Assets

Receivables and the allowance for irrecoverable debts

Contras and write-offs first, then the allowance on what is left; profit takes only the change in the allowance.

Draft: not yet reviewed by a teacher

Why it exists

A receivable is an asset only if the cash will really come in. When a customer certainly will not pay, there is no asset; when experience says some customers will not pay, the asset is smaller than the books say. Without adjustments the statement of financial position is overstated and the loss on credit sales lands in the wrong year.

Key rules

Write off an irrecoverable debt: Dr Irrecoverable debts expense, Cr Receivables. The debt is gone from the ledger and from the statement of financial position.
The allowance for receivables is a separate account with a credit balance. In the statement of financial position: receivables less the allowance.
The allowance is calculated on receivables after write-offs and contras.
Profit or loss takes the change in the allowance: an increase is Dr Irrecoverable debts expense, Cr Allowance; a decrease is the reverse.
A debt written off earlier and then recovered: Dr Bank, Cr Irrecoverable debts expense (or reinstate the debt first, then record the receipt).
A contra with a customer who is also a supplier: Dr Payables, Cr Receivables with the smaller amount.
A supplier statement is reconciled with the supplier's account: errors are corrected in our books, timing differences (a payment in transit) are not.

Examples

A Bakı wholesaler: receivables before adjustments 62,500, opening allowance 3,600. A restaurant has closed and its debt of 2,500 is irrecoverable. The allowance is 5% of the rest. In May a customer paid 800 that had been written off last year.

After the write-off: 62,500 − 2,500 = 60,000
New allowance: 60,000 × 5% = 3,000, a decrease of 3,600 − 3,000 = 600
Expense: 2,500 − 600 − 800 = 1,100
In the statement of financial position: 60,000 − 3,000 = 57,000

A write-off, the allowance and a recovered debt

How it works

The year-end order is always the same:

contras and irrecoverable debt write-offs;
the new allowance on the receivables that remain;
an entry for the difference between the new and the old allowance.

The year's irrecoverable debts expense = write-offs + the increase in the allowance (or − the decrease) − debts recovered. An aged receivables analysis and credit limits help decide which debts are doubtful and prevent new ones.

Traps

Taught in the course

Why it exists

Key rules

Write off an irrecoverable debt: Dr Irrecoverable debts expense, Cr Receivables. The debt is gone from the ledger and from the statement of financial position.

The allowance for receivables is a separate account with a credit balance. In the statement of financial position: receivables less the allowance.

The allowance is calculated on receivables after write-offs and contras.

Profit or loss takes the change in the allowance: an increase is Dr Irrecoverable debts expense, Cr Allowance; a decrease is the reverse.

A debt written off earlier and then recovered: Dr Bank, Cr Irrecoverable debts expense (or reinstate the debt first, then record the receipt).

A contra with a customer who is also a supplier: Dr Payables, Cr Receivables with the smaller amount.

A supplier statement is reconciled with the supplier's account: errors are corrected in our books, timing differences (a payment in transit) are not.