Chapter 5: Bad and Doubtful Debts.

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Chapter 5: Bad and Doubtful Debts.

Introduction to Bad and Doubtful Debts

In any business that extends credit to customers, there is a risk that some debts may not be collected. This chapter focuses on understanding bad debts—amounts that are confirmed as irrecoverable—and doubtful debts—amounts that may become uncollectible in the future. Accounting for bad and doubtful debts is essential for accurate financial reporting and aligns with the prudence concept, which emphasizes conservative estimation.

Understanding Bad Debts

Bad debts represent amounts owed by customers that have been confirmed as irrecoverable. When a customer goes bankrupt or fails to pay after all collection efforts, the debt is considered "bad" and must be written off from the accounts. Writing off bad debts is necessary to avoid overstating assets and income on the financial statements.

Journal Entry for Writing Off Bad Debts:

Debit: Bad Debts Expense
Credit: Accounts Receivable

This entry removes the uncollectible amount from the accounts receivable, reflecting a more accurate value of expected collections.

What Are Doubtful Debts?

Doubtful debts refer to accounts that may not be collectible in the future. These are not yet confirmed as bad but are at risk of becoming uncollectible. To account for doubtful debts, businesses create an Allowance for Doubtful Debts, a contra-asset account that offsets accounts receivable. This allowance is an estimated amount based on past experiences or industry standards and helps provide a realistic view of potential losses.

The Allowance for Doubtful Debts

The Allowance for Doubtful Debts is an essential accounting tool for estimating uncollectible accounts. It is based on a percentage of total receivables or an analysis of individual accounts. By establishing this allowance, companies anticipate potential losses and match them against the revenue earned in the same period, adhering to the matching principle.

Journal Entry for Establishing or Adjusting the Allowance:

Debit: Bad Debts Expense
Credit: Allowance for Doubtful Debts

This entry records an expense, which reduces net income, and increases the allowance, reducing the net receivables balance on the balance sheet.

Writing Off Accounts Against the Allowance

When an account is confirmed as uncollectible, it is written off against the Allowance for Doubtful Debts. This does not affect the profit or loss again, as the expense was previously recorded through the allowance.

Journal Entry for Writing Off Bad Debts Against Allowance:

Debit: Allowance for Doubtful Debts
Credit: Accounts Receivable

This reduces both the allowance and accounts receivable, keeping the financial records accurate.

Recovery of Bad Debts

Occasionally, debts that were written off may be partially or fully recovered. When this occurs, it is recorded as Other Income or specifically as Bad Debts Recovered on the income statement for transparency.

Journal Entry for Recovery of Bad Debts:

Debit: Cash
Credit: Bad Debts Recovered

This recognizes the unexpected income separately, without adjusting accounts receivable.

The Prudence Concept and Bad Debts

The prudence concept in accounting requires that assets and income should not be overstated, while expenses and liabilities should not be understated. Estimating doubtful debts and accounting for bad debts align with this principle by ensuring that financial statements present a realistic view of a company's financial health.

Impact of Bad and Doubtful Debts on Financial Statements

Bad and doubtful debts impact the income statement and balance sheet. The Bad Debts Expense reduces net income, while the Allowance for Doubtful Debts reduces the net accounts receivable on the balance sheet. This approach ensures that the company’s financial position is neither overstated nor misleading.

Conclusion

Bad and doubtful debts are crucial considerations in managing receivables. By accurately estimating and recording these amounts, businesses can maintain reliable and transparent financial records. This approach helps investors, creditors, and management make better decisions based on a true picture of the company's financial position.

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1. A ________ is an account receivable that is not difficult collect

a) Good debt

b) Bad debt

c) Doubtful debt

d) Specific Debt

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2. Amount owed by a customer (receivables) that business believes it will have no
difficulty in collecting from customer is:

a) Good debt

b) Bad debt

c) Doubtful debt

d) None of these

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3. Provision tells us about which of the following
1. Estimated bad debts.
2. Non-collectable debts.

a) Only i is correct.

b) Only ii is correct.

c) Both are correct.

d) None

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4. Which of the following is correct entry of bad debts recovered?

a) Dr: Bad debts expense Cr: Cash

b) Dr: Cash Cr: Receivables

c) Dr: Cash Cr: Receivables

d) Dr: Cash Cr: Bad debts Expense

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5. Which of the following is correct entry of bad debts recovered?

a) Dr: Bad debts expense Cr: Cash

b) Dr: Cash Cr: Receivables

c) Dr: Cash Cr: Bad debts Recovered

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6. Which of the following is correct entry of recovery of Allowance for bad debts?

a) Dr: Bad debts expense Cr: Cash

b) Dr: Cash Cr: Receivables

c) Dr: Cash Cr: Bad debts Recovered.

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7. Which of the following is correct?
The good debts do not require any special accounting treatment unlike bad and
doubtful debts
The doubtful debts must stay in the accounting records so that the business
continues to chase payments

a) Only i is correct.

b) Only ii is correct.

c) Both are correct.

d) none

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8. Which of the following debt has high risk?

a) 60 days old

b) 90 days old

c) 40 days old

d) Above 90 days old

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9. The following data pertains to Alpha Traders(AT).
Closing balance of trade debtors Rs. 750,000
Opening balance of allowance for doubtful debts Rs. 6,000
Debtors need to be written off. Rs. 5,000
Contra settlement to be recorded Rs. 20,000
AT’s policy is to maintain the allowance for doubtful debts @10%. The closing
balance of allowance for doubtful debts would be:
Select the most appropriate answer:

a) Rs 74,500

b) Rs 72,500

c) Rs 75,000

d) Rs 71,900

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10. The following data pertains to Alpha Traders(AT).
Closing balance of trade debtors Rs. 1,160,000
Opening balance of allowance for doubtful debts Rs. 90,000
Debtors need to be written off. Rs. 110,000
AT’s policy is to maintain the allowance for doubtful debts @10%. The closing
balance of allowance for doubtful debts would be:

a) 96,000

b) 107,000

c) 105,000

d) 116,000

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11. The following data pertains to Alpha Traders(AT).
Closing balance of trade debtors Rs. 1,160,000
Opening balance of allowance for doubtful debts Rs. 90,000
Debtors need to be written off. Rs. 110,000
Closing allowance is increased by 70,000. The closing balance of allowance for
doubtful debts would be:

a) 70,000

b) 107,000

c) 105,000

d) 160,000

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12. The following data pertains to Alpha Traders(AT).
Opening balance of allowance for doubtful debts Rs. 8,500
Bad debts written off during the year. Rs. 5,000
Closing balance of allowance for doubtful debts 10,000
Bad debts written off included 1,000 allowance balance which was provided in
previous year. The Bad debts expense for the year would be:
Select the most appropriate answer:

a) 5,500

b) 6,000

c) 6,500

d) 7,500

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13. Bad debts recovered is recognized as:

a) Increase in allowance

b) Other income

c) An expense

d) None of these

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14. Which of the following transaction will affect the receivable account?

a) Allowance for bad debts

b) Purchase return

c) Trade discount

d) Bad debts expense

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15. At 31 December 2021 an entity allowance for doubtful receivables amounted to
Rs. 48,000 which was 5% of the receivables at that date. At 31 December 2022
receivables totalled Rs 1,085,000. It was decided to write off Rs 53,000 of debt as
irrecoverable and based on past experience to keep the allowance for doubtful
receivables at 5% of receivables.
What should be the charge in P/L for the year ended 31 December 2022 for bad
and doubtful receivables

a) Rs 59,250

b) Rs 56,600

c) Rs 49,400

d) Rs 46,750

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16. At 31 December 2021 an entity allowance for doubtful receivables amounted to
Rs. 9,000. At 31 December 2022 receivables totalled Rs 120,000. During the year
bad debts of Rs 5,000 were written off and based on past experience, the entity
wishes to keep the allowance for doubtful receivables at 5% of receivables.
What should be the charge in P/L for the year ended 31 December 2022 for bad
and doubtful receivables.

a) Rs 2,000

b) Rs 3,000

c) Rs. 5,000

d) Rs. 8,000

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17. At 31 December 2022 receivables totalled Rs. 785,000 before making the
following adjustment.
i. It was decided to write off Rs 20,000 of bad debts as irrecoverable and create
specific allowance of 80% against balance of Rs. 75,000.
ii. General allowance for receivables is to be maintained at 5% of receivables.
Allowance for doubtful receivables as at 31-12-21 amount to 31000
What should be the allowance for doubtful receivables at December 2022

a) Rs 110,000

b) Rs. 109,500

c) Rs 95,500

d) Rs 94,500

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18. At December 31, 2018 a company's receivable totaled Rs. 600,000 and an
allowance for bad and doubtful debts of Rs. 60,000 had been brought down from last
year. It was decided to write off the debts totaling Rs. 25,000 and to adjust
allowance for receivable @ 10% of the receivable. At what amount receivables are
to be shown in statement of financial position as at 31 December 2018?

a) Rs. 572,500

b) Rs. 517,500

c) Rs. 540,000

d) Rs. 575,000

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19. Which is the purpose of maintaining an allowance for doubtful debt receivables

a) Records irrevocable debts without taking them out of the books of an entity

b) Records the expense of irrevocable debts

c) Have an estimate of future irrecoverable debts

d) Matches the estimate cost future irrecoverable debts against the revenue earned in giving rise to the potential irrecoverable debts

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20. Which of the following statements about prudence is correct?

a) Assets and income must be understated while liabilities and expenses must be overstated

b) The lowest possible values should be applied to income and assets and the highest possible values to expenses and liabilities.

c) Assets and income are not overstated while liabilities and expenses are not understated.

d) Understating of assets and income and overstating of liabilities and expense are desirable in preparing financial statements.

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21. On 30 June 2020, the balance in allowance for doubtful receivables showed Rs
16,000. During the year ended 30 June 2021, receivables of Rs 21,000 were written
off. If allowance for doubtful receivables at 30 June 2021 is Rs 18,000 then what
would be the total effect of bad and doubtful receivables on profit for the years?

a) Decreased by Rs 19,000

b) Decreased by Rs 23,000

c) Increased by Rs 19,000

d) Increased by Rs 23,000

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22. Allowance for doubtful debts’ account is:

a) liability account

b) asset account

c) contra asset account

d) expense account

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23. Which is the purpose of maintaining an allowance for doubtful debt receivables.

a) Records irrevocable debts without taking them out of the books of an entity

b) Records the expense of irrevocable debts

c) Have an estimate of future irrecoverable debts.

d) Matches the estimate cost future irrecoverable debts against the revenue earned in giving rise to the potential irrecoverable debts

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24. Contra Asset account has what type of balance?

a) Debit

b) Credit

c) Contra

d) All of these

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25. The journal entry of decrease in Allowance compared to previous year is?

a) Debit: Allowance Credit: Debtors

b) Debit: Debtors Credit: Allowance

c) Debit: Allowance Credit: Bad debts

d) Debit: Bad debts Credit: Allowance

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26. In September 2020 ABC company wrote off an amount of Rs. 56,000 due from a
costumer who had become bankrupt however in January 2021 the company
unexpectedly received half of the amount due from the costumer:
How should the company account for this amount in its accounts for the year
ended on December 2021?In September 2020 ABC company wrote off an amount of Rs. 56,000 due from a
costumer who had become bankrupt however in January 2021 the company
unexpectedly received half of the amount due from the costumer:
How should the company account for this amount in its accounts for the year
ended on December 2021?

a) as an accrual for Rs. 28,000

b) as increase in provision for doubtful debt of Rs 28,000

c) as a prepayment of Rs 28,000

d) as other income of Rs 28,000

Your score is

The average score is 45%

Introduction to Bad and Doubtful Debts

Understanding Bad Debts

What Are Doubtful Debts?

The Allowance for Doubtful Debts

Writing Off Accounts Against the Allowance

Recovery of Bad Debts

The Prudence Concept and Bad Debts

Impact of Bad and Doubtful Debts on Financial Statements

Conclusion

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