Irrecoverable Debts, Allowance and a Recovery at Marlow Print
Marlow Print prepares accounts to 31 December. At 31 December 20X5 the trade receivables ledger total is £128,000 and the allowance for doubtful debts brought forward is £3,600. Two balances are doubtful: X Ltd owes £4,200 and is in liquidation with no dividend expected; Y Ltd owes £3,000 and has agreed to pay 40p in the pound as full settlement, with the first payment received before the year end. The business also received £2,500 in November from a customer whose debt had been written off in 20X4; the bookkeeper credited this to sales. The owner's policy is to maintain an allowance of 3% of the remaining receivables. The owner asks why the allowance is needed at all when the doubtful balances have already been dealt with, and whether the recovery can simply be netted against the 20X5 write-offs.
1. Calculate the write-offs, closing allowance, net charge to profit or loss and net receivables at 31 December 20X5.
Read the worked answer
Write-offs: X Ltd £4,200 is irrecoverable. Y Ltd: 40p in the pound is recoverable, so 60% × £3,000 = £1,800 is written off; £1,200 remains receivable. Total write-offs = £6,000.
Remaining receivables = £128,000 − £6,000 = £122,000. Closing allowance = 3% × £122,000 = £3,660. Allowance brought forward = £3,600, so the increase charged to profit or loss = £60.
The £2,500 recovery relates to a debt written off in 20X4. It is not a trade receivable now. It is credited to profit or loss, often as a reduction of irrecoverable debts expense or as other income.
Net charge to profit or loss = write-offs £6,000 + allowance increase £60 − recovery £2,500 = £3,560. Net receivables = £122,000 − £3,660 = £118,340.
2. Explain why the recovery is not credited to trade receivables and how it should be recorded.
Read the worked answer
The recovery is not credited to trade receivables because that account was removed when the debt was written off in 20X4. There is no customer balance left to reduce. The correct entries are Dr Bank £2,500 and Cr Irrecoverable debts expense (or other income) £2,500.
Crediting sales would overstate revenue and gross profit, even though total profit might end up the same if the bad debt expense is also presented. It would also mislead the owner about the level of trading activity. If the bookkeeper has already credited sales, the correction is Dr Sales £2,500 / Cr Irrecoverable debts expense £2,500, so that the recovery is presented as a credit against the expense it originally related to.
3. Advise whether the allowance is still needed and whether it should be calculated before or after write-offs.
Read the worked answer
The allowance is still needed because the £6,000 write-off deals only with known irrecoverable balances at the year end. The remaining £122,000 contains customers who may not pay because of normal credit risk. An allowance of 3% = £3,660 estimates that risk and reduces receivables to their expected recoverable amount.
It should be calculated after the specific write-offs; otherwise the allowance would be applied to debts already known to be bad, double-counting the loss. If 3% were applied to the original £128,000, the allowance would be £3,840, which includes 3% of the £6,000 already written off. The allowance is an estimate, not a write-off: individual balances remain in the ledger until they are actually written off.