How are uncollectable debts and the risk of non-payment recorded?
Record bad debts written off and create an allowance for doubtful debts at balance day.
Writing off a confirmed bad debt, raising an allowance for doubtful debts at balance day, and showing net debtors on the balance sheet.
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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.
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.
Worked example
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), and the net debtors presentation on the balance sheet.