Irrecoverable Debt
The accruals concept dictates that when a sale is made, it is recognised in the accounts, regardless of whether or not cash has been received. If sales are made on credit, there may be problems collecting the amounts owing from credit customers. Some customers may refuse to pay their debt, declare bankrupt or may be in financial difficulties.
An irrecoverable occurs when a trader is certain that a credit customer cannot pay back the amount due. With such debts it is prudent to write them off from the accounts and to charge the amount as an expense to the income statement. The double entry to record an irrecoverable debt is
DR Irrecoverable debt account
CR Customer’s account
Provision for doubtful debts
There is always an element of risk that some credit customers may not settle their debts. The prudence concept states that the accounts of a firm should always anticipate for probable losses. The provision for doubtful debt is the estimated amount of bad debt that will arise from accounts receivable that have been issued but not yet collected. A provision for doubtful debts may be calculated as follows:
Past history of a business may show that a portion of credit customer’s balances is not recovered due to unforeseen circumstances. Therefore, it may be prudent to create a general provision for doubtful debts. The general provision may be calculated as a percentage of the Trade receivables at the end of a financial year.
Accounting treatment for provision for doubtful debts:
1. Creating a Provision for doubtful debts for the first time
DR Income statement
CR Provision for doubtful debts
For example:
Trade receivables $10 000
A provision for doubtful debts of 10% is to be created.
Provision for doubtful debts= 10% × $10 000 = $1 000
DR Provision for doubtful debts Account CR | |||
$ | $ | ||
Balance c/d | 1 000 | Income Statement | 1 000 |
1 000 | 1 000 | ||
Balance b/d | 1 000 | ||
Income Statement (Extract) | |||
$ | $ | $ | |
Less Expenses | |||
Provision for doubtful debts | 1 000 | ||
Statement of Financial Position (Extract) | |||
$ | $ | $ | |
Current Assets | |||
Trade Receivables (10 000 – 1 000) | 9 000 | ||
2. Increase in Provision for doubtful debts
DR Income statement
CR Provision for doubtful debts
Note: Amount increased should be calculated
For example:
Trade receivables $ 10 000
Provision for doubtful debts $ 800
A provision for doubtful debts of 10% is maintained.
Increase in provision for doubtful debts = (10% × 10 000) – 800 = $200
DR Provision for doubtful debts Account CR | |||
$ | $ | ||
Balance c/d | 1 000 | Balance b/f | 800 |
Income Statement | 200 | ||
1 000 | 1 000 | ||
Balance b/d | 1 000 | ||
Income Statement (Extract) | |||
$ | $ | $ | |
Less Expenses | |||
Increase in Provision for doubtful debts | 200 | ||
Statement of Financial Position (Extract) | |||
$ | $ | $ | |
Current Assets | |||
Trade Receivables (10 000 – 1 000) | 9 000 | ||
3. Decrease in Provision for doubtful debts
Note: Amount decreased should be calculated
DR Provision for doubtful debts
CR Income statement
For example:
Trade receivables $10 000
Provision for doubtful debts $1 350
A provision for doubtful debts of 10% is maintained.
Decrease in provision for doubtful debts = (10% × 10 000) –1 350 = (350)
DR Provision for doubtful debts Account CR | |||
$ | $ | ||
Income Statement | 350 | Balance b/f | 1 350 |
Balance c/d | 1000 | ||
1 350 | 1 350 | ||
Balance b/d | 1 000 | ||
Income Statement (Extract) | |||
$ | $ | $ | |
Gross Profit | *** | ||
Add other income: | |||
Decrease in Provision for doubtful debts | 350 | ||
Statement of Financial Position (Extract) | |||
$ | $ | $ | |
Current Assets | |||
Trade Receivables (10 000 – 1 000) | 9 000 | ||
Accounting treatment for bad debts recovered
This is a situation where a debt is written off as irrecoverable in one accounting period and the amount or part of the amount due is then unexpectedly received in a subsequent accounting period. In this case the following double entries must be made:
Recreate debt
DR Customer’s account
CR Bad debts Recovered account
Record amount received
DR Cash/ Bank account
CR Customer’s account
Transfer to Income statement
DR Bad debts Recovered account
CR Income statement
