The legal fees currently incurred of $5,000 are current liabilities and should already be included
$5,000. Therefore, we are decreasing expenses.
False. A contingent liability is disclosed by way of notes to the financial statements.
209
C H A P T E R
TOPIC LIST
SYLLABUS
REFERENCE
1 Irrecoverable
debts
D8(b)–(g)
2 Allowances
for
receivables
D8(h)–(i)
Irrecoverable debts
and allowances
In this chapter we look at two types of adjustment which need to
be made in respect of credit sales.
Irrecoverable
debts
Allowance for
receivables
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PART D: RECORDING TRANSACTIONS AND EVENTS
210
Study Guide
Intellectual level
D Recording transactions and events
8 Receivables and payables
(b) Identify the benefits and costs of offering credit facilities to
customers.
K
(c) Understand
the
purpose of an aged receivables analysis.
K
(d) Understand the purpose of credit limits.
K
(e) Prepare the bookkeeping entries to write off an irrecoverable
debt.
S
(f) Record an irrecoverable debt recovered.
S
(g) Identify the impact of irrecoverable debts on the statement
of profit or loss and statement of financial position.
S
(h) Prepare the bookkeeping entries to create and adjust an
allowance for receivables.
S
(i) Illustrate how to include movements in the allowance for
receivables in the statement of profit or loss and how the
closing balance of the allowance should appear in the
statement of financial position.
S
1
Irrecoverable debts
Irrecoverable debts are specific debts owed to a business which it decides are never going to be paid.
They are written off as an expense in the statement of profit or loss.
1.1 Introduction
Very few businesses expect to be paid immediately in cash, unless they are retail businesses on the high
street. Most businesses buy and sell to one another on credit terms. This has the benefit of allowing
businesses to keep trading without having to provide cash 'up front'. So a business will allow credit
terms to customers and receive credit terms from its suppliers. Ideally a business wants to receive
money from its customers as quickly as possible, but delay paying its suppliers for as long as possible.
This can lead to problems.
Most businesses aim to control such problems by means of credit control. A customer will be given a
credit limit, which cannot be exceeded (compare an overdraft limit or a credit card limit). If an order
would take the customer's account over its credit limit, it will not be actioned until a payment is received
to reduce the customer's outstanding balance.
Another tool in credit control is the aged receivables analysis. An aged receivables analysis is a report of
all receivables analysed by customer and by age of the receivable, eg balances outstanding for 30 days,
60 days and 90+ days. If a balance has been outstanding for a long period of time, it may indicate that
a customer is unable to pay. Most credit controllers will have a system of chasing up payment for long
outstanding invoices.
Customers might fail to pay, perhaps out of dishonesty or because they have gone bankrupt and cannot
pay. Customers in another country might be prevented from paying by the unexpected introduction of
foreign exchange control restrictions by their country's government during the credit period. Therefore,
the costs of offering credit facilities to customers can include:
Interest costs of an overdraft, if customers do not pay promptly
Costs of trying to obtain payment
Court
costs
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CHAPTER 12
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IRRECOVERABLE DEBTS AND ALLOWANCES
211
For one reason or another, a business might decide to give up expecting payment and to write the debt
off.
An
irrecoverable (or 'bad') debt
is a debt which is definitely not expected to be paid. An irrecoverable
debt could occur when, for example, a customer has gone bankrupt.
1.2 Writing off irrecoverable debts
To begin with, let's recap the ledger entries when a sale on credit is made to a customer.
DEBIT
Trade receivables
CREDIT Sales
All being well, a few weeks later the customer will pay the debt and cash will be received, at which
point the double entry is:
DEBIT
Cash account
CREDIT Trade
receivables
But what happens if, instead, the customer goes bankrupt and then can't pay? Remember that
according to the Conceptual Framework an asset is a resource controlled by an entity from which future
economic benefits are expected to flow. If the customer can't pay, then
no economic benefits are
expected to flow from the trade receivable. So the trade receivable no longer meets the definition of an
asset and it must be removed from the statement of financial position and is charged as an expense in
the statement of profit or loss. The ledger entries to write off an irrecoverable debt are:
DEBIT
Irrecoverable debts expense (statement of profit or loss)
CREDIT
Trade receivables (statement of financial position)
QUESTION
Irrecoverable debts I
Design Co has a total balance for trade receivables of $25,000 at the year end. A review of the
receivables balances highlights that one of its customers, Mann Co, has gone bankrupt. Design Co is
owed $4,000 by Mann Co for design work done during the year. This debt is now considered
irrecoverable.
Required
(a)
What is the balance for trade receivables to be shown in the statement of financial position at the
year end?
(b) What is the irrecoverable debts expense to be shown in the statement of profit or loss at the year
end?
ANSWER
TRADE RECEIVABLES (SOFP)
$
$
Balance b/d
25,000
Irrecoverable
debts expense
4,000
– Balance c/d
21,000
25,000
25,000
Balance b/d
21,000
Trade receivables will be shown at $21,000 in the statement of financial position.
IRRECOVERABLE DEBTS EXPENSE (SPL)
$
$
Trade receivables
4,000
P/L account
4,000
The irrecoverable debt expense in the statement of profit or loss is $4,000.
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