Irrecoverable Debts And Provision For Doubtful Debts (Copy)
4. Accounting Procedures
4.4 Irrecoverable Debts and Provision for Doubtful Debts
Meaning of Irrecoverable Debts
- Also known as bad debts, irrecoverable debts are amounts owed by customers that are no longer expected to be received.
- These arise when:
- The debtor becomes bankrupt or insolvent.
- Repeated attempts to recover the debt have failed.
- Irrecoverable debts must be written off as an expense in the income statement.
Journal Entry to Write Off Irrecoverable Debts
Dr Irrecoverable Debts Expense
Cr Trade Receivables
Example:
Ali’s debt of $1,200 is deemed irrecoverable.
Dr Irrecoverable Debts A/C 1,200
Cr Ali’s A/C (Trade Receivable) 1,200
Ledger Account: Irrecoverable Debts
| Date | Details | Dr ($) | Cr ($) |
|---|---|---|---|
| Dec 31 | Trade Receivables | 1,200 | |
| Jan 1 | Income Statement | 1,200 |
Recovery of Debts Previously Written Off
If a debt previously written off is later recovered, it is treated as additional income in the period it is received.
Journal Entry for Recovery of Bad Debt
Dr Bank
Cr Bad Debts Recovered (Income)
Example:
Ali pays $500 after his $1,200 was written off last year.
Dr Bank A/C 500
Cr Bad Debts Recovered A/C 500
Ledger Account: Bad Debts Recovered
| Date | Details | Dr ($) | Cr ($) |
|---|---|---|---|
| Jan 10 | Bank | 500 | |
| Dec 31 | Income Statement | 500 |
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Provision for Doubtful Debts
- A provision is an estimate of debts that may not be recovered in the future.
- It ensures adherence to the prudence concept:
- Anticipate possible losses
- Avoid overstating profit
- Created by estimating a percentage of the closing trade receivables balance.
Journal Entry to Create Provision
Dr Income Statement
Cr Provision for Doubtful Debts
Example:
Trade receivables = $20,000
Required provision = 5% = $1,000
Dr Income Statement 1,000
Cr Provision for Doubtful Debts A/C 1,000
Adjusting an Existing Provision
Increase in Provision
Dr Income Statement
Cr Provision for Doubtful Debts
Decrease in Provision
Dr Provision for Doubtful Debts
Cr Income Statement
Example 1:
Previous provision = $1,200
New required = $1,500 → Increase by $300
Dr Income Statement 300
Cr Provision for Doubtful Debts 300
Example 2:
Previous provision = $1,500
New required = $1,100 → Decrease by $400
Dr Provision for Doubtful Debts 400
Cr Income Statement 400
Ledger Account: Provision for Doubtful Debts
| Date | Details | Dr ($) | Cr ($) |
|---|---|---|---|
| Dec 31 | Income Statement (↓) | 400 | |
| Dec 31 | Income Statement (↑) | 300 | |
| Dec 31 | Balance c/d | 1,500 | |
| Jan 1 | Balance b/d | 1,500 |
Effect on Financial Statements
| Area | Effect of Irrecoverable Debts | Effect of Provision |
|---|---|---|
| Income Statement | Increases expenses, reduces profit | Increases expenses (if provision increases) or reduces profit |
| Statement of Financial Position | Trade receivables reduced directly | Trade receivables shown net of provision |
Presentation Example:
Trade Receivables: $20,000
Less: Provision for Doubtful Debts (5%) = $1,000
Net Receivables: $19,000
Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course
Worked Example: Full Scenario
Given:
- Trade receivables at year-end: $25,000
- Irrecoverable debt of $1,500 to be written off
- Existing provision: $1,000
- New required provision: 5% of (25,000 – 1,500) = $1,175
Steps:
- Write off Irrecoverable Debt
Dr Irrecoverable Debts 1,500
Cr Trade Receivables 1,500 - Adjust Provision
Old = 1,000
New = 1,175 → Increase by 175
Dr Income Statement 175
Cr Provision for Doubtful Debts 175 - Net Receivables on Balance Sheet
$25,000 – $1,500 = $23,500
Less provision $1,175
Net Trade Receivables = $22,325