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How does a business account for customers who may not pay, using bad debts written off and an allowance for doubtful debts?

Distinguish bad debts from doubtful debts, write off a bad debt, create and adjust an allowance for doubtful debts, and present accounts receivable at net realisable value

WACE Year 12 Accounting and Finance Unit 3 on receivables: writing off bad debts, creating and adjusting the allowance for doubtful debts, recording doubtful debts expense, and presenting accounts receivable at net realisable value on the balance sheet.

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  1. What this dot point is asking
  2. Bad debts versus doubtful debts
  3. Writing off a bad debt
  4. The allowance for doubtful debts
  5. Net realisable value

What this dot point is asking

SCSA wants you to distinguish the two, record the write-off and the allowance adjustment, and present receivables net of the allowance.

Bad debts versus doubtful debts

Writing off a bad debt

When a debt is known to be bad, remove it: debit Allowance for Doubtful Debts (if an allowance exists) or Bad Debts Expense, and credit Accounts Receivable. Writing a debt off against an existing allowance does not affect profit again, because the expense was already recognised when the allowance was created.

The allowance for doubtful debts

The allowance applies the matching principle: the estimated cost of uncollectable sales is recognised in the same period the sales revenue is earned, not later when specific debts go bad.

Net realisable value

On the Balance Sheet, accounts receivable is shown at gross, less the allowance, to give net realisable value:

Net realisable value=Accounts receivable−Allowance for doubtful debts\text{Net realisable value} = \text{Accounts receivable} - \text{Allowance for doubtful debts}