Accounting for Doubtful Debts
Allowance for doubtful debts is created by forming a credit balance which is netted off against the total receivables appearing in the balance sheet. A corresponding debit entry is recorded to account for the expense of the potential loss. Accounting entry to record the allowance for receivable is as follows:
|Debit||Allowance for Doubtful Debts (Expense)|
|Credit||Allowance for Doubtful Debts (Balance Sheet)|
Once an allowance for doubtful debts has been created, only the movement in the allowance will need to be charged to the income statement in future accounting period. So if estimated allowance for doubtful debt is same as last accounting period, no accounting entry will be required in the current period as the total receivables will be reduced by the amount of allowance which has already been created.
ABC LTD has trade receivable of worth $50,000 as at 31 December 2010. XYZ LTD, a receivable owing $10,000 to ABC LTD at the year end, has been recently been wound up. Consequently, ABC LTD does not expect to recover the amount due from XYZ LTD. Based on past experience, ABC LTD estimates that 5% of its receivables will default. Allowance for doubtful debts on 31 December 2009 was $1500.
ABC LTD must write off the $10,000 receivable from XYZ LTD as bad debt. Accounting entry to record the bad debt will be as follows:
|Debit||Bad Debt Expense||$10,000|
|Credit||XYZ LTD (Receivable)||$10,000|
A general allowance of $2,000 [( 50,000-10,000) x 5%] must be made. As a general allowance of $1500 has already been created, only $500 additional allowance must be charged to the income statement:
|Debit||Allowance for Doubtful Debts (Expense)||$500|
|Credit||Allowance for Doubtful Debts (Balance Sheet)||$500|
Note that $10,000 in respect of receivable from XYZ LTD has been excluded from the calculation of the general allowance as it has already been written off in full.
|Bad Debt Expense|
|XYZ LTD (Receivable)||10,000||Income Statement||10,000|
|XYZ LTD Receivable|
|Sales||10,000||Bad Debt Expense||10,000|
|Allowance for Doubtful Debts|
|Balance c/d||2,000||Balance c/d||1,500|