IGCSE Accounting 0452 - 5.1 Sole Traders - Irrecoverable Debts and Provisions

Introduction

This section focuses on how sole traders account for irrecoverable debts and provide for doubtful debts. It's a crucial aspect of preparing accurate financial statements as it reflects the realistic value of assets.

Irrecoverable Debts

Irrecoverable debts are amounts owed to the business that are unlikely to be collected. A sole trader needs to recognise these as a loss in the profit and loss account.

The process involves identifying debts that are deemed irrecoverable and writing them off.

Provisions for Doubtful Debts

A provision for doubtful debts is an estimate of the amount of outstanding debts that the business does not expect to collect. This is also recognised as an expense in the profit and loss account.

The provision is calculated using a percentage of the total credit sales.

Calculating Provision for Doubtful Debts

The formula for calculating the provision for doubtful debts is:

Provision = (Credit Sales) x (Percentage Provision)

The percentage provision is determined by the sole trader based on their experience and the creditworthiness of their customers.

Example

A sole trader has credit sales of $20,000 and decides to provide for doubtful debts at 5%. The calculation is:

$$Provision = 20000 \times 0.05 = 1000$$

The sole trader would record an expense of $1,000 for doubtful debts.

Accounting Entries

Irrecoverable Debts

When a debt is deemed irrecoverable, the following journal entry is made:

Debit: Debtors (or Accounts Receivable) - $Amount of irrecoverable debt

Credit: Bad Debts Expense - $Amount of irrecoverable debt

Provision for Doubtful Debts

To create the provision, the following journal entry is made:

Debit: Bad Debts Expense - $Amount of provision

Credit: Provision for Doubtful Debts - $Amount of provision

Presentation in the Profit and Loss Account

The provision for doubtful debts is shown as an expense in the profit and loss account. The irrecoverable debts are removed from the debtors balance in the balance sheet.

Account Name	Debit	Credit
Bad Debts Expense	$1,000
Provision for Doubtful Debts		$1,000

Impact on Financial Statements

The provision for doubtful debts reduces the profit before tax. The debtors balance in the balance sheet is adjusted to reflect the irrecoverable debts.

Example Table

The following table shows how the provision for doubtful debts affects the balance sheet and profit and loss account.

Account	Amount
Profit and Loss Account	$1,000 (Bad Debts Expense)
Balance Sheet	$5,000 (Debtors - reduced by $1,000)

Important Considerations

The accuracy of the provision for doubtful debts depends on the sole trader's ability to assess the creditworthiness of their customers. Regular review of the debtors ledger is essential.