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

Objective

This section focuses on how sole traders make adjustments for irrecoverable debts and provisions for doubtful debts. Understanding these adjustments is crucial for presenting a true and fair view of a sole trader's financial position.

Irrecoverable Debts

Irrecoverable debts are amounts owed by customers that are unlikely to be collected. A sole trader needs to recognise these debts as irrecoverable to accurately reflect their assets and profit.

The process involves:

1. Identifying debts that are unlikely to be collected.
2. Writing off these debts from the accounts.

Provisions for Doubtful Debts

A provision for doubtful debts is an estimate of the amount of money that a sole trader does not expect to collect from their customers. This is based on an assessment of the creditworthiness of the customers and the historical experience of the business.

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

The formula is:

$$\text{Provision for Doubtful Debts} = \frac{\text{Credit Sales} \times \text{Percentage}}{\text{Credit Sales}}$$

For example, if credit sales are £20,000 and the provision rate is 2%, the provision is:

$$\text{Provision} = \frac{20,000 \times 0.02}{20,000} = £400$$

Journal Entries

The following journal entries are made to record irrecoverable debts and the provision for doubtful debts:

Irrecoverable Debts Journal Entry

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

Date	Account	Debit (£)	Credit (£)
Date of write-off	Debtors (or specific customer account)	Amount of irrecoverable debt
Date of write-off	Bad Debts (Income Statement)		Amount of irrecoverable debt

Example: A debt of £500 from Customer A is deemed irrecoverable. The journal entry would be:

Date	Account	Debit (£)	Credit (£)
2024-07-26	Debtors - Customer A	500
2024-07-26	Bad Debts		500

Provision for Doubtful Debts Journal Entry

To create a provision for doubtful debts, the following journal entry is made:

Date	Account	Debit (£)	Credit (£)
End of accounting period	Bad Debts (Income Statement)	Amount of provision
End of accounting period	Provision for Doubtful Debts (Balance Sheet)		Amount of provision

Example: A provision of £400 is calculated. The journal entry would be:

Date	Account	Debit (£)	Credit (£)
2024-07-26	Bad Debts	400
2024-07-26	Provision for Doubtful Debts		400

Adjusting Entries

At the end of the accounting period, adjusting entries are made to reflect the irrecoverable debts and the provision for doubtful debts.

The adjusting entries are:

• To record irrecoverable debts: A debit to the Bad Debts account and a credit to the Debtors account.
• To create a provision for doubtful debts: A debit to the Bad Debts account and a credit to the Provision for Doubtful Debts account.

Impact on Financial Statements

The adjustments for irrecoverable debts and the provision for doubtful debts have the following impact on the financial statements:

• Statement of Financial Position (Balance Sheet): The provision for doubtful debts is shown as a deduction from the total amount of debtors.
• Profit and Loss Account (Income Statement): The Bad Debts account is shown as an expense, reducing profit.