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ACT 1100 Introduction to Accounting Lecturer: Troy J. Wishart Summer Course

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Lecture Notes 5

Definition Bad Debt is an amount written off against a debtor failed to honour his obligations credit transaction in the past. Bad Debt is an amount written off against a debtor who has failed to honour his obligations within a reasonable period, as a result of a credit transaction in the past.

Definition charged direct to the debtor’s account eliminate the amount owing, Bad Debt is charged direct to the debtor’s account so as to eliminate the amount owing, which is an asset of the Business.

How are Bad Debts Determined? The three most commonly used methods to determined Bad Debts are as follows: percentage of debtors 1. A percentage of debtors  based on past experience. examination of the accounts 2.An examination of the accounts  of individual debtor and listing debts likely to become bad. 3.Ageing Schedule 3.Ageing Schedule.

How are Bad Debts Determined? written off to a Bad Debt account provision for bad debts account.  Bad debt can either be written off to a Bad Debt account or written off against the provision for bad debts account.

Accounting Treatment The double entry is: – Debit – Debit the Bad Debt account – Credit – Credit the Debtor’s account with the amount written off.

Accounting Treatment Actual debts are written off in the profit and loss account in the year that the debt is recognised as bad.

Bad Debt – Exercise Two debtors Lall and Greene owed the business $85 and $104 respectively from earlier transactions. Both debtors had failed to honour their obligation, but Greene only after making an earlier payment of $20 in relation to his debt of $104, some 18 months ago. The directors decided to write off both debts. Enter the transactions in the appropriate accounts.

Recovery of Bad Debt bad debt is recovered re-open the account If bad debt is recovered during the next accounting period, we must re-open the account by:  Debiting  Debiting the Debtor’s account and  Crediting  Crediting Bad Debt account.

Recovery of Bad Debt receipt from the Debtor: To account for the receipt from the Debtor:  Debit the Cash account and  Credit the Debtor’s account.

Recovery of Bad Debt recovered sometime in the future, If the debt is recovered sometime in the future,  Credit the bad debt recovery account and  Debit the cash account with the amount received.

Provision for Bad Debts Lecture Notes 5

Definition A provision is any amount: reasonably necessary – retained as reasonably necessary of providing for any liability or loss – for the purpose of providing for any liability or loss likely to be incurred – which is either likely to be incurred, certain to be incurred – or certain to be incurred uncertain as to amount or as to the date – but uncertain as to amount or as to the date on which it will arise.

What is it? An account showing the expected amounts of debtors at the balance sheet who might not be able to pay their accounts.

Why are they needed? showing too high a value The value of the debtors on the balance sheet will be showing too high a value and could mislead anyone.

Why are they needed? ccurate calculation of profit and losses. It allows for a more accurate calculation of profit and losses. matching principle It is in keeping with the matching principle of accounting

How are they different from Bad debts? certain will not collect be collected. Bad debts are amounts that the business is certain will not collect be collected. guesses of debts that will go bad The provision for bad debts are best guesses of debts that will go bad.

How are they different from Bad debts? written off Bad Debts are written off does not write off the debt. Provisions for bad debt does not write off the debt.

How are they different from Bad debts? provisions for possible bad debts. To make provision for bad debt is to make provisions for possible bad debts. debts already bad. Bad debts are debts already bad.

Why make a Provision cater for expected or probable loss. The provision for bad debts account is opened to cater for expected or probable loss.

Why make a Provision Provision for bad debt is seen as matching expenses of the period against revenue of that period.

How do they come about? K Charles who business begun on Jan 1, 2000 has sold goods for $50,000. Included in the total is a credit sale of $250 to C Young who has died. Besides that debt a credit sale of $550 to L Hall is unlikely to be paid. Hall’s 3 month credit ends on Jan 31, 2001, but K Charles has to produce a set of financial statements on Dec 31, Charles can’t wait until Jan 31, ‘01 to see if Hall will pay.

How to Treat a Provision for Bad Debt not entered into any debtor’s account debtor who may default is not known The provision is not entered into any debtor’s account, since the specific debtor who may default is not known.

How to Treat a Provision for Bad Debt To create a provision for bad debt – Debit Debit the Profit and Loss account Credit Credit the Provision for Bad Debt account.

How to Treat a Provision for Bad Debt To increase a provision –  Credit  Credit the Provision for Bad Debt account with the increase  Debit  Debit the Profit and Loss account with the said amount.

How to Treat a Provision for Bad Debt For a decrease in the provision –  Debit  Debit the Provision for Bad Debt account with the decrease  Credit  Credit the Profit and Loss account with a similar amount.