Bad debts and Provision for Doubtful Debts

1. Bad debts and Provision for Doubtful Debts Chapter 13

2. BAD DEBTS AND BAD DEBTS RECOVERED

3. Bad Debts • A bad debt is an amount owing to a business which will not be paid by the debtor. • Reason: • Debtor has disapearred • Debtor gone out-of-business • Debtor unable to pay • If all reasonable steps to obtain payment have failed, the debt is written offas a bad debt.

4. Accounting Entries: Dr Bad Debts Cr Debtor With the irrecoverable (unable to be paid) amount of a debt

5. Example 1 • On 1 April 2011, ABCcompany sold goods for $2,000 to Mr. Lee, $1,500 to Mr. Wong and $3,000 to Mr. Wu. • On 1 June 2011, Mr. Lee and Mr. Wong paid the company $800 and $1,000 respectively with cheque. • Later, on 31Dec 2011 Mr. Wong and Mr. Wu became bankrupt, and it is impossible for the company to collect these debts. The company decided to write these off as bad debts.

6. On 1 April 2011, aBC. company sold goods for $2,000 to Mr. Lee, $1,500 to Mr. Wong and $3,000 to Mr. Wu. Journal entries

7. Ledger ABC Co. Sales Acc. Mr. Lee Mr. Wong Mr. Wu

8. On 1 June 2011, Mr. Lee and Mr. Wong paid the company $800 and $1,000 respectively with cheque. Journal entries

9. ledger ABC Co. Cash Book (Bank column only) Sales Ledger Mr. Lee Mr. Wong Mr. Wu

10. Later, on 31 Dec 2011 Mr. Wong and Mr. Wu became bankrupt, and it is impossible for the company to collect these debts. The company decided to write these off as bad debts. Journal entries

11. LEDGER ABC Co. Nominal Ledger Bad Debts Account Sales Ledger Mr. Wong Mr. Wu

12. B. Bad Debts Recovered • A bad debt recovered arises when a debtor pays some, or all, of the amount owed, after the amount was written off as a bad debt.

13. Accounting entries

14. Example 2 • The following balances were part of the trial balance of Mr. Chan on 31 December 2012: $ Debtors 10,000 Bad Debts 1,000 • On 31 December 2012, Mr. Chan received cheques of $ 1,000 from debtors, whose debts had been previously written off as bad debts in the current year respectively. No entry has been made for these transactions

15. On 31 December 2012, Mr. Chan received cheques of $ 1,000 from debtors, whose debts had been previously written off as bad debts in the current year respectively. No entry has been made for these transactions Journal entries

16. LEDGER ABC Co. Cash Book (Bank column only) Nominal Ledger Debtors Account

17. Ledger Bad Debts Bad Debt Recovered

18. Bad Debts & Bad debts Recoveredin profit & loss account • Continued from Example 2 Mr. Chan Profit & Loss for the year ended 31 Dec 2012 $ $ Gross Profit xx Add: Revenues: Bad Debts Recovered1000 1000 xx Less: Expenses: Bad Debts1000 (1000) Net Profit xx

19. Reducing the possibility of bad debts • Not to sell goods on credit • Applying credit control • Taking legal action against the debtor

20. PROVISION FOR DOUBTFUL DEBTS

21. Provision for Doubtful Debts • A provision for doubtful debts is an estimate of the amount which a business will lose in a financial year because of bad debts. • Considerations in deciding the amount of provision: • Looking at each individual debtor’s account • Estimating on the basis of past experience • Considering the length of time debts have been outstanding

22. Accounting entries

23. A. Creating Provision • Example 3: • Sachin’s financial year ends on 31 December. • During the year ended 31 December 2004 he wrote off bad debts totalling $ 950. • On 31 December his debtors owed $ 25,000. He decided to create a provision for doubtful debts of 4 % of the debtors.

24. On 31 December 2004, his debtors owed $ 25,000. He decided to create a provision for doubtful debts of 4 % of the debtors. Journal entries *) 1,000 = 4% x $ 25,000

25. LEDGER Sachin Nominal Ledger Bad Debts Account Doubtful Debts Account

26. LEDGER Provision for Doubtful Debts Account

27. Final Accounts Sachin Profit & Loss Account for the year ended 31 Dec 2004 Gross Profit xx Add: Revenues xx xx Less: Expenses: Bad Debts 950 Doubtful Debts1,000 (1,950) Net Profit xx

28. Final Accounts Sachin Balance Sheet at 31 December 2004

29. B. Increasing a Provision • Continued from example 3: • On 31December 2004, Sachin created a provision for doubtful debts of $ 1,000. • During the year ended 31 December 2005, Sachin wrote off bad debts totalling $ 990. • On 31 December 2005, his debtors owed $ 28,000. He decided to maintain the provision for doubtful debts at the rate of 4 % of the debtors.

30. On 31 December 2005, his debtors owed $ 28,000. He decided to maintain the provision for doubtful debts at the rate of 4 % of the debtors. Journal entries *) (4 % x $ 28,000) - $ 1,000

31. LEDGER Sachin Nominal Ledger Bad Debts Account Doubtful Debts Account

32. LEDGER Provision for Doubtful Debts Account

33. Final Accounts Sachin Profit & Loss Account for the year ended 31 Dec 2005 Gross Profit xx Add: Revenues xx xx Less: Expenses: Bad Debts 990 Doubtful Debts120 (1,110) Net Profit xx

34. Final Accounts Sachin Balance Sheet at 31 December 2005

35. C. Reducing a Provision • Continued from example 3: • On 31 December 2005, Sachin’s provision for doubtful debts amounted to $ 1,120. • On 31 December 2006, his debtors owed $ 24,000. He decided to maintain the provision for doubtful debts at the rate of 4% of the debtors.

36. On 31 December 2006, his debtors owed $ 24,000. He decided to maintain the provision for doubtful debts at the rate of 4% of the debtors. Journal entries *) 1,120 – (4 % x $ 24,000)

37. LEDGER Sachin Nominal Ledger Doubtful Debts Account

38. LEDGER Provision for Doubtful Debts Account

39. Final Accounts Sachin Profit & Loss Account for the year ended 31 Dec 2006 Gross Profit xx Add: Revenues: Reduction in Provision for Doubtful Debts160 160 xx Less: Expenses: (xx) Net Profit xx

40. Final Accounts Sachin Balance Sheet at 31 December 2006