IGCSE Provision for Doubtful Debts
In this lesson, you will learn how to account for irrecoverable debts and debts that are written off but later recovered. You will also learn how to calculate, adjust, and record the provision for doubtful debts, as well as how to enter these transactions in the journal.
Related Lessons:
Irrecoverable Debts
Irrecoverable debts are debts that have been confirmed as not recoverable or collectible from trade receivables.
A business may choose to write off the debt and expense it off to the Income Statement.
To write off the debt of a trade receivable:
Dr Irrecoverable debts
Cr Trade receivables
At the end of the accounting year, irrecoverable debts are transferred to the income statement:
Dr Income Statement
Cr Irrecoverable debts
Recovery of Irrecoverable Debts
Irrecoverable debt that was previously written off may be recovered subsequently. These are regarded as an income to the business.
On recovery of debt previously written off:
Dr Cash or Bank
Cr Irrecoverable debt recovered
At the end of the accounting year, this is transferred to the income statement:
Dr Irrecoverable debt recovered
Cr Income Statement
Calculating Provision for Doubtful Debts
The provision for doubtful debt is an estimate of the amount of debts that may not be collected from credit customers. This possible loss is recorded as an expense to the business.
To calculate the amount of provision for doubtful debt, we multiply the ending balance of trade receivables with an estimated percentage expected to default.
Example:
Ending trade receivables is $40,000
Provision for doubtful debt is estimated at 5%
Provision for doubtful debt is 40,000 x 5% = $2,000
Recording in Journals & Accounts
The provision for doubtful debt is a contra asset to the trade receivables. This makes it a Credit account.
On creating a provision for doubtful debts, the business is estimating the possible losses from defaulted debts. Therefore, expense increases.
Dr Income Statement
Cr Provision for doubtful debts
In the Statement of Financial Position, provision for doubtful debt is deducted from trade receivables to show their expected collectible value.
Example:
Trade receivables $40,000
Less provision for doubtful debt $2,000
Net trade receivables $38,000
Increase & Decrease in Provision for Doubtful Debts
Increase in provision for doubtful debts:
When the current year provision for doubtful debts is more than the amount of balance brought down, the business estimated loss increases.
Example:
Provision for doubtful debt on 1 January 20X1: $1,500
Provision for doubtful debt on 31 December 20X1: $2,000
Increase in provision for doubtful debt = 2,000 – 1,500 = $500
Journal
Dr Income statement
Cr Provision for doubtful debt
Income statement:
Expense:
Increase in provision for doubtful debts
Decrease in provision for doubtful debts:
When the current year provision for doubtful debts is less than the amount of balance brought down, the business estimated loss decreases.
Example:
Provision for doubtful debt on 1 January 20X1: $2,000
Provision for doubtful debt on 31 December 20X1: $1,200
Decrease in provision for doubtful debt = 1,200 – 2,000 = $800
Journal
Dr Provision for doubtful debt
Cr Income statement
Income statement:
Income:
Decrease in provision for doubtful debts