1. Basic double entry for doubtful debts
As stated above, a doubtful debt is an amount owed by a customer that the business believes might prove difficult to collect but they still hope to do so.
The accounting treatment has to serve two objectives.
- The exercise of prudence requires that the value of the receivable should be adjusted downwards (perhaps to zero) and an expense recognised for the loss in value; but
- The receivable must stay in the accounting records so that the business continues to chase payment.This is achieved in the following way.
Illustration:
Accounting for doubtful debts – basic double entry
Note that the allowance account might also be called the provision for doubtful debts account.
The allowance is a credit balance which is then set against the carrying amount of the receivables in the statement of financial position.
Illustration: Presentation of receivables in statement of financial position
Measurement of the allowance
An allowance is only recognised for a debtor (receivable) if the business knows that the debtor might not pay. Therefore, when a business has information about the financial difficulties of specific debtors it would set up an allowance account for these.
In addition, a business with many debtors would know from experience that at each year end some of the debtors are in difficulty but it does not know who these are yet. In such cases a business might recognise a further general amount in the allowance. Note that the business would have to justify this amount; it cannot recognise a general allowance as it pleases. This must be based on verifiable experience.
In summary, when a bad debt is written off, receivables are reduced. An allowance for irrecoverable debts is different from bad debts. When an allowance for irrecoverable debts is created, total receivables are not reduced. Instead, the allowance for irrecoverable debts is recorded in a separate account in the general ledger – an allowance for irrecoverable debts account. This always has a credit balance.
2. Accounting for changes in the allowance account
The double entry shown above is a little simplistic. In practice a business will recognise an allowance balance at each year end. When this is the case it is the movement on the allowance that is recognised as an expense.
It is not obvious in the above example but the way to calculate the expense in respect of the allowance account is to identify the movement on the allowance.
Remember that any balance on the allowance account is a credit balance.
Illustration: Change in the allowance
3. Bad and doubtful debts together
Any question on this area will involve both bad debts and doubtful debts.
This is best seen with an example.
Example:
A business has trade receivables of Rs. 75,000.
It identifies that Rs. 5,000 of these debts are irrecoverable and should be written off.
An allowance for irrecoverable debts of Rs. 2,000 should be created. It is the first time that the business has opened such an account.
These transactions will be accounted for as follows:
4. Doubtful debts recovered
The accounting treatment to record a receipt of cash in respect of a doubtful debt is the same as for any other debt.
Illustration: Subsequent recovery of doubtful debt – double entry
There is no special accounting treatment to reflect the fact that the business has received cash for a debt against which it has already recognised an expense.
Common sense suggests that the business should now recognise a credit to the statement of comprehensive income but this happens automatically through the use of basic allowance accounting.
This is because the recovered amount will no longer be included as an allowance when this is re-estimated at the year-end. If all other things are equal this will cause the allowance account to fall. This fall results in a credit to the bad and doubtful debt expense account thus reducing the expense recognised in the statement of comprehensive income.
5. Aged receivables analysis
Preparing an aged receivables analysis is a method of attempting to assess the likelihood of bad debts or to make an assessment of doubtful receivables. This is an analysis for each individual credit customer of their total debtor balance, showing how long each invoice has been outstanding. A typical format for an aged receivables analysis is given below:
Illustration: Aged debtors (receivables) analysis
If a customer has old amounts outstanding, these should be investigated and an attempt should be made to collect payment. However the investigation may indicate that the amount should either be written off as a bad debt, or that an allowance should be made for an irrecoverable debt. (In other words, the debt is not written off yet, but the chances of it being paid look doubtful.)
6. Summary of the rules on bad and doubtful debts
The rules for dealing with bad debts and doubtful debts at the end of the financial year can be summarised as follows.
Illustration:
Read Also: BAD DEBTS AND DOUBTFUL DEBTS
 |
| Accounting for doubtful debts – basic double entry |
Note that the allowance account might also be called the provision for doubtful debts account.
The allowance is a credit balance which is then set against the carrying amount of the receivables in the statement of financial position.
Illustration: Presentation of receivables in statement of financial position
 |
| Presentation of receivables in statement of financial position |
Measurement of the allowance
An allowance is only recognised for a debtor (receivable) if the business knows that the debtor might not pay. Therefore, when a business has information about the financial difficulties of specific debtors it would set up an allowance account for these.
In addition, a business with many debtors would know from experience that at each year end some of the debtors are in difficulty but it does not know who these are yet. In such cases a business might recognise a further general amount in the allowance. Note that the business would have to justify this amount; it cannot recognise a general allowance as it pleases. This must be based on verifiable experience.
In summary, when a bad debt is written off, receivables are reduced. An allowance for irrecoverable debts is different from bad debts. When an allowance for irrecoverable debts is created, total receivables are not reduced. Instead, the allowance for irrecoverable debts is recorded in a separate account in the general ledger – an allowance for irrecoverable debts account. This always has a credit balance.
2. Accounting for changes in the allowance account
The double entry shown above is a little simplistic. In practice a business will recognise an allowance balance at each year end. When this is the case it is the movement on the allowance that is recognised as an expense.
It is not obvious in the above example but the way to calculate the expense in respect of the allowance account is to identify the movement on the allowance.
Remember that any balance on the allowance account is a credit balance.
Illustration: Change in the allowance
 |
| Change in the allowance |
3. Bad and doubtful debts together
Any question on this area will involve both bad debts and doubtful debts.
This is best seen with an example.
Example:
A business has trade receivables of Rs. 75,000.
It identifies that Rs. 5,000 of these debts are irrecoverable and should be written off.
An allowance for irrecoverable debts of Rs. 2,000 should be created. It is the first time that the business has opened such an account.
These transactions will be accounted for as follows:
4. Doubtful debts recovered
The accounting treatment to record a receipt of cash in respect of a doubtful debt is the same as for any other debt.
Illustration: Subsequent recovery of doubtful debt – double entry
 |
| Subsequent recovery of doubtful debt – double entry |
There is no special accounting treatment to reflect the fact that the business has received cash for a debt against which it has already recognised an expense.
Common sense suggests that the business should now recognise a credit to the statement of comprehensive income but this happens automatically through the use of basic allowance accounting.
This is because the recovered amount will no longer be included as an allowance when this is re-estimated at the year-end. If all other things are equal this will cause the allowance account to fall. This fall results in a credit to the bad and doubtful debt expense account thus reducing the expense recognised in the statement of comprehensive income.
5. Aged receivables analysis
Preparing an aged receivables analysis is a method of attempting to assess the likelihood of bad debts or to make an assessment of doubtful receivables. This is an analysis for each individual credit customer of their total debtor balance, showing how long each invoice has been outstanding. A typical format for an aged receivables analysis is given below:
Illustration: Aged debtors (receivables) analysis
 |
| Aged debtors (receivables) analysis |
If a customer has old amounts outstanding, these should be investigated and an attempt should be made to collect payment. However the investigation may indicate that the amount should either be written off as a bad debt, or that an allowance should be made for an irrecoverable debt. (In other words, the debt is not written off yet, but the chances of it being paid look doubtful.)
6. Summary of the rules on bad and doubtful debts
The rules for dealing with bad debts and doubtful debts at the end of the financial year can be summarised as follows.
Illustration:
Read Also: BAD DEBTS AND DOUBTFUL DEBTS
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