Professional Documents
Culture Documents
Bad debts
-With many businesses a large proportion, if not all, of the sales are on credit.
-The business is therefore taking the risk that some of the customers may never pay for the goods sold to them on
credit.
-This is a normal business risk and such bad debts are a normal business expense.
-They must be charged to profit and loss as an expense when calculating the profit or loss for the period.
-The other thing that needs to be done is to remove the bad debt from the asset account.
-This will mean closing the debtor’s account, but not always.
-When a debt is found to be ‘bad’, the asset as shown by the debt in the debtor’s account is worthless. --It must be
eliminated from the account.
-This is done by crediting the debtor’s account to cancel the asset and increasing the expense account of bad debts
by debiting it there.
There are a range of possible scenarios that may exist concerning a bad debt.
1. the debtor may be refusing to pay one of a number of invoices;
2. the debtor may be refusing to pay part of an invoice;
3. the debtor may owe payment on a number of invoices and has indicated that only a proportion of the total
amount
- Whatever the reason, once a debt has been declared ‘bad’, the journal entry is the same
.
- debit the bad debt account with the amount of the bad debt and
Credit the debtor’saccount in the Sales Ledger to complete the double entry.
-At the end of the period, the total of the bad debts account is transferred to the profit and loss account.
-When we are drawing up our financial statements, we want to achieve the following objectives:
-to charge as an expense in the profit and loss account for that year an amount representing debts that will never be
paid ;so that the profit for the year will not be over stated
-to show in the balance sheet a debtors figure as close as possible to the true value of debtors at the balance sheet
date. So that the value of trade receivables is not over stated
-thus applying the prudence concept
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-The prudence concept– says that this possibility needs to be provided for in the current period, otherwise both
the debtor balance reported in the balance sheet and the profit reported in the profit and loss account will
almost certainly be overstated.
-It is impossible to determine with absolute accuracy at the year end what the true amount is in respect of
debtors who will never pay their accounts
-In order to arrive at a figure for doubtful debts, a business must first consider that some debtors will never
pay any of the amount they owe, while others will pay a part of the amount owing only, leaving the remainder
permanently unpaid.
The accounting entries needed for the provision for doubtful debts are:
Debit the profit and loss account with the amount of the provision (i.e. deduct it from gross profit
as an expense).
Credit the Provision for Doubtful Debts Account.
.Exhibit
At 31 December 20X3, the debtors figure after deducting bad debts was £10,000. It is estimated that
2 per cent of debts (i.e. £200) will eventually prove to be bad debts, and it is decided to make a
provision for these. The accounts will appear as follows:
Profit and Loss Account (extract) for the year ended 31 December 20X3
£
Gross profit xxx
Less Expenses:
Provision for doubtful debts (200)
20X3 £
Dec 31 Profit and loss 200
In the balance sheet, the balance on the provision for doubtful debts will be deducted from the total
of debtors:
Current assets £ £
Debtors 10,000
Less Provision for doubtful debts ( 200)
9
,
8
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0
0
-You’ll have noticed that we are using two different accounts to make the two different debtor
adjustments. This is done in order to make it clear how much is:
-By charging both (1) and (2) in the profit and loss account for the year, we present the full pic-ture of the
amounts provided for in respect of both bad and doubtful debts.
-By showing (2) as a deduction from the figure of debtors in the balance sheet at the year end, we then get a
net figure, which represents a more accurate figure of the value of debtors than the total of all the debtor
balances in thesalesledger
Debit Profit and Loss Account with the increase in the provision (i.e. deduct it from gross
profit as an expense).
Credit the Provision for Doubtful Debts Account.
These entries are illustrated in Exhibit below
Exhibit
Profit and Loss Account (extract) for the year ended 31 December 20X4
£
Gross profit xxx
Less Expenses
Provision for doubtful debts (increase) ( 40)
20X4 £ 20X4 £
Dec 31 Balance c/d 240 Jan 1 Balance b/d 200
Dec 31 Profit and loss 40
240 240
20X5
Jan 1 Balance b/d 240
Current assets £ £
Debtors 12,000
Less Provision for doubtful debts ( 240)
11,760
Exhibit
Provision for Doubtful Debts
20X5 £ 20X5 £
Dec 31 Profit and loss 30 Jan 1 Balance b/d 240
== 31 Balance c/d 210
240 240
20X6
Jan 1 Balance b/d 210
Profit and Loss Account (extract) for the year ended 31 December 20X5
£
Gross profit xxx
Add Reduction in provision for doubtful debts 30
Current assets £ £
Debtors 10,500
Less Provision for doubtful debts ( 210)
10,290
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- increases in the provision for doubtful debts increases the total for expenses. On the other hand, a reduction
in the provision for doubtful debts will be added to the gross profit.
Dr Debtor’s account
Cr Bad debts recovered account
-When payment is received from the debtor in settlement of all or part of the debt:
Dr Cash/bank
Cr Debtor’s account(with the amount received)
-At the end of the financial year, the credit balance in the bad debts recovered account is
trans-ferred
to either the bad debts account or direct to the credit side of the profit and loss account.
- The effect is the same, since the bad debts account will, in itself, be transferred to the profit and loss
account at the end of the financial year.
Activi
ty
25.
5
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Review questions
1 In a new business during the year ended 31 December 20X7 the following debts are found to be bad,
and are written off on the dates shown:
31 May S Gill & Son £340
30 September H Black Ltd £463
30 November A Thom £156
On 31 December 20X8 the schedule of remaining debtors, amounting in total to £14,420, is exam-ined,
and it is decided to make a provision for doubtful debts of £410.
You are required to show:
(a) The Bad Debts Account, and the Provision for Doubtful Debts Account.
(b) The charge to the Profit and Loss Account.
(c) The relevant extracts from the Balance Sheet as at 31 December 20X7.
2 A business had always made a provision for doubtful debts at the rate of 4% of debtors. On
1 January 20X8 the provision for this, brought forward from the previous year, was £320.
During the year to 31 December 20X8 the bad debts written off amounted to £680.
On 31 December 20X8 the remaining debtors totalled £16,800 and the usual provision for doubtful
debts is to be made.
You are to show:
(a) The Bad Debts Account for the year ended 31 December 20X8.
(b) The Provision for Doubtful Debts Account for the year.
(c) Extract from the Profit and Loss Account for the year.
(d) The relevant extract from the Balance Sheet as at 31 December 20X8.
3 A business started trading on 1 January 20X7. During the two years ended 31 December
20X7 and 20X8 the following debts were written off to the Bad Debts Account on the dates stated:
31 May 20X7 F Lamb £175
31 October 20X7 A Clover £230
31 January 20X8 D Ray £190
30 June 20X8 P Clark £75
31 October 20X8 J Will £339
On 31 December 20X7 there had been a total of debtors remaining of £52,400. It was decided to
make a provision for doubtful debts of £640.
On 31 December 20X8 there had been a total of debtors remaining of £58,600. It was decided to
make a provision for doubtful debts of £710.
You are required to show:
(i ) The Bad Debts Account and the Provision for Doubtful Debts Account for each of the two
years.
(ii) The relevant extracts from the Balance Sheets as at 31 December 20X7 and 20X8.
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4 A business, which started trading on 1 January 20X7, adjusted its doubtful debt provision at the end of
each year on a percentage basis, but each year the percentage rate is adjusted in
accordance with the current ‘economic climate’. The following details are available for the three years
ended 31 December 20X7, 20X8 and 20X9.
Bad debts written off Debtors at Percentage provision
year to 31 December 31 December for doubtful debts
£ £
20X7 1,240 41,000 4
20X8 2,608 76,000 6
20X9 5,424 88,000 5
You are required to show:
(a) Bad Debts Accounts for each of the three years.
(b) Provision for Doubtful Debts Accounts for each of the three years.
Balance Sheet extracts as at 31 December 20X7, 20X8 and 20X9.
5 A business which prepares its financial statements annually to 31 December suffered bad debts:
20X7 £420
20X8 £310
20X9 £580
The business had a balance of £400 on the provision for doubtful debts account on 1 January 20X7. At
the end of each year, the business considered which of its debtors appeared doubtful and
carried forward a provision:
20X7 £500
20X8 £600
20X9 £400
Show the entries in the profit and loss account and prepare the provision for doubtful debts account for
each of the three years.
6
(a) Businesses often create a provision for doubtful debts.
(i ) Of which concept (or convention) is this an example? Explain your answer.
(ii ) What is the purpose of creating a provision for doubtful debts?
(iii ) How might the amount of a provision for doubtful debts be calculated?
(b) On 1 January 20X8 there was a balance of £500 in the Provision for Doubtful Debts Account,
and it was decided to maintain the provision at 5% of the debtors at each year end.
The debtors on 31 December each year were:
£
20X8 12,000
20X9 8,000
20X0 8,000
Show the necessary entries for the three years ended 31 December 20X8 to 31 December 20X0
inclusive in the following:
(i ) the Provision for Doubtful Debts Account;
(ii ) the Profit and Loss Accounts.
(c) What is the difference between bad debts and provision for doubtful debts?
(d ) On 1 January 20X0 Warren Mair owed Jason Dalgleish £130. On 25 August 20X0 Mair was
declared bankrupt. A payment of 30p in the £ was received in full settlement. The remaining
balance was written off as a bad debt. Write up the account of Warren Mair in Jason
Dalgleish’s ledger.
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‘ 7 The balance sheet as at 31 May 20X7 of Forest Traders Limited included a provision for doubtful debts
of £2,300. The company’s accounts for the year ended 31 May 20X8 are now being prepared. The
company’s policy now is to relate the provision for doubtful debts to the age of debts outstanding. The
debts outstanding at 31 May 20X8 and the required provisions for doubtful debts are as follows:
Provision for
Debts outstanding Amount doubtful debts
£ %
Up to 1 month 24,000 1
More than 1 month and up to 2 months 10,000 2
More than 2 months and up to 3 months 8,000 4
More than 3 months 3,000 5
Customers are allowed a cash discount of 2 1/2% for settlement of debts within one month. It is now
proposed to make a provision for discounts to be allowed in the company’s accounts for the year ended
31 May 20X8.
Required:
Prepare the following accounts for the year ended 31 May 20X8 in the books of Forest Traders Limited
to record the above transactions:
8 A business makes a provision for doubtful debts of 3% of debtors, also a provision of 1% for discount
on debtors.
On 1 January 20X8 the balances brought forward on the relevant accounts were provision for
doubtful debts £930 and provision for discounts on debtors £301.
You are required to show for the years 20X6, 20X7 and 20X8, the
(a) Bad Debts Account.
(b) Bad Debts Recovered Account.
(c) Provision for Doubtful Debts Account.
(d ) Extract from the Profit and Loss Account.
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10. Explain the procedure to be followed when a customer whose debt has been written off as bad
subsequently pays the amount originally owing.
On 1 January 20X7 D Watson had debtors of £25,000 on which he had made a provision for doubtful
debts of 3%.
During 20X7,
(i) A Stewart who owed D Watson £1,200 was declared bankrupt and a settlement of 25p in the
£ was made, the balance being treated as a bad debt.
(ii) Other bad debts written off during the year amounted to £2,300.
On 31 December 20X7 total debtors amounted to £24,300 but this requires to be adjusted as follows:
(a) J Smith, a debtor owing £600, was known to be unable to pay and this amount was to be
Written off.
(b) A cheque for £200 from S McIntosh was returned from the bank unpaid.
D Watson maintained his provision for doubtful debts at 3% debtors.
Required:
For the financial year ended 31 December 20X7, show the entries in the following accounts: (i )
Provision for doubtful debts
(ii) Bad debts
What is the effect on net profit of the change in the provision for doubtful debts?
11 D Faculti started in business buying and selling law text books, on 1 January 20X3. At the end of each of
the next three years, his figures for debtors, before writing off any bad debts, were as follows:
Required:
(a) Prepare Faculti’s bad debts expense account and provision for doubtful debts account for
20X3 and 20X4.
(b) The amounts due from debtors, B Roke, £70, and HA Ditt, £42 became irrecoverable in 20X6
and were written off. Prepare the ledger account entries to record these write-offs.
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