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Bad debts

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Page 1: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Bad debts

Page 2: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

ExplanationIf a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt.

A bad debt is therefore an expense for the business.

MP Ltd sold goods costing £50 to Mr Farnish. Unfortunately Mr Farnish is experiencing financial difficulties and is unable to pay his debt.

MP Ltd also sold goods costing £240 to Mr Goldstone. Mr Goldstone paid £200, but is unable to pay the remaining £40.

Using white boards, show the affects of these bad debts on the three accounts

Page 3: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Example

Dr £ Cr £

Mr Farnish 50Mr Goldstone 40

90

Profit & Loss 90a/c

Mr Farnish Account

Mr Goldstone Account

Dr Cr

£ £

Sales 50 Bad debts 50

Dr Cr

£ £Sales 240 Cash 200

Bad debts 40

Bad debts AccountDr Cr

Page 4: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Provision for bad debtsIt is impossible to determine with absolute accuracy how much the value of bad debts will be. In order to arrive at a figure of doubtful debts, a business must first consider that some debtors will never be able to pay whilst other might be able to pay a some of the debt.

A doubtful debt = not sure if the debt can be repaid

A bad debt = the debt will not be repaid

Some businesses make an ‘aging schedule’ showing how long the debts have been owing. The longer the debt has been owed the more likely these debts will be turned in to ‘bad debts’

Period debt owing £ % doubtful Allowance

1-4 weeks 5,000 1 50

5-7 weeks 3,000 3 90

8-10 weeks 800 4 32

10-15 weeks 200 5 10

Page 5: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

ExampleAt 31 December 2011, the accounts receivable figure after deducting bad debts was £10,000. it is estimated that 2% of the debts (£200) will eventually prove to be bad debts and it is decided to make a provision for these.

Profit & Loss

Dr Cr

Allowance for doubtful debts

200

£ £

Allowances for doubtful debt

Dr Cr

Profit & loss 200

£ £

Page 6: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

ExampleA business started on 1 January 2007 and its financial year end is

31 December. A table of debtors, the bad debts written off and the

estimated doubtful debts at the rate of 2% of debtors at the end of

each year, as well as the double entry accounts are below.

See worksheet

Page 7: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Assessment 1Hart & Partners started a business on January 1 2009. During its first year of trading the following debts were found to be bad and the business decided to write them off as bad:

May 16 Bayley £550

July 31 Carter £223

Nov 9 Roche £467

On 31 December 2009, the schedule of remaining debtors, amounting in total to £26,000, is examined and it is decided to make a provision for doubtful debts of 2%.

1. Show the bad debts account and the provision for doubtful debts account

2. The charge to the profit & loss account3. The relevant extracts from the balance sheet

Page 8: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore
Page 9: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Assessment 2Date Total debtors Profit & Loss Dr / Cr Final figure for

Balance sheet

2007 7000

2008 8000

2009 6000

2010 7000

The table shows the figure for debtors appearing in a trader’s books.

The provision for doubtful debt is to be 1% of debtors. Complete the

table indicating the amount to be debited or credited to the profit &

loss accounts for the final year ended and the amount for the final

figure of debtors to appear in the balance sheet on each date.

Page 10: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore
Page 11: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Questions – In a new business during the year ended 31 December 2013, the following debts are found to be bad, and are written-off on the dates shown:31 May S.Gill & Son £60030 Sept H.Black Ltd £40030 Nov A.Thom £200

On 31 December the schedule of remaining accounts receivable totalling £15,000 is examined and it is decided to make an allowance for doubtful debts of £500.

You are required to show:a.The bad debts a/c and the allowance for doubtful debts a/cb.The charge to the income statementc.The relevant extracts from the statement of financial position as at 31 December 2013

Page 12: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Bad debts a/cAllowance for

doubtful debts a/c

May 31 S.Gill & Son 600

Sep 30 H.Black Ltd 400

Nov 30 A.Thom 200

Dec 31 P&L 1,200

1,200 1,200

Dec 31 P&L 500

Income statement (extract)

Sales:COGSGross Profit

Expenses:Bad debtsAllowance for doubtful debts......Net Profit

Statement of financial position (extract)

Fixed Assets:

Current Assets:Debtors - £15,000

less allowance for doubtful debt (£500)

£14,500

Liabilities

Capital employed

Page 13: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Question 2A business had always made an allowance for doubtful debt at the rate of 2% of accounts receivable. On 1 January 2011 the amount for this brought forward from the previous year was £300.

During the year to 31 December 2011 the bad debts written-off amounted to £700On 31 December the accounts receivable balance was £17,000 and the usual allowance for doubtful debt was made (2%)

You are required to show:•The dab debts account for the year ended 31 December 2011•The allowance for doubtful debts account for the year•Extract from the income statement•Extract from the statement of financial position.

Bad debts a/cAllowance for

doubtful debts a/c

Jan 1 bal b/d 300Dec 31 bal c/d 340

Dec 31 P&L 40

340 340

Page 14: Bad debts. Explanation If a business finds it impossible to collect debt then the debt should be ‘written off’ as a bad debt. A bad debt is therefore

Homework –

1. finish bad debt work book

2. Draw a bad debt poster on the last 2 pages

in the bad debt work book explaining the

process of bad debts. Use page 285-294 to

help you.

Tuesday