4.4 Irrecoverable debts and provision for doubtful debts (3)
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1.
ABC Company had previously written off a debt of £350 from Mr. Jones. The company subsequently receives £280 from Mr. Jones. Prepare a journal entry and the necessary ledger accounts to record this recovery.
Journal Entry:
| Date | Particulars | Debit (£) | Credit (£) |
| 15th May | Debtors (Mr. Jones) | 280 | |
Ledger Accounts:
Debtors Account (Mr. Jones)
| Date | Particulars | Debit (£) | Credit (£) |
| (Previous Balance) | Initial Balance | | |
| 15th May | Recovery from Mr. Jones | 280 | |
| (New Balance) | Final Balance | | |
Explanation: The journal entry debits the Debtors account (increasing the balance) and credits the account from which the debt was previously written off (reducing the balance). The ledger accounts show the impact of this transaction on the Debtors account.
2.
Explain why it is important for a business to regularly review and adjust its provision for doubtful debts. What factors might influence the need for an adjustment?
Regular review and adjustment of the provision for doubtful debts is crucial for maintaining the accuracy and relevance of the financial statements. The initial provision is based on historical data and assumptions, but these may change over time. Failure to review and adjust the provision can lead to financial statements that do not accurately reflect the business's financial position.
Several factors might influence the need for an adjustment:
- Changes in Economic Conditions: During economic downturns, businesses are more likely to experience difficulties with customers paying their debts. This may necessitate an increase in the provision.
- Changes in Credit Policies: If a business changes its credit policies (e.g., offering more lenient credit terms), it may need to increase the provision to reflect the higher risk of non-payment.
- Changes in Customer Creditworthiness: If the creditworthiness of the business's customers changes (e.g., due to financial difficulties), the provision may need to be adjusted.
- Recovery of Previously Written-Off Debts: If a business successfully recovers debts that were previously written off as bad debts, it may need to reduce the provision.
- Changes in Industry Practices: Changes in industry practices regarding credit and collections can also influence the need for an adjustment. For example, a shift to online sales might impact the risk of non-payment.
- Legal or Regulatory Changes: New laws or regulations related to debt collection can impact the likelihood of recovering debts and may require an adjustment to the provision.
By regularly reviewing and adjusting the provision, the business ensures that its financial statements provide a reliable and accurate picture of its financial health. This is essential for stakeholders such as investors, lenders, and regulators.
3.
Question 1
ABC Company uses the indirect method to deal with doubtful debts. During the year, a review of the accounts receivable revealed that £12,000 of debtors were deemed uncollectible. The existing provision for doubtful debts was £1,500. Prepare the following:
- A journal entry to record the adjustment to the provision for doubtful debts.
- A ledger account for the provision for doubtful debts.
Answer 1
Journal Entry:
| Date | Particulars | Debit (£) | Credit (£) |
| 31 December 2023 | Provision for Doubtful Debts | £10,500 | |
| Debtors (Control Account) | | £10,500 |
Ledger Account: Provision for Doubtful Debts
| Date | Particulars | Debit (£) | Credit (£) |
| 1 January 2023 | Opening Balance | £1,500 | |
| 31 December 2023 | Adjustment | £10,500 | |
| 31 December 2023 | Closing Balance | £12,000 | |