Receivables, Payables and Bad Debts
What the exam tests
This domain tests trade receivables and payables, writing off bad debts, allowances for doubtful debts, and the movement in the allowance. Expect journal entries and profit effects.
Core rules
- A bad debt write-off removes the receivable: Dr Bad debts expense; Cr Receivables.
- An allowance for doubtful debts is an estimate of receivables unlikely to be collected.
- The allowance is a credit balance contra-asset. The movement in the allowance is the expense or credit in profit or loss.
- A bad debt recovered is income, often credited to bad debts recovered.
Worked example
Receivables are 20,000. A debt of 500 is written off, leaving 19,500. An allowance of 5% is required: 19,500 x 5% = 975. If the existing allowance was 800, the increase is 175. Journal for the increase: Dr Doubtful debts expense 175; Cr Allowance for doubtful debts 175. The write-off itself is: Dr Bad debts 500; Cr Receivables 500. The allowance is based on receivables after the write-off.
Traps
Do not calculate the allowance on the original receivables before write-off if the question says the allowance is based on remaining receivables. Do not debit the allowance account when increasing it. Do not treat the whole new allowance as the expense; only the movement is charged. Do not confuse a bad debt with a discount allowed.
Key points
- Write off bad debts against receivables.
- The allowance is a credit-balance contra-asset.
- Only the movement in the allowance affects profit.
- Calculate the allowance after write-offs unless told otherwise.