The Allowance the Sales Director Wants Frozen
Zephyr Engineering has trade receivables of Rs 4,850,000 at 30 September 2025 and an allowance for doubtful debts brought forward of Rs 210,000. The aged analysis shows Rs 3,100,000 under 60 days, Rs 1,000,000 between 60 and 120 days, and Rs 750,000 over 120 days. The over-120-day figure includes Rs 380,000 owed by a customer that entered liquidation in August, and Rs 120,000 owed by a customer disputing an invoice, where legal advice says recovery is possible but not probable. Zephyr's historical loss rates are 1% for under-60-day balances, 6% for 60-to-120-day balances and 25% for over-120-day balances; the company applies these to balances not specifically provided. During the year a customer whose Rs 65,000 debt was written off in 2023 paid in full. The sales director says the allowance should be left at Rs 210,000 because a bigger charge will upset the bank, and asks that the recovery be credited to his sales ledger account to improve his collection figures.
1. Calculate the required allowance for receivables at 30 September 2025 and the charge to profit or loss, showing how the disputed balance is treated.
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Step 1 – specific provision. The Rs 380,000 customer is in liquidation; recovery is not expected, so provide in full: Rs 380,000.
Step 2 – general provision on remaining balances. The disputed Rs 120,000 is not specifically provided because recovery is possible but not probable; legal advice does not support a specific provision, so it stays inside the ageing and attracts the applicable rate.
| Ageing | Balance | Rate | Provision |
|---|---|---|---|
| Under 60 days | 3,100,000 | 1% | 31,000 |
| 60–120 days | 1,000,000 | 6% | 60,000 |
| Over 120 days, excluding liquidated customer | 370,000 | 25% | 92,500 |
| Specific: liquidated customer | 380,000 | 100% | 380,000 |
| Required allowance | 563,500 |
Step 3 – charge. Charge = closing allowance 563,500 - opening allowance 210,000 = Rs 353,500.
Reasoning notes. The liquidated balance is removed from the ageing before applying the 25% rate; applying 25% to the full 750,000 and then adding 380,000 would double-count part of the provision. The over-120-day bucket is therefore 750,000 - 380,000 = 370,000, which still includes the disputed 120,000. The rates are applied to gross receivables and the allowance is presented as a deduction from trade receivables, not netted customer by customer in the statement of financial position.
2. Explain the correct accounting treatment of the Rs 65,000 recovered from a customer whose debt was written off in 2023, and why the sales director's suggestion is unacceptable.
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Correct treatment. The debt was written off in 2023 and is no longer carried as a receivable. The receipt is a recovery of an amount previously expensed. The entry is Dr Bank 65,000 / Cr Allowance for receivables (or impairment gain in profit or loss) 65,000. If credited to the allowance, the closing allowance stays at 563,500 and the movement becomes 353,500 - 65,000 = Rs 288,500; if credited to profit or loss as a separate gain, the charge remains 353,500 and the gain 65,000. Either presentation gives the same net profit effect.
Why not the sales ledger. Crediting the customer's account would create a credit balance for someone who owes nothing, misstate receivables and collection statistics, and conceal the nature of the income. It would also make the sales director's collection figures look better than they are – a reporting distortion, not a bookkeeping convention.
Judgement point. The recovery is not a sale and must never be shown as revenue; showing it as revenue would misstate gross profit, revenue trends and possibly the sales director's performance measures. The recoveries should also prompt a review of whether the original write-off policy and credit control were adequate.
3. Draft the response to the sales director, addressing the request to keep the allowance at Rs 210,000. Include the professional and reporting consequences.
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Substance of the response. The allowance is not a discretionary balance; it is an accounting estimate that must reflect the best available information about expected credit losses. The evidence – a liquidation, an ageing profile and historical loss rates – supports Rs 563,500, not Rs 210,000. Freezing the allowance would overstate receivables and profit by Rs 353,500 and would misstate the bank covenant position, which is precisely the outcome the director is seeking.
Professional points to make. (1) The estimate must comply with the applicable financial reporting framework; a deliberate understatement to protect a covenant breaches integrity and objectivity. (2) The director's request creates an intimidation threat (the covenant, and implicitly the accountant's position) that cannot be neutralised by agreeing. (3) The 65,000 recovery must be recorded as a recovery, not credited to a customer account. (4) The conversation should be documented and confirmed in writing.
Escalation. If the director persists, refer the matter to the managing director or those charged with governance, and ensure the external auditor is aware of the disagreement and of the covenant pressure. Where the matter is material and unresolved, consider the firm's whistleblowing policy and the obligations of the professional body.
Tone. The response should be factual and non-accusatory: set out the evidence, the calculation under the accounting standard, the alternative treatments considered and why they were rejected, and offer to walk through the numbers with the director and the bank if necessary.