Accounting Practices 501 Chapter 8 Balance Day Adjustments (Allowance for Doubtful Debts) Cathy Saenger, Senior Lecturer, Eastern Institute of Technology © Pearson 2011

Allowance for Doubtful Debts Ch8E - Doubtful debts 2 Let’s say we have the following Accounts Receivable schedule at balance date (31 March) Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $

Allowance for Doubtful Debts Ch8E - Doubtful debts 3 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ The outstanding $18,000 will only be received in the next accounting period

Allowance for Doubtful Debts Ch8E - Doubtful debts 4 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ From experience, the accountant would know that a certain percentage of the outstanding Accounts Receivable amount will not be recovered

Allowance for Doubtful Debts Ch8E - Doubtful debts 5 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ Some bad debts on the outstanding amount will probably occur, but only in the next accounting period and the Sales were generated in the current accounting period – what now?

Ch8E - Doubtful debts 6 This is what happens …….. interesting stuff!! Allowance for Doubtful Debts

Ch8E - Doubtful debts 7 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ Let’s say we estimate that 5% of the outstanding Accounts Receivable amount will not be recovered in the next accounting period

Allowance for Doubtful Debts Ch8E - Doubtful debts 8 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ We then need to push the Accounts Receivable amount down by 5% ($900) to provide a more realistic value

Allowance for Doubtful Debts Ch8E - Doubtful debts 9 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ The question is - which account will we write the $900 off from? ? Don’t know! - 900

Allowance for Doubtful Debts Ch8E - Doubtful debts 10 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ The solution is to create an account called Allowance for Doubtful Debts which will be used to push down the total of Accounts Receivable in the Balance Sheet to show a more realistic figure ? - 900

Allowance for Doubtful Debts Ch8E - Doubtful debts 11 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ ? General Journal Date Account Titles Ref noDebitCredit 31/3 Allowance for Doubtful Debts 900

Allowance for Doubtful Debts Ch8E - Doubtful debts 12 General Journal Date Account Titles Ref noDebitCredit 31/3 Allowance for Doubtful Debts 900 The Allowance for Doubtful Debts account is a negative asset (used to push down Acc Rec) and is therefore credited The million dollar question – what will it balance with?

Allowance for Doubtful Debts Ch8E - Doubtful debts 13 General Journal Date Account Titles Ref noDebitCredit 31/3 Allowance for Doubtful Debts 900 A Doubtful Debts expense account is created to balance the amount Doubtful Debts expense900 Being entry to create an allowance for doubtful debts (5% of Acc Rec) The Doubtful Debts expense account will in turn push down the profit to show a more realistic profit

Allowance for Doubtful Debts Ch8E - Doubtful debts 14 Schedule of Accounts Receivable as at 31 March 10,000 2,000 4,000 2,000 $18,000 Mrs. A Mrs. B Mr. X Mr. Y $ General Journal Date Account Titles Ref noDebitCredit 31/3 Doubtful Debts expense900 Allowance for Doubtful Debts 900 Being entry to create an allowance for doubtful debts (5% of Acc Rec)

Ch8E - Doubtful debts 15 The Doubtful Debts Expense will be classified as a Finance Expense in the Income Statement The Allowance for Doubtful Debts account is classified as a Current Asset (negative) in the Balance Sheet This means that the Profit will decrease and the Current Assets will decrease, which gives a truer picture of the financial position and performance of the business Let’s look at the financial statements

Week 7 (E) - Doubtful Debts 16 ………. Less Expenses Finance Expenses Doubtful Debts$900 ………. Current Assets Accounts Receivable$18,000 Less Allowance for Doubtful Debts 90017,100 Extract from the Income Statement for the year ended …….. Extract from the Balance Sheet as at …