IGCSE Accounting 0452 - 4.4 Irrecoverable Debts and Provision for Doubtful Debts

This section explains how to account for irrecoverable debts and the provision for doubtful debts. It covers the concept of doubtful debts, methods for estimating irrecoverable amounts, and the journal entries and ledger accounts required to record these transactions.

Understanding Doubtful Debts

Doubtful debts are amounts owed to a business by its customers that are unlikely to be collected. It's important for businesses to recognise these potential losses to present a realistic view of their financial position.

Methods for Estimating Irrecoverable Amounts

There are several methods used to estimate the amount of doubtful debts:

• Percentage of Credit Sales: A fixed percentage of credit sales is estimated as irrecoverable.
• Aging of Accounts Receivable: Accounts receivable are grouped by the length of time they have been outstanding (e.g., 0-30 days, 31-60 days, 61-90 days, over 90 days). Higher percentages of older debts are deemed irrecoverable.

Provision for Doubtful Debts

A provision for doubtful debts is an estimate of the amount of irrecoverable debts. This is an income statement expense that reduces the profit figure.

The provision is calculated using one of the methods described above. The journal entry to create the provision is:

Debit: Provision for Doubtful Debts

Credit: (Name of Account Receivable - e.g., Accounts Receivable)

Journal Entries and Ledger Accounts

Journal Entry to Create Provision

The following journal entry is made to create the provision for doubtful debts:

Date	Account	Debit (£)	Credit (£)
(Date of Entry)	Provision for Doubtful Debts	$$ \text{Amount} $$
(Date of Entry)	Accounts Receivable		$$ \text{Amount} $$

Example: Assume the provision for doubtful debts is estimated at £2,000.

Journal Entry:

Date	Account	Debit (£)	Credit (£)
(Date)	Provision for Doubtful Debts	2,000
(Date)	Accounts Receivable		2,000

Ledger Account - Provision for Doubtful Debts

The provision for doubtful debts is a credit balance account on the statement of financial position (Balance Sheet). It is shown as a deduction from accounts receivable.

Date	Description	Debit (£)	Credit (£)	Balance (£)
(Date of Creation)	Opening Balance			$$ \text{Amount} $$
(Date of Adjustment)	Adjustment for Doubtful Debts		$$ \text{Amount} $$	$$ \text{Amount} $$
(Closing Balance)	Closing Balance			$$ \text{Amount} $$

Ledger Account - Accounts Receivable

The accounts receivable account is adjusted to reflect the provision for doubtful debts.

Date	Description	Debit (£)	Credit (£)	Balance (£)
(Date of Adjustment)	Provision for Doubtful Debts	$$ \text{Amount} $$		$$ \text{Amount} $$
(Closing Balance)	Closing Balance			$$ \text{Amount} $$

Example Calculation (Aging of Accounts Receivable Method)

Assume the following aging of accounts receivable:

• 0-30 days: £10,000
• 31-60 days: £5,000
• 61-90 days: £2,000
• Over 90 days: £1,000

Assume the business applies a 20% provision to the over 90 days category, 50% to the 61-90 days category, and 10% to the 31-60 days category.

Calculation:

• Over 90 days: £1,000 x 20% = £200
• 61-90 days: £2,000 x 50% = £1,000
• 31-60 days: £5,000 x 10% = £500

Total Provision for Doubtful Debts: £200 + £1,000 + £500 = £1,700

Journal Entry:

Date	Account	Debit (£)	Credit (£)
(Date)	Provision for Doubtful Debts	1,700
(Date)	Accounts Receivable		1,700

Important Considerations

• The provision for doubtful debts is an estimate and may not be entirely accurate.
• The method used to calculate the provision should be applied consistently from period to period.
• The provision for doubtful debts is a contra-asset account and reduces the carrying value of accounts receivable.