Financial Accounting for Business Management 6 Bad Debts and Provision for Bad Debts Bad/Irrecoverable Debts · A debt that a business is certain (or almost certain) it will never be paid. · Also known as an irrecoverable debt. · Income Statement - Bad debts are written off as an expense. · Balance Sheet -debtors are reduced by a corresponding amount. · No longer considered an asset - no longer going to be a future economic benefit. · Therefore is shown as a liability on the balance sheet- you have not paid for it yet. Provision/Allowance for Doubtful Debts · Some doubt/uncertainty over whether some or all of the debt will be paid. · Provision for doubtful debts (Allowance for receivables) is the estimate by a business of the likely % of its debtors which may go bad during any one corresponding period. . You don't not record any of the debtors, but you need to be able provide for it, just in case · Balance Sheet - Set up a provisional account as well · E.g. "Last year we didn't get 5% of debts, therefore we will make a provision this year, of 5% of our debtors" · E.g. o A business has debtors of £10,000 in its books of accounts o One of the debtors has declared bankruptcy and the amount of £1,000 owed will not be repaid o Based on previous experience, the business also knows that approximately 5% of debtors tend to go bad, and hence, the business wishes to make a provision £ o Increase in provision: Gross Debtors 10,000 · Dr Doubtful D prov (Income st), · CR Doubtful debt prov (B/S) Less bad debts written off 1000 Provision for doubtful debts (5%) 450 Net Debtors in Balance Sheet 8,550 9,000 Summary Increase in provision Decrease in provision . Dr INCREASE in DD provision (income statement) · Cr doubtful debt provision (B/S) · Dr doubtful debt provision (B/S) . Cr DECREASE in DD provision (income statement)
Adjustments to Financial Statements 1 · Consider the following trial balance extract: · Bad debts of £1,000 is given in the trial balance · What this means is that the debtors figure of £10,000 has already been adjusted by the £1,000 of bad debts TRIAL BALANCE EXTRACT FOR YEAR END 31 MARCH 2013 DR(£) CR (£) Bad debts 1,000 Debtors 10,000 . Hence, the bad debts of £1,000 is written off as an expense in the income statement and debtors of £10,000 is shown in the balance sheet for the year ended 31 March 2013 . NO ADJUSTMENTS REQUIRED IN THIS EXAMPLE Adjustments to Financial Statements 2 TRIAL BALANCE EXTRACT FOR YEAR END 31 MARCH 2013 DR (£) CR (€) · Consider the following trial balance extract: Bad debts 1,000 . At 31st of March 2013, an additional debtor of the business went bankrupt. Debtors 10,000 · This debtor owed the business £500. · Income: Expenses - bad debts (1000+500) 1500 · B/s: Current Assets - Debtoors (10000-500) 9500