Provision for doubtful debts


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 debts 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:

  • A fixed percentage of trade receivables.
  • Analysis of sales ledger and identifying potential bad debts.
  • Analysis of age of debt.

Provision for doubtful debts consists of 2 types:

  • Specific provision
  • General provision


Specific Provision

This is allowance created in respect of a specific credit customer who is known to be facing serious financial problems or have a trade dispute with the entity. Such balances may be identified by examining an aged receivable analysis. Long outstanding balances identified from such analyses could be considered for inclusion in the allowance for doubtful debts as specific provision.

Example

Trade Receivables                              $ 6 200

Provision for doubtful debts               $ 170

Additional Information:

  1. A debt of $ 800 is to be written off.
  2. The provision for doubtful debts is to be provided for a specific debt of $200, plus 2% of the remaining trade receivables.


Trade Receivables                  6 200

Irrecoverable debt                  (800)

Specific Provision                    (200)

Net Trade receivables            5 200

General Provision for doubtful debts = 2/100 * 5 200 = $104

Increase in Provision for doubtful debts  = (Specific Provision + General Provision) – Old PFDD

                                                                        = (200 + 104) – 170 = $134


DR                                                  Provision for doubtful debts Account                                                 CR


$


$

Balance c/d

304

Balance b/f

170



Income Statement

134


304


304



Balance b/d

304


Income Statement (Extract)


$

$

$

Less Expenses




Irrecoverable debt


800


Increase in Provision fro doubtful debts


134



Statement of Financial Position (Extract)


$

$

$

Current Assets




Trade Receivables (6 200 – 800 – 304)


5096




General Provision

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 allowance for doubtful debts in addition to the specific allowance. The general allowance may be calculated as a percentage of the Trade receivables at the end of a financial year.


Accounting treatment for provision for doubtful debts:

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




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



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