Question 4.9: Let us assume that a business has, at its year-end (31 Decem...
Let us assume that a business has, at its year-end (31 December), receivables totalling $1,028,000. After careful consideration, it comes to the conclusion that debts totalling $28,000 will not be recovered and need to be written off. The journal entry would be:
| Date | Account name and narrative reference | Folio | Debit side | Credit side |
| Dec 31 | Bad debts | 28,000 | ||
| Receivables | 28,000 | |||
| Writing off bad debts to a bad debts expense account | ||||
| Dec 31 | Profit and loss—bad debts | 28,000 | ||
| Bad debts | 28,000 | |||
| Writing of the bad debts expense for the year |
The relevant ledger accounts are as shown below:
| Receivables | |||||
| Dec 31 | Balance b/f | 1,028,000 | Dec 31 | Bad debts | 28,000 |
| Dec 31 | Balance b/f | 1,000,000 | |||
| 1,028,000 | 1,028,000 | ||||
| Dec31 | Balance b/f | 1,000,000 | |||
| Bad debts | |||||
| Dec 31 | Receivables | 28,000 | Dec 31 | Profit and loss | 28,000 |
The double entry to the bad debts account is to the profit and loss account:
| Profit and loss | |||||
| Dec 31 | Bad debts | 28,000 | |||
These entries mean that the balance on the receivables account is $1,000,000. Remember that this balance reflects the amount left after specific decisions (i.e. write-offs) have been made about specified debtors. But, as we saw in Chapter 3, it is probably unrealistic to expect all of the debtors included in this total to pay. We can be fairly certain that some won’t pay, but we don’t know which ones, so we cannot credit the debtors account (which will be the sum of a host of individual debtor accounts). Instead, we can set up another contra account, ‘provision for doubtful debts’.
Suppose that, on the basis of past experience, we decide that approximately 2.5% of the debtors will not pay. This gives us an estimate of $25,000, which is journalised as follows:
| Date | Account name and narrative reference | Folio | Debit side | Credit side |
| Dec 31 | Increase in doubtful debts provision | 25,000 | ||
| Doubtful debts provision | 25,000 | |||
| The increase in the size of the doubtful debt provision for the year | ||||
| December 31 | Profit and loss—increase in DDP | 25,000 | ||
| Increase in doubtful debts provision | 25,000 | |||
| Writing off to profit and loss the increase in doubtful debts provision that arose in the year |
After posting, the accounts would be:
| Doubtful debts provision | |||||
| Dec 31 | Increase in DDP | 25,000 | |||
| Increase in doubtful debts provision | |||||
| Dec 31 | Doubtful debts provision | 25,000 | Dec 31 | Profit and loss | 25,000 |
Note that this is an expense account, which will be charged to the profit and loss account. The profit and loss account will then reflect both expenses relating to bad and doubtful debts, as shown:
| Profit and loss account | |||||
| Dec 31 | Bad debts | 28,000 | |||
| Dec 31 | Increase in bad debts | 25,000 | |||
As we have seen in earlier chapters, these two amounts may appear in the income statement separately, or as a single figure for bad and doubtful debts, $53,000. The figures in the balance sheet will be:
| Receivables | 1,000,000 |
| Less Doubtful debts provision | 25,000 |
| 975,000 |
In future years it is only the actual bad debts plus the amount of change in the required doubtful debts provision that needs to be transferred to the profit and loss. For example, if receivables/ debtors at the end of the next financial year had reduced to $800,000, the doubtful debts provision needed would reduce to $20,000. So, for this second year there would be the actual bad debts and a revenue—’reduction in doubtful debts’—provision that would appear in the profit and loss account.