Doubtful & Bad Debts

8/11/2019 Doubtful & Bad Debts

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DOUBTFUL & BAD DEBTS

ADJUSTMENT ENTRIES

MUTHU


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BAD DEBTS IRRECOVERABLE DEBTS

An entity may not be able to recover its balancesoutstandingin respect of certain receivables.In accountancy, it refer to such receivables asIrrecoverable Debts or Bad Debts.

Bad debts could arise for a number of reasonssuch as customer going bankrupt, trade dispute orfraud.

Every time an entity realizes that, it unlikely torecover its debt from a receivable, it must 'write off'the bad debt from its books.This ensures that the entity's assets (i.e.receivables) are not stated above the amount, itcan reasonably expect to recover which is in line

with the concept of prudence.


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Debit

Bad Debt Expense

Credit Receivable

The credit entryreduces the receivable balance

to nilas no amount is expected to be recovered

from the receivable.

The debit entryhas the effect of cancelling theimpact on profit of the sales that were previously

recognized in the income statement.


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EX

ABC Ltd sells goods to DEF Ltd for Rs.500 on credit.

ABC Ltd subsequently finds out that DEF Ltd is being

liquidated and therefore the prospects of recovering

its dues are very low.Rs. Rs.

Debit Bad Debt Expense 500

Credit To DEF LTD (Receivable) 500


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BAD DEBT RECOVERED

Occasionally, a bad debt previously written offmay subsequently settle its debt in full or in

part.

In such case, it will be necessary to canceltheeffect of bad debt expense previously

recognized up to the amount settlement.


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EX

ABC Ltd sells goods to DEF Ltd for Rs.500 oncredit. ABC Ltd subsequently finds out that

DEF Ltd is being liquidated and therefore the

prospects of recovering its dues are very low.ABC Ltd therefore writes off the receivable

from its books. However, the administrator

appointed to oversee the liquidation of DEF Ltdinstructs the company to pay Rs.300 to ABC

Ltd in full settlement of its dues.


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ENTRY

As Rs.300 of the bad debt has been recovered,it is necessary to cancel the effect of previously

recognized bad debt expense up to this

amount.

Rs. Rs.

Debit Cash 300

Credit

Bad Debt Recovered (Income)

300


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SPECIFIC ALLOWANCE

This is allowance created in respect of specific

receivables which are known to be facing

serious financial problems or have a trade

disputewith the entity.

Such balances may be identified by examining

an aged receivable analysis which details the

time lapsedsince the creation of a receivable.

Long outstanding balances identified from suchanalyses could be considered for inclusion in

the allowance for doubtful debts.


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CONT..

The difference between the treatmentof a bad debtand a specific allowance for doubtful debt is that inthe latter case, the receivable ledger of the specificdebt is not removed in case the debtor actuallypays whereas in the case of bad debts, thereceivable ledger is reduced to nil.Also, specific allowance may not be created for theentire amount of the doubtful receivable but only aportion of it.

For instance, if there is a 50% chance ofrecovering a doubtful debt in respect of a certainreceivable, a specific allowance of only 50% maybe required. On the contrary, bad debt is normally

recognized in full.


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GENERAL ALLOWANCEPast history of a business may show that a portion ofreceivable balances is not recovered due to unforeseencircumstances.

Therefore, it may be prudent to create a generalallowance for doubtful debts in addition to the specificallowance.

The general allowance may be calculated on the basis ofpast experience concerning recoverability of debts.

The practice of creating general provisions is on thedecline after revisions in the International FinancialReporting Standards (IFRS).

Specifically, IAS 39 prohibits creation of generalprovisions on the basis of past experience due to thesubjectivityinvolved in creating such an estimate.

Instead, reporting entity is required to carry out

impairment reviewto determine the recoverability of the


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ACCOUNTING FOR DOUBTFUL DEBTS

Allowance for doubtful debts is created byforming a credit balance which is netted off

against the total receivables appearing in the

balance sheet.A corresponding debit entry is recorded to

account for the expense of the potential loss.

Debit

Allowance for Doubtful Debts (Expense)

Credit

Allowance for Doubtful Debts (Balance

Sheet)


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CONT

Once an allowancefor doubtful debts has beencreated, only the movement in the allowance

will need to be charged to the income statement

in future accounting period.So if estimated allowance for doubtful debt is

same as last accounting period, no accounting

entry will be required in the current period asthe total receivables will be reduced by the

amount of allowance which has already been

created.


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EX

ABC LTD has trade receivable of worthRs.50,000 as at 31 December 2010.

XYZ LTD, a receivable owing Rs.10,000 to ABCLTD at the year end, has been recently been

wound up.Consequently, ABC LTD does not expect torecover the amount due from XYZ LTD.

Based on past experience, ABC LTD estimatesthat 5% of its receivables will default.

Allowance for doubtful debts on 31 December2009 was Rs.1500.


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ABC LTD must write off the Rs.10,000

receivable from XYZ LTD as bad debt

Rs.

Rs.

Debit

Bad Debt Expense

10,000

Credit

XYZ LTD (Receivable)

10,000


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Note that Rs.10,000 in respect of receivable

from XYZ LTD has been excluded from the

calculation of the general allowance as it has

already been written off in full.

Bad Debt Expense

Debit Rs. Credit Rs.

XYZ LTD (Receivable) 10,000Income Statement 10,000

10,000 10,000


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XYZ LTD Receivable

Debit

Rs.

Credit

Rs.

Sales

10,000

Bad Debt Expense

10,000

10,000

10,000

Allowance for Doubtful Debts

Debit Rs. Credit Rs.

Balance c/d

2,000

Balance b/d

1,500

Income Statement 500

2,000 2,000

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Doubtful & Bad Debts

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