topic 9 adjustments for irrecoverable debts

• An irrecoverable debt occurs when a receivable probably will not pay the amount that is owed and the assets and capital of the business would be overstated if the debit balance was left in their account
• The accounting treatment of irrecoverable debts is:

  DR Irrecoverable debts account (GL) CR The customer's account (SL)

  The book of original entry for irrecoverable debts is the journal
• Irrecoverable debts are an expense of running the business, and the total of irrecoverable debts for an accounting year is an expense in the IS

  • irrecoverable debts are a business expense and must not be included in the trade receivables on the SOFP
  • they would be shown as a DR in the trial balance
• The accounting treatment for irrecoverable debts recovered:

  DR Irrecoverable debts recovered account CR Income statement
• Provision for doubtful debts:

  • irrecoverable debts are customers who will probably not pay, but among the remainder there is also a possibility that others might not pay
  • customers who might not pay are called doubtful debts
  • a provision is made for receivables where there is a possibility that they may not pay
  • this provision is deducted from receivables on the SOFP so that current assets aren't over valued
  • the provision is a percentage of total receivables
• Treatment of doubtful debts in the financial statements:

  • an increase in the provision is an expense
  • a decrease in the provision is income
• Preparing financial statements from a trial balance:

  • the trial balance will include the provision for doubtful debts account
  • the bal bd for doubtful debts account is a credit
• The older a debt is the more likely the debt may turn 'irrecoverable'. An ageing receivables schedule is similar to making a specific provision but it is a more realistic method of calculating the provision for doubtful debts because it uses a higher percentage the older the debt
• Explain the process for completing financial statements when the entries for bad debt has not been recorded in the relevant ledger accounts - If an irrecoverable debt has gone through the business books then the balance will be included in the trial balance figure for irrecoverable debts. However, if it appear as additional info in the trial balance then its dual effect needs to be applied to the balances of the relevant accounts. The amount will need to be added as an expense in the IS. The same amount will be taken away from receivables in the SOFP
• Explain how a business will make a provision for doubtful debts - Provision for doubtful debts is a policy within a business which estimates a certain percentage of receivables which might not pay their outstanding debts. The difference between the current and previous year's provision is calculated. If this years provision is higher then the difference will be an expense, if its lower it will be an income. However, the entire current provision will be taken away from the receivables figure in the SOFP
• Explain the difference between a general and specific provision - A general provision is made for doubtful debts when a business estimates based on past experience that a certain percentage of receivables will not pay the business but is unable to state specifically which receivables this may be so a general provision is made. A specific provision is made for bad debts when a business is made aware that a specific person is unable to pay and so their entire balance/debt to the business is written off