Chapter 5

PREPARATION OF POST
ADJUSTED FINANCIAL
STATEMENTS
(Bad debt, Bad debts recovered
and Allowance for doubtful debts)

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 Learning Objectives
• To explain the terms bad debts, doubtful debts, bad debts
recovered and allowance for doubtful debts
• To identify the different methods used to estimate doubtful
debts
• To describe how account receivable is recognized in the
accounts
• To describe the journal entries for account receivables
• To prepare the financial statement after the adjustments on
account receivables have been considered

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 (Name of the business entity)
Statement of Financial Position as at …
RM RM RM
Fixed Assets/PPE: Cost Acc. Depn NBV
Land and building xxx xxx xxx
Motor vehicles xxx xxx xxx
xxx
Intangible Assets:
Goodwill xxx
Investment:
Loan to XYZ xxx
Current Assets:
Stock xxx
Debtors/Account receivable xxx
Bank*
(A CREDIT Bank acc. is recorded under current liability) xxx
Cash xxx xxx
XXX
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 Introduction
• A business can sell its goods on cash as well as
on credit basis.

• When goods are sold on credit basis, the debtor

is normally given a certain period of time to
settle the amount due.

• This period is known as credit period or credit

term.
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• The credit term is normally stated in the invoice
and is written as follows:
➢2/15, net 30

Where the number:

• 2 denote the percentage of discount allowed for the
credit sale.
• 15 denote the period in which the discount is given.
• 30 denote the credit period where full settlement of
the amount due is required.
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• The credit period 2/15, net 30 would simply means that if
the debt is settle within 15 days from the date of sale, the
debtor is entitled to a discount of 15%.

• The discount is calculated based on the value of goods

purchased.

• However, if the debtor is unable to make payment within

the discount period, full amount had to be paid within 30
days from the date of sale.

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 Bad debts
• When the debtor failed to pay the amount due up
to a considerable period of time it is considered as
bad.

• Bad debt is treated as expenses.

• This would mean that the bad debts will be written

off in the Statement of Profit and Loss to show a
reduction in profit as a result of uncollectable
debts.

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 Example 1
Busat Enterprise sold goods on credit to Kecik on 1 January
2013 amounting to RM5,000. On 1 January 2014, due to a
financial set back Kecik was unable to pay his debt and therefore
Busat Enterprise declared the debt as bad.

Financial year of Busat Enterprise ends on every 31 December.

The entry made in Busat Enterprise ledger on 31.12.2014 would

be as follows:

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 Bad Debts Account

31.12.2014 Kecik acc. 5,000 31.12.2014 P/L 5,000

==== ====

Kecik account ( Debtor)

1 Jan. 2014 Bal. b/d 5,000 31.12.2014 Bad debts 5,000

==== ====

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• The previous example is one of the two
ways to account for uncollectible debts.

• It is known as the “Direct Write-Off”

method.

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• The “Direct Write-Off” Method is defective
for two reasons:
1. It does not set up an allowance for
uncollectable resulting in overstated amount
of debtors.
2. It violates the Matching concepts where
expense (Bad debts) were not properly
matched against revenue.

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 Matching
concept

• The Matching concept states that expenses incurred should be

matched against revenues earned in the same period to determine net
profit or loss.
Accrual
concept

• Thus, based on Matching concepts, determination of net profit or loss

would require revenues earned from sales to be matched against the
expenses incurred in relation to that particular revenue (1) and this
matching must be made in the same period (2).

• Referring back to Example 1, can you spot the error made in recording
bad debts?
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 Illustration 1
A business sales revenues for 2 consecutive years are as follows:
Year 1 Year 2
RM RM
Sales 20,000 20,000
Less: Expenditures
Other expenses 8,000 8,000
Bad debts 1,200
Net Profit 12,000 10,800

Bad debts written off in year 2 resulted from credit sales made in year 1.

* The preparation of financial statement violates the matching concept.

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 Allowance for Doubtful Debts
• Therefore, to be consistent with the Matching concepts, an adjustment needs to
be made so that the reported profit will not be over-estimated/under-estimated.

• The adjustment requires the creation of an account known as ‘Allowance for

doubtful debt’.

• The account is created to:

– determine and record the estimated value of bad debts to be written off to
the income statement for a particular period and to
– make provision of the uncollectable portion of debts or the debts which
are expected to be bad.

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Methods of estimating doubtful debt

a) Ageing of debtors accounts

Debtors accounts will be ranked according to the
age of their credit periods. Each age group will
be multiplied by a fixed percentage
predetermined by the business. The older the
debts, the greater the possibility that it will be
become bad and thus a higher percentage is
multiplied to determine the amount of doubtful
debt.
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 Illustration 2
Estimated bad
Age group Amount (RM) Amount (RM)
debts (%)
Not yet due 60,000 1 600
1 - 30 days Over 40,000 due 2 800
31 - 60 days Over 15,000 due 5 750
61 - 90 days Over 10,000 due 10 1,000
91 - 180 days Over 5,000 due 15 750
Over 180 days Oer 4,000 due 20 800
Total 134,000 4,700

* The amount RM4,700 is the balance needed in the allowance for

doubtful debts account.

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b) Specific identification

Observing which debtor account had lapse in

payment. This method use estimated figure of
the amount that is expected to be bad.

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c) Percentage of debtors account

Under this method, the business is unable to indicate

the precise debtors that will not pay. Therefore, an
estimate will be made using certain percentage to be
multiplied based on total debtors accounts.

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d) Percentage of net sales

This method uses net credit sales as a base in making the

estimates. For example, assuming that the net credits sales
for a particular year is RM900,000. Allowance for bad
debts will be calculated based on this figure. Say, 5% (or
any other percentage) of this amount – RM900,000 X
5%=4,500) will be recorded in the ‘Allowance for
doubtful debt account’.

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 Creation of the Allowance of
Doubtful Debts Account
• When an estimate for doubtful debts is made for the first
time, the ‘Allowance for doubtful debts account’ will be
created in the books.

DR Bad Debts
CR Allowance for Doubtful Debts
DR SOPL or P&L
CR Bad Debts

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 Extract of the Statement of Financial Position
showing the effect of ADD

Statement of Financial Position as at ….

Current Assets
Debtors/Account Receivables XXX
Less: Allowance for Doubtful Debt (xxx)
Net Debtors XXX

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 Example 2

The financial year of Bee Sing Enterprise ends on every

31 December. In 2013, Bee Sing Enterprise anticipated
that 5% of its total debtors, that is RM20,000, will go bad.

How will this transaction be recorded in the ledger of Bee

Sing Enterprise on 31.12.2013 ?

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 Answer
Step 1

Determine the estimated amount of bad debts to be

recorded in the ‘Allowance for doubtful account’.

PFDD = RM20,000 x 5%
= RM1,000

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Step 2
Record the amount using the following journal entries.

DR Bad debts expense

CR Allowance for doubtful debts
(Being allowance for doubtful debts at 5%)

DR SOPL
CR Bad debts Expense
(Being closing of bad debts expenses to income statement)

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 Allowance for doubtful debts

31.Dec.2013 Bal. c/d 1,000 31 Dec. 2013 Bad debts 1,000

===== =====
1.Jan.2014 Bal. b/d 1,000

Bad debts

31.Dec.2013 ADD 1,000 31.Dec.2013 SOPL 1,000

====== ======

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Step 3

Showing the effect in the Statement of financial position as

follows:

Statement of Financial Position as at …

*** Current Asset:

Trade Debtors/Account Receivable 20,000
Less: Allowance for doubtful debts (1,000)
Net Debtors 19,000

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 Writing-off bad debts After the creation of
Allowance for doubtful debts account

• In cases where bad debts is to be written-off after the ‘Allowance

for doubtful account’ has been created, the bad debt account will not
be debited.

• This is so because the bad debts expense has already been recognized
when allowance for doubtful debts was made in the same accounting
period in which the credit sales was made.

• Therefore, instead of the ‘Bad debts account’, the ‘Allowance of

doubtful debts account’ will be debited and a complementary credit
entry will be made in the ‘Debtors account’ / ‘Accounts receivable
account’.
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Journal entries:
DR Allowance for doubtful debts
CR Debtors Account
(Being bad debts written-off after Allowance
of Bad Debts account was created)

* Notice that bad debt account is not affected and thus, closing entry
to the income statement is not applicable.

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 Example 3
Financial year of Joyous Enterprise ends on every 31 December. In 2012,
total debtors account shows an amount of RM40,000. The beginning
balance in the ‘Allowance for Doubtful Debts account is RM1,500.
During the year, an amount of RM500 was proven uncollectable and the
business decided to write-of the debts.

It was the policy of Joyous Enterprise to estimate 5% of its total debtors

as doubtful debts.

1. How much is the new amount of Allowance for doubtful debts for 2012?
2. How does the change affect the accounts of Joyous Enterprise for the
year ended 31.12.2012?

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 Answer
• Do the same procedures:
1. Step 1 – determine the new amount of ADD
2. Step 2 – record bad debts
3. Step 3 – record the new balance in the ADD
a/c and balance off the a/c *****
4. Step 4 – show the effect of ADD in the
Statement of Financial Position

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Step 1

[RM40,000 – RM500] X 5% = 1,975

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Step 2

DR ADD 500
CR Debtors a/c or
Account Receivables 500

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Step 3

DR ADD
*** SOPL
CR SPOL
ADD ***
(there will be issues of over/under provision of ADD that
must be addressed here).
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 Allowance for Doubtful Debts
2
31. Dec.2012 Debtors 500 1 Jan.2012 Bal. b/d 1,500

Bal c/d 1,975 31.Dec.2012 SOPL 975

===== 3 =====
1 ( ***RM40,000 – RM500) X 5% = 1,975)

This amount will be shown in

SOPL as an Expense

Debtors/Account Receivables
2
1 Jan 2012 Bal b/d 40,000 31. Dec.2012 ADD 500
bal. c/d 39,500
===== =====
1 Jan 2013 Bal b/d 39,500
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 Extract of the Statement of Financial Position
showing the effect of ADD

Statement of Financial Position as at 31.12.2012

Current Assets
Debtors/Account Receivables 39,500
Less: Allowance for Doubtful Debt (1,975)
Net Debtors 37,525

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 Under Provision in Allowance for
Doubtful Debts

• The amount transferred to SOPL from ADD indicates that

there was an increase in the estimated ADD.

• Therefore, to accommodate such increase, the amount will

be taken from the P&L.

• This is known as under provision of ADD.

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 Over provision in Allowance for
Doubtful debts

• When the new estimates of ADD is lower than the

beginning balance, the amount transferred to SOPL from
ADD indicates the return of the over estimated ADD.

• This amount will be added back to the P&L.

• This is known as over provision of ADD.

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 Example 4

Joyous Enterprise total debtors in 2013 dropped

from RM40,000 to RM35,000. Apart from that,
there is an amount of RM50 uncollectable debts
that needs to be written of. Maintaining the same
policy where the business has to provide 5% of its
total debtors as doubtful debts:

1. Determine the new amount of ADD.

2. Show how the new ADD is recorded in the
ledger of Joyous Enterprise on 31.12.2013.
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 Answer

ADD = [RM35,000 – RM50] x 5%

= RM1,748

*** Take note that the new ADD decreased

from RM1,975 in year 2012 to RM1,748 in
2013.

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 Allowance for Doubtful Debts
31. Dec.2013 Debtors 50 1.Jan.2013 Bal. b/d 1,975
SOPL 177
Bal c/d 1,748
===== =====
Current year ADD = (RM35,000 – RM50) X 5% = 1,748
This amount
Will be shown in
SOPL as Revenue

Debtors/Account Receivables

1 Jan. 2013 bal. b/d 35,000 31. Dec.2013 ADD 50

31. Dec.2013 bal. c/d 34,950
===== =====
1 Jan 2014 bal. b/d 34,950
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Extract of Statement of Financial Position showing
the effect of ADD

Statement of Financial Position as at 31.12.2013

Current Assets
Debtors/Account Receivables 34,950
Less: Allowance for Doubtful Debt (1,748)
Net Debtors 33,202

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 Bad debts Recovered
• There are cases where a debts, which has been
written of as bad in the previous period, is then
unexpectedly received in the current accounting
period.

• Under such situation, account receivable/debtors

account needs to be re-instated.

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Journal entries:
1. DR Debtors
CR Bad debts Recovered
(Being debtors account reinstated)

2. DR Cash
CR Debtors
(Being cash received)

3. DR Bad debts Recovered

CR SOPL
(Being closing entry to Income Statement)

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