-not all trade receivables will pay the amount they owe (principle of prudence)
-to apply the principle of matching