2.4.

3 Bad Debts and Allowance for Doubtful Debts

Most businesses sell their goods and services on credit. In most advanced nations,
credit is the engine of economic growth. However, with credit comes a risk of
failure to collect some of the debts, and in some instances all the debts owed.
Where a debt is irrecoverable, it is termed as a BAD DEBT. There are also
situations that arising from past business experience and/or expected economic
constraints, that what is owed to the business is not, in full and/or in part going to
be collected. It is therefore, prudent to make an ALLOWANCE FOR DOUBTFUL
DEBTS.

2.4.3.1 Bad Debts

These arise when it is certain that the debt will not be paid. A bad debt is an
EXPENSE. The double entry for a bad debt is:

Debit: Expense Account (Profit or Loss)

Credit: Receivable’s Account (Statement of Financial Position)
Example
The following were transactions recorded in the books of Temwani:
01.06.2018 Lwiindi bought goods on credit valued at K520.00
03.06.2018 Credit sales to S. Banda, K3,180
15.06.2018 Lwiindi was unable to pay K120 of the amounts owed
28.06.2018 K1,180 of S. Banda’s debt was treated as bad.
Required:
Post the entries into receihe vables and the bad debts accounts.
Solution:
Lwiindi Account S. Banda Account
Date Details Debit Credit Date Details Debit Credit
01.06.18 Sales 520.00 03.06.18 Sales 3,180.00
15.06.18 Bad debt 120.00 28.06.18 Bad debt 1,180.00
30.06.18 Bal. c/d 400.00 30.06.18 Bal. c/d 2,000.00
520.00 520.00 3,180.00 3,180.00

Bad Debts Account Profit or Loss Account (extract) for the year ended 31.12.18
Date Details Debit Credit K
15.06.18 Lwiindi 120.00 Gross Profit xxxx
28.06.18 S. Banda 1,180.00 Less: Expenses
30.06.18 P&L 1,300.00 Bad debts (1,300.00)
1,300.00 1,300.00
KINDLY NOTE that if a debt which was written off as bad, and is
recovered either in part or in full, the amount recovered is treated as
INCOME and will fall under OTHER INCOME in the Income Statement.
This is called Bad debts recovered.
2.4.3.2 Allowance for Doubtful Debts
Remember the Prudence Principle! This is also applied here to the
extent that it is rare that any business involved in credit sales can never
have possible debts that will be unpaid (irrecoverable debts).
Therefore, to ensure that the financial performance of a business is not
over and/or understated, a provision for doubtful debts is made in
relation to outstanding debts.
The amounts to be provided for Doubtful Debts is determined either as
PERCENTAGE or an AMOUNT of the total outstanding Debts
(Receivables).
The double entry where a provision for doubtful debts is made will be:
Debit: Allowance for Doubtful Debts Expense Account – Profit or Loss
Credit: Allowance for Doubtful Debts Account - Statement of Financial
Position
Illustration:
At 31 December 2016, the receivables amount after deducting bad
debts was K 100,000. It is estimated that 2 per cent of debts (K 2,000)
will eventually prove to be bad debts, and it is decided to make a
provision for the same. The calculation is as follows:

K100,000 x (2%) or K100,000 x 2/100

= K2,000
Solution:
Receivables Account Allowance for Doubtful Debts (Expense) Account
Date Details Debit Credit Date Details Debit Credit
01.12.16 Bal. b/d 100,000 31.12.16 Provision 2,000
31.12.16 Bal. c/d 100,000 31.12.16 P&L 2,000
100,000 100,000 2,000 2,000

Allowance for Doubtful Debts Account

Date Details Debit Credit
31.12.16 Provision 2,000
31.12.16 Bal. c/d 2,000
2,000 2,000
01.01.17 Bal. b/d 2,000
In the trial balance, the adjustment will be effected as below.
1. Before the adjustment
K K
Receivables (Debtors) 100,000

2. After the adjustment

K K

Receivables (Debtors) 100,000

Allowance for doubtful debts – expense 2,000
Allowance for doubtful debts 2,000

To Income Statement To Statement of Financial Position

 Profit or Loss Account (extract) for the year ended 31.12.16

K K

Gross Profit xxxx

Less: Expenses

Allowance for Doubtful (Expense) (2,0000)

debts

Rent (24,000 – 6,000) 18,000

 Statement of Financial Position (extract) as at 31.12.16
Cost Provision for Net Book
Depreciation Value
K K K
Non Current Assets XXXX XXXX XXXX

Current Assets
Inventory XXXX
Receivables 100,000
Add: Prepayment – Rent 6,000
Less: Allowance for Doubtful Debts (2,000)
104,000
Cash and Bank XXXX
There are possibilities that the provided allowance for doubtful debts
may be increased and/or reduced.
a) Increase in the Allowance for Doubtful Debts
An increase in the allowance for doubtful debts will give rise to an
expense – Allowance for Doubtful Debts (Expense). This also increases
the Allowance for Doubtful Debts amount in the Statement of Financial
Position.
The illustrated ledger accounts are shown below.
Using the same information as above, the Allowance for Doubtful
Debts is increased to 3% (K3,000) in 2017 from 2% (K2,000) for 2016.
The adjustment to be made is only 1% (K100,000 x 1%) which K 1,000
(Income Statement)
Statement of Financial Position: (K2,000+K1,000) to bring to K3,000
If:
Increased by 3% (K3,000) from 2% (K2,000) = Allowance for doubtful
debt (expense) will increase by K3,000 (Income Statement).
Statement of Financial Position: (K2,000+K3,000) to bring to K5,000

The ledger accounts will be:

 Solution:
Receivables Account Allowance for Doubtful Debts (Expense) Account

Date Details Debit Credit Date Details Debit Credit

01.01.17 Bal. b/d 100,000 31.12.17 Provision 1,000
31.12.17 Bal. c/d 100,000 31.12.17 P&L 1,000
100,000 100,000 1,000 1,000

Allowance for Doubtful Account

Date Details Debit Credit
1.01.17 Bal. b/d 2,000
31.12.17 Provision 1,000
31.12.17 Bal. c/d 3,000
3,000 3,000
01.01.18 Bal. b/d 3,000
In the trial balance, the adjustment will be effected as below.
1. Before the adjustment
K K
Receivables (Debtors) 100,000
Allowance for doubtful debt 2,000

2. After the adjustment

K K

Receivables (Debtors) 100,000

Allowance for doubtful debts - expense 1,000
Allowance for doubtful debts 3,000
2,000

To Income Statement To Statement of Financial Position

Profit or Loss Account (extract) for the year ended 31.12.17
K K

Gross Profit xxxx

Less: Expenses

Allowance for Doubtful debts - Expense (1,0000)

 Statement of Financial Position (extract) as at 31.12.17
Cost Provision for Net Book
Depreciation Value
K K K
Non Current Assets XXXX XXXX XXXX

Current Assets
Inventory XXXX
Receivables 100,000
Less: Allowance for Doubtful Debts (3,000)
97,000
Cash and Bank XXXX
b) Reduction in the Allowance for Doubtful Debts
A reduction in the allowance for doubtful debts will give rise to an
Income – Allowance for Doubtful Debts (Income) in the Income
Statement on one hand and reduce the Allowance for Doubtful Debts
amount in the Statement of Financial Position on the other hand. The
illustrated ledger accounts are shown below.
Using the same information as above, the Allowance for Doubtful
Debts is reduced to 1% in 2017 from 2% of 2016. The adjustment to be
made is only 1% (K100,000 x 1%) which K 1,000. The ledger accounts
will be:
Solution:
Receivables Account Allowance for Doubtful Debts Account –(Recovered)
Date Details Debit Credit Date Details Debit Credit
01.01.17 Bal. b/d 100,000 31.12.17 Provision 1,000
31.12.17 Bal. c/d 100,000 31.12.17 P&L 1,000
100,000 100,000 1,000 1,000

Allowance for Doubtful Account

Date Details Debit Credit
1.01.17 Bal. b/d 2,000
31.12.17 Provision 1,000
31.12.17 Bal. c/d 1,000
2,000 2,000
01.01.18 Bal. b/d 1,000
In the trial balance, the adjustment will be effected as below.

1. Before the adjustment

K K
Receivables (Debtors) 100,000
Allowance for doubtful debt 2,000

2. After the adjustment

K K

Receivables (Debtors) 100,000

Allowance for doubtful debts – (recovered) 1,000
Allowance for doubtful debts 1,000
2,000

To Income Statement To Statement of Financial Position

 Profit or Loss Account (extract) for the year ended 31.12.17

K K

Gross Profit xxxx

Other Income

Allowance for Doubtful Debts – (recovered) 1,000

TOTAL INCOME XXXX

Less: Expenses (XXXX)

 Statement of Financial Position (extract) as at 31.12.17
Cost Provision for Net Book
Accum. Value
Depreciation
K K K
Non Current Assets XXXX XXXX XXXX

Current Assets
Inventory XXXX
Receivables 100,000
Less: Provision for Doubtful Debts (1,000)
99,000
Cash and Bank XXXX
Exercise 15
Juba starts a business on 1 January 2015 and his financial year end is 31
December. A table of the receivables, bad debts written off and the
allowable doubtful debts at variant rates of receivables at the end of
each year is now given.
Show the entries in the bad debts and the allowance for doubtful debts
accounts, and the extracts in the final accounts.
Financial Year Receivables at the Bad debts written off Allowance for doubtful
beginning of the year during the year debts at the end of the
year
K K %
2015 25,000 2,650 2
2016 30,500 1,050 2
2017 27,500 750 3
2018 38,100 1,805 2