1. Irrecoverable debt and allowance for doubtful debt
Amjid Malik

2. explain the difference between
Aim:
To explain the period-end adjustments for irrecoverable debts and doubtful debts.
Objectives:
You should be able to
explain the difference between
irrecoverable debts (bad debt) written off
allowance for doubtful debts
record irrecoverable debts (bad debt) and doubtful debts in ledger a/c’s and in ETB
disclose trade receivables (trade debtors) in a statement of financial position (balance sheet) net of the doubtful debt allowance.

4. Credit sales & Irrecoverable debt
When sales are made to credit customers they are recognised as income when the invoice is sent out on the assumption that the money due will eventually be received from the customer/receivable. The double entry to record the credit sale is:
Dr. trade receivable debts (SLCA) X
Cr. Sales a/c X
For a business which supplies goods/services on credit terms it is inevitable that irrecoverable debts (bad debt) will arise in relation to those sales.

5. Indroduction
The amount owed by credit customer should only be classed as an asset (trade receivable) if it is probable that it is recoverable. (ie that the customer will pay the amount due).
If it becomes apparent that a customer will not pay, the item no longer meets the definition of an asset.
The accounting treatment will depend upon whether the debt is considered to be an irrecoverable debt (bad debt) or a doubtful debt.

6. Assessment focus point
There are two main ways in which this topic could be tested:
It could form part of a task on ‘accounting adjustments’, with calculations required.
You may be asked to include irrecoverable and doubtful debts in the trial balance.
VAT implications are not required

7. Irrecoverable debts (Bad Debts)
These debts are owing to a business which it considers will never be paid –definitely irrecoverable.
These debts need to written off to the statement of profit or loss.
Remove from the sales ledger control account

8. TREATMENT OF IRRECOVERABLE DEBTS- DOUBLE ENTRY
Irrecoverable debts are written off when they become uncollectable.
In the Main Ledger
Debit – irrecoverable debts account
Credit – trade receivable’s account
We do not debit the sales (revenue) a/c as sale itself was bona fide (authentic, genuine).
At year-end: Transferred to SPL as an expense
Debit – statement of profit or loss
Credit – irrecoverable debts a/c

9. TREATMENT OF IRRECOVERABLE DEBTS- DOUBLE ENTRY
Also, in the subsidiary sales ledger:
Cr. Customer’s individual account – to remove the debt X
(to match the entry in the SLCA)
Example: Lewis reviews his receivables (which total £10,000) and notices an amount due from John of £500. He knows that this will never be recovered so he wants to write it off.

10. Sales ledger control a/c Irrecoverable debts expense a/c
Solution: Double entry- D/E
Sales ledger control a/c
Bal b/d
10,000
Irrecoverable debts
Balance c/d
500
9,500
Balance b/d
Irrecoverable debts expense a/c
S/L Control
500
SPL

11. Solution: Double entry- D/E
In the subsidiary sales ledger there will also be an entry in John’s account:
John’s a/c
Bal b/d
500
Irrecoverable debts written off
The accounting treatment of irrecoverable debts means that the debt is completely removed from the accounting records and the statement of profit or loss is charged with an expense i.e it will reduce the profit by £500

12. Journal entry to write off the debt
Account Name
Debit £
Credit £
Irrecoverable debts
500
SLCA
Being: Write off an irrecoverable debt –
Account of Jones written off as irrecoverable in the sales ledger – Credit Jones £500.
SPL
Being: Transfer to the SPL of irrecoverable debts for year

13. Recovery of a debt
From time-to-time, a former trade receivable whose account has been written off will make a payment
DEBIT – BANK/CASH
CREDIT – IRRECOVERABLE DEBTS A/C
(or a separate irrecoverable debts recovered account) - (SPL)
(at the end of the year, debts recovered are
transferred to the credit column of the statement
of profit or loss as income. This will have the
effect of increasing the profit for the year)

14. Case study: recovery of a debt
T Hughes is a customer – the balance of his
account of £25 was written off as a
irrecoverable debt on 15 December 20-7.
Today, on 15 April 20-8, T. Hughes wishes to
pay off the amount of the debt – with a
cheque for £25
See: Osborne Tutorial: Pg 117

15. You TrY:
ACTIVITY 7.1 -OSBORNE TUTORIAL Page 127

16. Allowance for doubtful debt
Some trade receivables accounts will give the business concern - they may never be paid. This is a debt which is possibly irrecoverable.
An allowance for doubtful debt needs to be made against the debt - as a prudent precaution.
NOTE: The business cannot show the full
amount of trade receivables on the Statement
of Financial position as an asset, to do this
implies that the business will get the full
amount (recoverable).

17. Allowance for doubtful debt
Allowance for doubtful debts is the estimate by a business of the likely percentage of its trade receivables which may become irrecoverable during any one accounting period.
Note the debt is not written off (in the SLCA) as it is not certain that they are irrecoverable.
Allowances reduce the value of receivables in the statement of financial position (SOFP)

18. Treatment for allowance for doubtful debts (ADD)
Allowance of D.D is different from irrecoverable debts, because there is only the possibility (not certainty) that these debt will not be paid.

19. Accrual principle of accounting
Allowance of doubtful debts (ADD) is an application of the accrual basis of accounting.
By reducing the trade receivable figure, a more accurate figure is shown in the statement of financial position (SOFP) of the amount that the business can expect to receive.
Extract of SOFP
Current Assets:
Inventory X
Trade receivables X
Less Allowance for doubtful debt (X) X

20. Allowance for doubtful debt
A new account is created, called allowance for doubtful debts account. (SOFP a/c)
This account balance is offset against the trade receivables (sales ledger control account) balance in the statement of financial position (following the accrual basis of accounting) and
the expense taken to the statement of profit or loss via the allowance for doubtful debts adjustment account. (SPL a/c)

21. Treatment for allowance for doubtful debts
Allowance for doubtful debts account: this records the accumulated total of the allowance (SOFP a/c)
Allowance for doubtful debts: adjustment account :this records the amount to create, increase or decrease the allowance each year (SPL a/c).

22. TYPES OF ALLOWANCE There are two types of allowances to consider:
SPECIFIC ALLOWANCES: provided where there is doubt over the recoverability of a particular customer’s balance.
GENERAL ALLOWANCES: a % applied to the total receivables (sales ledger control account balance) after:
(i) Writing off irrecoverable debts
(ii) Deducting the total balance owed by any customers for whom a specific allowance has been made. The general allowance is increased or decreased as necessary at year end.

23. specific allowance
Is an allowance applied to one or more specific debts where the risk of default is thought to be higher

24. General allowance
Is an allowance applied to the total trade receivables after writing off irrecoverable debts and taking account of any specific allowance

25. Rules for calculating the general allowance
Take the following steps in this order:
Take the receivables balance per the sales ledger
control account
2. Deduct the irrecoverable debts (bad debts) and
3. Then deduct any amounts specifically provided for
4. Then finally calculate the general allowance on the
balance (ie after taking account of bad and specific
debt).
Each business will have a specific policy regarding
general allowances.

26. Rules for calculating the general allowance
Receivables Balance (Debtors) £
Less Irrecoverable Debts to be written off (£)
Less Specific allowance (£)
General allowance % applied to …………… ?
Total allowance = specific + general allowance
Remember: only the movement in the general allowance needs to be accounted for in the statement of profit or loss

27. Assessment focus point
In the assessment you will need to calculate the account for doubtful debts in accordance with the policy of the organisation stated in the task.
Example: ‘ The allowance for doubtful debts needs to be adjusted to 1% of outstanding trade receivables.’

28. Example: OSBORNE Page 113
A business with trade receivables of £10,000.
Trade receivables accounts totalling £200 are to be written off as a bad debt (irrecoverable debt)
An allowance for doubtful debts is to be made amounting to 2% of the remaining trade receivables after the £200 has been off.

29. Example: OSBORNE Page 113 Gross trade receivables £10,000
Less: irrecoverable debt £
£ 9,800
Less: allowance for doubtful
2% £
Net trade receivables £ 9,604
Note: the level of percentage is likely to
reflect the level of risk of the doubtful debt

30. Extract of SOFP – Current Assets – DOUBTFUL DEBT
Inventory (Stock) x
Trade receivables (SLC) 9,800
Less allowance for Doubtful debt
9,604
Prepayment of expenses x
Accrual of income x
Bank/Cash x x

31. You Try
Activity Osborne Tutorial 7.3 Pg 127

32. Initial creation of an allowance for doubtful debt
Making an allowance for doubtful debts comes after writing of the irrecoverable debts (if any):
Study: STEPS 1 – 4 (Osborne Tutorial page 118)
Pg 118

33. Adjustments to allowance for doubtful debt
Once an initial allowance for doubt debt has been created, only the adjustments (an increase or a decrease in the allowance) need to be made thereafter as a result of:
A policy change- e.g change in the fixed percentage.
An arithmetical adjustment- change in the trade receivables

34. Increasing the allowance
This is recorded into the double-entry
bookkeeping system as follows:
DEBIT - allowance for doubtful debts: adjustment account (SPL) (with the amount of increase)
CREDIT – allowance for doubtful debts account (SOFP) (with the amount of increase).
Transfer out of adjustment account to SPL..
DEBIT – statement of profit or loss (Expense)
CREDIT – allowance for doubtful debts: adjustment account

35. You Try
Osborne Tutorial Activity 7.2 Page 127

36. decreasing the allowance
This is recorded into the double-entry
bookkeeping system as follows:
DEBIT - allowance for doubtful debts account (SOFP) (with the amount of increase)
CREDIT – allowance for doubtful debts: adjustment account (SPL) (with the amount of increase)
Transfer out of adjustment account to SPL..
DEBIT – allowance for doubtful debts: adjustment account (SPL).
CREDIT – statement of profit or loss (Income)

37. Irrecoverable debts and doubtful debts
ACCOUNTS PREPARATION

38. Case study: how it works
Osborne Tutorial Pages
Study the example
Pg 120

39. You Try
Activity Osborne Tutorial Pg 128
Activity 7.5

40. The extended trial balance
Case study
Osborne Tutorial Page 124
Study the example
Tara Smith
Irrecoverable debts and allowance for doubtful debts
Pg 124

42. Class Activity:
ND Trading has a balance on its sales ledger control account at 31 December 20X5 of £60,000. Included within this balance is £3,000 of irrecoverable debts to write off and a specific allowance to be made of £600.
At 31 December 20X4, the allowance for doubtful debts will be 3% of the outstanding trade receivables.
Complete the trial balance extract by entering the figures in the correct places.

43. Trial balance (Extract)
Ledger accounts
Ledger balances
Dr £
Cr £
Sales ledger control
Irrecoverable debts
Allowance for doubtful debts
Allowance for doubtful debt -adjustments

44. Trial balance (Extract)
Ledger accounts
Ledger balances
Dr £
Cr £
Sales ledger control
57,000
Irrecoverable debts
3,000
Allowance for doubtful debts
2,292
Allowance for doubtful debt -adjustments
292
Workings:
Opening balance per sales ledger control ,000
Less Irrecoverable debts ( 3,000)
Adjusted balance per sales ledger control account ,000
Less specific allowance ( 600)
56,400
General allowance (£56,400 x 3%) ,692
Total allowance = £600 + £1, = £2,292
ADD adjustment:
Opening allowance £2,000
Adjustment to TB SPL £ 292
Closing allowance – to TB SOFP £2,292

45. Osborne Tutorial – Activities 7.6 to 7.7
Your Try: Activities
Osborne Tutorial – Activities 7.6 to 7.7

46. Irrecoverable debts and doubtful debts - Summary
ACCOUNTS PREPARATION

47. Example
Ross Engineering has an existing allowance for doubtful debts of £300 based on 5 per cent of receivables.
After writing off irrecoverable debts, the amounts of receivables at the end of the next two financial years are found to be:
31 December £8,000
31 December £7,000
The business continues to keep the allowance for doubtful debts equal to 5 per cent of receivables.
You are to show how the allowance for doubtful debts account and allowance for doubtful debts: adjustment account will be adjusted at the end of the financial years ended 31 December 20-5 and 31 December 20-6, and how it will be recorded in the appropriate financial statements.

48. Allowance for doubtful debts account (SOFP a/c)
Solution:
Allowance for doubtful debts account (SOFP a/c)
20-5
1-Jan
Balance b/d
300
31-Dec
Balance c/d
400
Allowance for doubtful debts: adjustment
(increase in allowance)
100
20-6
(decrease in allowace) 50
350
20-7

49. Allowance for doubtful debts: adjustment account (SPL a/c)
20-5
31-Dec
Allowance for doubtful debts:
100
SPL
20-6 50
Allowance for doubtful debts
400

50. Statement of profit or loss for the year ended 31 December 2005
Extract from financial statements produced for year ended 31 December
20-5
Statement of profit or loss for the year ended 31 December 2005
Expenses: Dr Cr
Allowance for Doubtful debt-adjustment (increase)
100
Statement of Financial Position as at 31 December 2005
Current Assets:
Inventory x
Receivables-(Sales Ledger Control ) ,000
Less: Allowance for Doubtful Debts (400)
7,600

51. Statement of profit or loss for the year ended 31 December 2006
Extract from financial statements produced for year ended 31 December:
20-6
Statement of profit or loss for the year ended 31 December 2006
Other Income Dr Cr
Allowance for Doubtful debt-adjustment (reduction) 50
Statement of Financial Position as at 31 December 2006
Current Assets:
Stock (Inventory) x
Sales Ledger Control (Receivables) ,000
Less: Allowance for Doubtful Debts (350)
6,650

52. Homework Lesson 8 – Chapter 7
Read chapter 7 and answer all questions in Tutorial book and work book (Osborne)
Do the TZ activities – Will be collected next week for marking. (Osborne)
Read ahead Chapter 8: The rules of accounting for next week. (Osborne)
Additional activities (Optional):
BPP Knowledge Topic KT7
BPP Question Bank activities

53. The end Any question?