paul a. borg b.a. (hons) econ., dip. lab. stud. accounting

PAUL A. BORG B.A. (Hons) Econ., Dip. Lab. Stud. Accounting Course

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Unit 12: Bad Debts and Allowance for Doubtful Debts

Preliminary Questions & Coursework

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1. What is meant by a bad debt?

A bad debt occurs when it becomes certain that an account receivable (debtor) is not in

a position to pay his/her debts or part of them. Certainty is usually achieved when the

Court declares that person to be bankrupt.

2. What double entry is made when a debt is seen to be bad?

When a debt is seen to be bad the account of the debtor must be credited (as if he paid)

and the debit entry is made in a ‘Bad Debts’ A/c. This action is known in accounting as

writing off a bad debt. Thus, if J Smith owed us €500 and he is declared bankrupt by the

court on 1/11/2012 and will not be giving us any of the money, the accounts would

appear as follows when the entry for the bad debt is made:

________________________________J Smith A/c_____________________________

1 Jan 2012 Bal. b/d 500 1 Nov 2012 Bad debts 500

_______________________________Bad Debts A/c____________________________

1 Nov 2012 J Smith 500

3. What happens to the total of the bad debts account at the end of the financial year?

At the end of the financial year the total of the bad debts account is transferred to the

Income Statement. Thus, if there are no other bad debts during the year, the Bad Debts

A/c above would appear as follows at the end of the year:

_______________________________Bad Debts A/c____________________________

1 Nov 2012 J Smith 500 31 Dec 2012 Tr. To Inc. St. 500

4. With regard to bad debts and allowances for doubtful debts, which TWO objectives does

the accountant want to achieve when drawing up final accounts?

When drawing up final accounts, TWO objectives that accountants want to achieve are:

to charge as expenses in the Income Statement for that year, an amount

representing sales of that year for which the firm will not be paid;

to show in the Statement of Financial Position as correct a figure as possible of

the true value of accounts receivable at the date of the Statement of Financial

Position.

The first objective fulfils the Accruals concept while the second fulfils the Prudence

concept.

5. What is an Allowance for Doubtful Debts A/c used for?

An Allowance for Doubtful Debts A/c is used only for estimates of the amount of the

debtors at the year-end that are likely to finish up as bad debts.

6. Fill in the blanks in the following statements:

(a) A _____ _______ account is used only when the debt has been proved to be a bad

debt and is written off.

(b) An ______________ _______ _______________ _______ account is used only for

estimates of the amount of the accounts receivable at the year-end that are likely to

finish up as bad debts.

…/cont PAUL A. BORG - Accounting

Unit 12: Bad Debts and Allowance for Doubtful Debts – PQs & CW of 8

7. What accounting entries are needed to make an allowance for doubtful debts in the year

in which the allowance is first made?

When an allowance for doubtful debts is made for the first time, the accounting entry is

to credit the Allowance for Doubtful Debts A/c and debit the Income Statement. Assume

that the accounts receivable as at 31 December 2010 were €6,000 and that an allowance

of 5% of accounts receivable (5% of €6,000 = €300) was made on doubtful debts on 31

December 2010. The entry would appear as follows:

_______________________Allowance for Doubtful Debts A/c____________________

31 Dec 2010 Bal. c/d 300 31 Dec 2010 Tr. To Inc. St. 300

01 Jan 2011 Bal. b/d 300

8. Which double entry is now needed in the second year to INCREASE the allowance for

doubtful debts?

The double entry needed in the second year to INCREASE the allowance for doubtful

debts is to credit the Allowance for Doubtful Debts A/c and debit the Income Statement

with the increase. Thus if in the second year, accounts receivable increased to €8,000

and the percentage allowance was still the same, then the allowance is increased to €400

(5% of €8,000) or, alternatively, by 100 (€400-€300). The entry would appear as

follows:


31 Dec 2011 Bal. c/d 400 01 Jan 2011 Bal. b/d 300

___ 31 Dec 2011 Tr. To Inc. St. 100

400 400

01 Jan 2012 Bal. b/d 400

9. Which double entry is now needed in the third year to DECREASE the allowance for

doubtful debts?

The double entry needed in the third year to DECREASE the allowance for doubtful

debts is to credit the Income Statement and debit the Allowance for Doubtful debts A/c

with the decrease. Assume that in the third year, accounts receivable decreased to

€5,000 and the percentage allowance was still the same. Then the allowance is decreased

to €250 (5% of €5,000) or, alternatively, by 150 (€250-€400). The entry would appear as

follows:


31 Dec 2012 Tr. To Inc. St. 150 01 Jan 2012 Bal. b/d 400

31 Dec 2012 Bal. c/d 250 ___

400 400

01 Jan 2013 Bal. b/d 250

10. Which double entry is needed when a bad debt is recovered?

When a bad debt is recovered, it is necessary to debit the account receivable A/c and the

credit entry is made in a Bad Debts Recovered A/c. Alternatively the credit entry may be

made in the Bad Debts A/c if this is a small amount.

11. What does the term net accounts receivable mean?

Net accounts receivable means the actual value of the accounts receivable less the

balance on the Allowance for Doubtful debts A/c. It is the amount of Net accounts

receivable that is shown on the Statement of Financial Position.



12. What does the term allowance or provision mean in Accounting?

In Accounting the term allowance or provision is used to show that the entries in this

account are based on guesswork, intelligent guesswork but still guesswork! Thus if the

provision for depreciation A/c shows a balance of €14,000 on non-current assets that

cost €20,000, it does not necessarily mean that the firm can or must sell these fixed

assets for €6,000. The firm may sell them for more – thus making a gain – or for less –

thus making a loss on disposal. If the allowance for doubtful debts A/c shows a balance

of €400, this does not necessarily mean that €400 of the debtors may or will actually not

pay the firm. It is only an estimate made to achieve the objectives outlined in Q4, above.

13. With regard to final accounts, where and how are bad debts and allowance for doubtful

debts shown (refer to PQs of Unit 5, question #12)?

Bad debts are shown only in the Income Statement.

Any change in the balance of the allowance for doubtful debts is shown in the Income

Statement. Thus:

Extract from the Income Statement for the year ended …

€ €

GROSS PROFIT XXX add Revenues:

Decrease in Allowance for Doubtful Debts XXX

Bad debts recovered XXX

less Expenses:

Bad Debts XXX

OR

Extract from the Income Statement for the year ended …

€ €

GROSS PROFIT XXX add Revenues:

Bad debts recovered XXX

less Expenses:

Increase in Allowance for Doubtful Debts XXX

Bad Debts XXX

The balance of the Allowance for Doubtful Debts is shown in the Statement of Financial

Position under Current Assets as follows:

Extract from the Statement of Financial Position as at …

€ € €

CURRENT ASSETS

Inventory XXX

Accounts Receivable (Debtors) XXX

less Allowance for Doubtful Debts XXX

Net accounts receivable XXX

Bank XXX

Cash XXX

TOTAL CURRENT ASSETS XXX

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Coursework Classwork Homework

25.3 25.4A

25.5 25.6A

SEC 2001 P2A #5 SEC 2009 P2A #5

SEC 2004 P1 #4 (specific allow.) SEC 2003 P2B #4

SEC 2007 P1 #4

Answers in Excel file <PB_Acc_U12answers.xlsx>

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Paul A. Borġ B.A. (Hons) Econ. Dip. Lab. Stud., 2020

Class Demos (CD)

25.3 A business started trading on 1 January 2007. During the two years ended 31

December 2007 and 2008 the following debts were written off to the Bad Debts

Account on the dates stated:

31 May 2007 F Lamb £175

31 October 2007 A Clover £230

31 January 2008 D Ray £190

30 June 2008 P Clark £75

31 October 2008 J Will £339

On 31 December 2007 the total accounts receivable were £52,400. It was decided to

make an allowance for doubtful debts of £640.

On 31 December 2008 the total accounts receivable were £58,600. It was decided to

make an allowance for doubtful debts of £710.

You are required to show:

(a) The Bad Debts Account and the Allowance for Doubtful Debts Account for

each of the two years.

(b) The relevant extracts from the Statements of Financial Position as at 31

December 2007 and 2008.

Exercise from Frank Wood’s Business Accounting I, 11th edition __________________________________________________________________________



25.5 A business which prepares its financial statements annually to 31 December suffered

bad debts which were written off:

2007 £420

2008 £310

2009 £580

The business had a balance of £400 on the Allowance for Doubtful Debts Account

on 1 January 2007.

At the end of each year, the business considered which of its accounts receivable

appeared doubtful and carried forward an allowance of:

2007 £500

2008 £600

2009 £400

Show each of the entries in the Income Statements and prepare the Allowance for

Doubtful Debts Account for each of the three years.


SEC 2001 p2A #5

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SEC 2004 p1 #4

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Homework (HW)

25.4A A business which started trading on 1 January 2007, adjusted its allowance for

doubtful debts at the end of each year on a percentage basis, but each year the

percentage rate is adjusted in accordance with the current ‘economic climate’. The

following details are available for the three years ended 31 December 2007, 2008

and 2009.

Bad debts written off

year to 31 December

Accounts receivable at 31 December

after bad debts written off

Percentage allowance

for doubtful debts

£ £ %

2007 1,240 41,000 4

2008 2,608 76,000 6

2009 5,424 88,000 5

You are required to show:

(a) Bad Debts Account for each of the three years.

(b) Allowance for Doubtful Debts Account for each of the three years.

(c) Extracts from the Statements of Financial Position as at 31 December 2007,

2008 and 2009.




25.6A (a) Businesses often create an allowance for doubtful debts.

(i) Of which concept is this an example? Explain your answer.

(ii) What is the purpose of creating an allowance for doubtful debts?

(iii) How might the amount of an allowance for doubtful debts be calculated?

(b) On 1 January 2008 there was a balance of £500 in the Allowance for Doubtful

Debts Account, and it was decided to maintain the allowance at 5% of the

Accounts Receivable at each year end. The Accounts Receivable on 31

December each year were:

2008 £12,000

2009 £8,000

2010 £8,000

Show the necessary entries for the three years ended 31 December 2008 to 31

December 2010, inclusive, in the following:

(i) the Allowance for Doubtful Debts Account;

(ii) the Income Statements.

(c) What is the difference between bad debts and allowance for doubtful debts?

(d) On 1 January 2010 Warren Mair owed Jason Dalgleish £130. On 25 August

2010 Mair was declared bankrupt. A payment of 30p in the £ was received in

full settlement. The remaining balance was written off as a bad debt. Write up

the account of Warren Mair in the ledger of Jason Dalgleish.


SEC 2009 p2A #5

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SEC 2003 p2B #4

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SEC 2007 p1 #4

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paul a. borg b.a. (hons) econ., dip. lab. stud. accounting

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