Bad and Doubtful Debts - TCE Accounting (Tasmania)
“Record bad debts written off and create an allowance for doubtful debts at balance day.”
A bad debt is a debtor confirmed as uncollectable, written off as an expense. A doubtful debt is an estimate at balance day of debtors who probably will not pay; it is recorded through an allowance (a contra-asset) so the loss is matched to the period the sales were made, not the later period when the debt actually fails.
What this dot point is asking
Selling on credit creates a risk that some debtors never pay. Unit 3 records this risk in two stages: writing off debts known to be bad, and estimating, at balance day, the debts that are doubtful. The aim is to report debtors at the amount the business realistically expects to collect.
Writing off a bad debt
When a specific debtor is confirmed uncollectable, the amount is removed from debtors and recognised as an expense.
- Debit Bad debts expense
- Debit GST clearing (recovering the GST originally charged)
- Credit Debtors Control
The debtor is also removed from the subsidiary ledger.
The allowance for doubtful debts
At balance day, prudence says the likely future losses on current debtors should be recognised now, in the period the sales (and profit) were recorded. Rather than naming specific debtors, the business estimates a total and creates an allowance.
A contra-asset account holding the estimated amount of current debtors not expected to pay. It is subtracted from Debtors Control on the balance sheet to show net realisable debtors, without removing any specific debtor yet.
The adjustment is debit Doubtful debts expense, credit Allowance for doubtful debts. Note that creating the allowance does not involve GST, because no specific debt has actually failed yet.
A bad debt is certain and specific, so it is written off and reverses the GST. A doubtful debt is an estimate across many debtors, so it raises an allowance and does not touch GST. Keeping the two apart is essential.
Worked example
This example shows the two-stage process: first removing a confirmed bad debt from the books, then estimating and recording the allowance for debts that may prove doubtful.
Step 1: Record the write-off
When a specific debt is confirmed uncollectable, it is removed from Debtors Control and recognised as an expense. Because the original sale included GST, that GST is reversed through GST clearing, since the revenue the tax was based on has not been collected.
A debtor owing (including GST) is confirmed uncollectable.
- Debit Bad debts expense
- Debit GST clearing
- Credit Debtors Control
Step 2: Calculate and record the allowance
At balance day, the business estimates what percent of remaining debtors may not pay. This estimate covers many debtors rather than any specific one, so no GST adjustment is made. The calculation applies the percentage to the Debtors Control balance after the write-off.
After the write-off, Debtors Control is . The business estimates 2.5 percent will prove doubtful.
Required allowance .
- Debit Doubtful debts expense
- Credit Allowance for doubtful debts
Step 3: Present net debtors on the balance sheet
The allowance is a contra-asset that is deducted from Debtors Control, showing readers the amount the business realistically expects to collect.
- Debtors Control:
- Less Allowance for doubtful debts:
- Net debtors:
Final answer: Net debtors
Estimating the allowance
The allowance is an estimate, so the business needs a defensible method. Two are common at this level. A percentage of net credit sales applies a rate to the sales figure for the period, on the logic that a roughly constant proportion of credit sales historically goes bad. A percentage of closing debtors applies a rate to the Debtors Control balance after any write-offs, which targets the balance sheet figure directly. Whichever is used, the rate should be based on past experience and applied consistently from year to year so the figures stay comparable.
If a previous allowance already exists, the adjustment only raises or lowers it to the new required figure; you do not credit the full new amount on top of the old balance. For TASC tasks the allowance is usually created fresh, but watch the wording carefully for whether a balance is already on the books.
Recovering a debt written off
Occasionally a debtor pays after being written off. The write-off is first reversed (debit Debtors Control, credit Bad debts recovered or Bad debts expense, and reinstate the GST), then the cash receipt is recorded normally. This keeps the audit trail intact and reports the recovery as it happens.
Why this matters
These adjustments stop debtors being overstated and ensure the cost of credit sales that go bad is charged in the right period. Exam questions reward correct handling of GST on a write-off (reversed) versus the allowance (no GST), the choice and consistent application of an estimation method, and the net debtors presentation on the balance sheet.
GST is only adjusted when a specific debt is actually written off, because that is when the sale is confirmed to have failed. The doubtful debts allowance is an estimate over many debtors, so it never touches the GST clearing account. Adding GST to the allowance overstates the expense and the GST adjustment.
Exam-style questions
Questions in the style of TASC exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
Practice7 marksOn 28 June a debtor, T. Cole, who owed 120 GST) was confirmed uncollectable and written off. After the write-off, Debtors Control stood at $52\,000. The business estimates that 3 percent of debtors will prove doubtful. Prepare the general journal entries for the write-off and for the balance day adjustment, and show how net debtors appears on the balance sheet.Show worked answer →
Write-off entry (the debt is confirmed bad, so GST is reversed):
Debit Bad debts expense 120; Credit Debtors Control $1,320. T. Cole is also removed from the debtors subsidiary ledger.
Allowance adjustment (an estimate over many debtors, so no GST):
Required allowance .
Debit Doubtful debts expense 1,560.
Balance sheet (current assets):
Debtors Control 1,560 = Net debtors $50,440.
Markers reward the reversed GST on the write-off only, the GST-free allowance, the correct 3 percent calculation, and the net-debtors presentation.
Practice4 marksExplain why the allowance for doubtful debts is created at balance day rather than waiting until specific debts actually fail, and state the accounting principle this supports.Show worked answer →
A full 4 mark answer links prudence and matching to the timing of the expense.
The allowance applies the matching principle: the cost of credit sales going bad should be charged in the same period the sales (and the related profit) were recorded, not in a later period when the debt finally fails. It also applies prudence, recognising a probable future loss as soon as it is foreseeable so that debtors and profit are not overstated.
Waiting until each debt actually fails would push the expense into the wrong period and report debtors at more than the business realistically expects to collect. Creating the allowance reports debtors at net realisable value now. Markers reward naming matching (and/or prudence) and explaining the period-matching of the expense to the relevant sales.