How are bad debts written off and how does an allowance for doubtful debts apply the accrual basis to expected future losses?
Recording bad debts written off and establishing an allowance for doubtful debts as a balance day adjustment, and reporting the net realisable value of accounts receivable
A focused VCE Accounting Unit 4 Area of Study 1 answer on bad and doubtful debts. Distinguishes writing off a bad debt from creating an allowance for doubtful debts, records both, explains the accrual basis and faithful representation, reports net realisable value of receivables, and reconciles the worked figures.
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What this dot point is asking
VCAA wants you to record a bad debt write-off, establish and adjust an allowance for doubtful debts as a balance day adjustment, and report accounts receivable at the amount expected to be collected, justifying the treatment with the Conceptual Framework.
Bad debts versus doubtful debts
Writing off a confirmed bad debt is certain; the allowance is an estimate that applies the accrual basis by recognising the expected loss in the period the related credit sales were made, not when a specific debt later fails.
Recording each
- Bad debt written off: Debit Bad Debts (expense), Debit GST Clearing (to reverse GST on the original sale), Credit Accounts Receivable. The customer's balance is removed.
- Allowance created or increased at balance day: Debit Doubtful Debts (expense), Credit Allowance for Doubtful Debts (contra asset).
Worked example
Why this matters
The allowance applies the accrual basis and period assumption: the expense of expected non-collection is matched to the period of the credit sales that created the risk. Reporting receivables net of the allowance gives a faithful representation of the asset, avoiding overstating both the asset and profit. Examiners test the difference between writing off against the expense and writing off against the allowance.
Exam-style practice questions
Practice questions written in the style of VCAA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
2022 VCAA3 marksWith reference to one accounting assumption, explain the purpose of the Allowance for Doubtful Debts account.Show worked answer →
Name the assumption and explain the allowance as a balance day adjustment.
The relevant assumption is the accrual basis: expenses are recognised in the period in which they are incurred, not when cash changes hands.
Some credit sales of the current period are unlikely to be collected. The Allowance for Doubtful Debts estimates that probable future loss now, so the expected expense is matched against the revenue (sales) of the same period.
It is a negative asset (offset against Accounts Receivable) so that the Balance Sheet reports receivables at their net realisable value, the amount actually expected to be collected. Marks: name the assumption, explain matching the expected loss to the period, and link to net realisable value.
2022 VCAA3 marksOn 30 June 2022, PSF decided to write off a debt of $3 960 from Forrest Sushi after this restaurant was declared bankrupt (Memo 70). Prepare the General Journal entry to write off Forrest Sushi's debt. A narration is not required.Show worked answer →
The $3 960 owed includes GST, and under the allowance method the write-off is charged against the existing allowance, with the GST recovered.
Split the amount: 3 960 / 1.1 = 360.
General Journal entry:
Debit Allowance for Doubtful Debts 360; Credit Accounts Receivable (Forrest Sushi) $3 960.
One mark each for: debiting the Allowance (not Bad Debts again, since the loss was already estimated); recovering the 3 960 from Accounts Receivable.
2021 VCAA2 marksNetball House had Accounts Receivable of 3 000 at 30 June 2021. It wrote off 90 500, sales returns $500). Show how Accounts Receivable would be reported in the Balance Sheet as at 30 June 2021.Show worked answer →
Report receivables at net realisable value: gross Accounts Receivable less the closing Allowance.
Accounts Receivable after the write-off = 110 000 - 2 750 = $107 250.
Allowance for Doubtful Debts = 4% of net credit sales = 4% x (90 500 - 500) = 4% x 90 000 = $3 600.
Balance Sheet (Current Assets):
Accounts Receivable 107 250
less Allowance for Doubtful Debts (3 600)
= $103 650 (net realisable value).
One mark for the 3 600 allowance to show $103 650.