Question 3.15: Boston Enterprises has accounts receivable of $350,000 at th...
Boston Enterprises has accounts receivable of $350,000 at the end of the accounting year to 30 June 2017. Investigation of these accounts receivable reveals that $10,000 is likely to prove irrecoverable, and that recovery of a further $30,000 is doubtful.
Extracts from the financial statements would be as shown below.
| Income statement (extracts) for the year ended 30 June 2017 | |
| $ | |
| Bad debts written off | 10,000 |
| Doubtful debts expense | 30,000 |
| Statement of financial position (extracts) as at 30 June 2017 | |
| $ | |
| Accounts receivable | 340,000* |
| Less allowance for doubtful debts | 30,000 |
| 310,000 | |
*(i.e. $350,000 – $10,000)
The allowance for doubtful debts is, of course, an estimate and it is quite likely that the actual amount of debts that ultimately prove to be bad will be different from the estimate.
Let us say that during the next accounting period it was discovered that $26,000 of the debts considered doubtful proved to be irrecoverable. These debts must now be written off as follows:
- reduce accounts receivable by $26,000
- reduce allowance for doubtful debts by $26,000.
However, an allowance for doubtful debts of $4,000 will still remain. This amount represents an overestimate made when creating the allowance for the year to 30 June 2017. As the allowance is no longer needed, it should be eliminated. Remember that the allowance was created by raising an expense in the income statement for the year to 30 June 2017. As the expense was too high, the amount of the overestimate should be ‘written back’ in the next accounting period. In other words, it will be treated as income for the year to 30 June 2018. This will mean:
- reducing the allowance for doubtful debts by $4,000
- increasing income by $4,000.
Ideally, of course, the amount should be written back to the 2017 income statement; however, it is too late to do this. At the end of the year to 30 June 2018, not only will 2017’s overestimate be written back, but a new allowance should be created to take account of the trade receivables arising from 2018’s credit sales that are considered doubtful.