Accounting Fundamentals: Chapter 8 - Irrecoverable Debts and Allowance for Receivables

Irrecoverable debts

Receivables that are not expected to be paid.
They are “written off” and charged to the SoPL as an expense.

Key journal: Writing off irrecoverable debt

Event: Irrecoverable debt written off

Dr Irrecoverable debt expense (P/L)
Cr Trade receivables (asset)

Remove debt from personal/memorandum ledgers — business will not chase it.

Journal entry: Cash received from previously written-off debt

Event: Customer pays a debt previously written off

Dr Cash (asset)
Cr Irrecoverable debt expense (P/L)

This reverses part of the expense when cash is collected.

Allowance for receivables (doubtful debts)

An estimate of the amount of trade receivables a business does not expect to collect, recorded as a contra asset to reduce receivables to their realistic net value.

Increase in Allowance for Receivables

Scenario: The business estimates that more debts may not be collected (doubtful debts increase).

Journal Entry:

Dr Irrecoverable debt expense (Statement of Profit or Loss)
Cr Allowance for receivables (CA,contra asset)

Purpose:

• Reflects additional potential losses in the P/L.

• Increases the contra asset account to reduce net receivables in the SOFP.

Tip: Always record write-offs first, then adjust the allowance.

Decrease in Allowance for Receivables

Scenario: The business estimates that fewer debts will be uncollectable (doubtful debts decrease).

Journal Entry:

Dr Allowance for receivables (CA,contra asset)
Cr Irrecoverable debt expense (Statement of Profit or Loss)

Purpose:

• Reduces previously estimated losses in the P/L.

• Decreases the contra asset, increasing net receivables in the SOFP.

Tip: Use when customer payment risk is lower than originally estimated.

Formula for Net receivables in SoFP

Net receivables = Trade receivables (after write-offs) − Allowance for receivables.

Example:

• Receivables £50,000

• Allowance £5,000

• Net receivables = £45,000

4 step process for calculating Net Receivables (Golden Rule)

1. Calculate closing receivables before any adjustments

   • Opening receivables

   • Add credit sales

   • Subtract cash received

2. Write off guaranteed bad debts FIRST (golden rule)

   • Subtract the specific debt that will definitely not be paid
     → This gives the adjusted receivables balance

3. Calculate the allowance on what is left

   • Apply the allowance (policy) to the adjusted balance
     → This gives the allowance figure

4. Net off

   • Subtract the allowance from adjusted receivables
     → This gives net receivables

Golden rule:

Always remove certain bad debts before calculating the allowance.

Calculating irrecoverable debt expense (P/L)

Debts written off
+ Increase in allowance (Dr) OR − Decrease in allowance (Cr)
− Cash recovered from previously written-off debts

Result:

• Dr → Irrecoverable debt expense (P/L)

• Cr → Other income (if any cash recovered)

Irrecoverable debt written off (Journal Entry)

Dr Irrecoverable debt expense
Cr Trade receivables

Cash received from previously written-off debt (Journal Entry)

Dr Cash
Cr Irrecoverable debt expense

Increase in allowance for receivables (Journal Entry)

Dr Irrecoverable debt expense
Cr Allowance for receivables

Decrease in allowance for receivables (Journal Entry)

Dr Allowance for Receivables
Cr Irrecoverable Debt Expense

Exam tip

Always write off debts first, then calculate and adjust allowance, then net trade receivables for SOFP.

Helps avoid miscalculations in exam questions.

A business had opening trade receivables of £8,600. During the year it made credit sales of £44,000, received cash from customers of £49,000, and had irrecoverable debts of £600. At the year end, the company requires an allowance for receivables of 10%.

Required:

1. Calculate the closing trade receivables balance

2. Calculate the allowance for receivables

3. Calculate the total irrecoverable debt expense for the year

4. Calculate the net receivables figure for the statement of financial position

5. State the key journals required

Solution / Worked Example:

Trade receivables closing balance = £3,000
(Opening £8,600 + Credit sales £44,000 − Cash £49,000 − Write-offs £600)

Irrecoverable debts written off = £600 → expense in P/L

Allowance = 10% of receivables AFTER write-offs
10% × £3,000 = £300

Total irrecoverable debt expense (P/L):
£600 (write-offs) + £300 (allowance) = £900

Net receivables in SOFP:
£3,000 − £300 = £2,700

Key journals:

• Write-off → Dr Irrecoverable Debt Expense / Cr Trade Receivables

• Allowance → Dr Irrecoverable Debt Expense / Cr Allowance