IRRECOVERABLE DEBTS, ALLOWANCE FOR IRRECOVERABLE DEBTS, IRRECOVERABLE DEBTS RECOVERED

WHAT IS A DEBT?

• Debt = sum of money owed by customer
• Arises from credit sales to a customer
• When is it irrecoverable?

TREATMENT OF IRRECOVERABLE DEBT

• Must be written off
• According to prudence
• Prudence states : forecast possible losses
• So, even if the debt is not irrecoverable but there is a doubt that we cannot recover the debt, we need to make an allowance for irrecoverable debts

ACCOUNTING ENTRIES FOR IRRECOVERABLE DEBTS

• Write off the debt= cancel customer account
• How to cancel an account?
• Customer account has debit or credit balance?
• If it has a ………….. balance, How to cancel it ?

TRANSFER THE IRRECOVERABLE DEBTS AT END OF FINANCIAL YEAR

• Transfer to Statement of profit or loss

WORKED EXAMPLE FOR IRRECOVERABLE DEBTS TREATMENT

IRRECOVERABLE DEBTS VS ALLOWANCE FOR IRRECOVERABLE DEBTS

• Irrecoverable debt is an expense ; allowance for irrecoverable debts is possible liability
• Irrecoverable debts = past event
• Allowance for irrecoverable debts = possible future event

REASONS FOR PROVISION FOR DOUBTFUL DEBTS

• Prudence - anticipate possible losses
• Matching - match expense with revenue
• Going concern - show net trade receivables after adjusting for allowance at end in SOFP

FORMAT OF ALLOWANCE FOR IRRECOVERABLE DEBTS ACCOUNT

HOW TO CALCULATE PROVISION FOR DOUBTFUL DEBTS

• Take a % of closing trade receivables
• Allowance for irrecoverable debts = Rate (x%) * Trade receivables at end of year
• Note: trade receivables at end must be net of irrecoverable debts
• Apart from general allowance, we also have specific allowance. ( specific sum is to be taken as allowance for irrecoverable debts)

WHAT ARE THE FACTORS TO BE CONSIDERED TO DETERMINE THE % OF DEBTS THAT MAY BECOME BAD?

• Past history of trade receivables
• Rate of irrecoverable debts in previous years
• State of economy
• Age of debts
• Specific information about customers in difficulty

3 TYPES OF ALLOWANCE

• Creation ( for the first time )
• Increase in allowance
• Decrease in allowance

IRRECOVERABLE DEBTS RECOVERED

• Debt already written off and then the customer pays back the money
• Since we already cancelled off the account, we need to recreate the debt.

ACCOUNTING ENTRIES FOR IRRECOVERABLE DEBTS RECOVERED - RECREATE THE DEBT

• Debit Customer a/c
• Credit irrecoverable debt recovered

SHOW MONEY COMING INTO BUSINESS

• Debit cash/bank account
• Credit customer account

TRANSFER TO STATEMENT OF PROFIT OR LOSS

• Debit irrecoverable debt recovered
• Credit statement of profit or loss