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
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.
Exam-style practice questions
Practice questions written in the style of TASC exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
TCE 20227 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.
TCE 20234 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.