Irrecoverable Debts and Provision for Doubtful Debts

An irrecoverable debt (also called a bad debt) is a trade receivable that the business has decided it will DEFINITELY NOT collect. Common reasons include customer insolvency (bankruptcy), customer disappearance, or a legal decision that the debt cannot be enforced.

Accounting treatment: The debt must be written off — removed from trade receivables and recognised as an expense, in accordance with the prudence concept (assets should not be overstated).

Journal entry to write off:

Date	Account	Dr $	Cr $
30 Jun	Irrecoverable Debts Expense	800
	Trade Receivables (Customer X)		800
	Writing off irrecoverable debt — Customer X

Effect:

• Income statement: Irrecoverable Debts Expense increases → profit decreases.
• SFP: Trade receivables are reduced by the amount written off.

Recovery of a previously written-off debt: If a customer later pays a debt that was previously written off:

1. Reverse the write-off: Dr Trade Receivables, Cr Irrecoverable Debts Expense (or a separate "bad debts recovered" income account).
2. Record the receipt: Dr Cash/Bank, Cr Trade Receivables.

This is a two-step process — first REINSTATE the debt, then RECORD the payment.

A provision for doubtful debts (also called an allowance for doubtful debts) is an ESTIMATE of the amount of trade receivables that the business might NOT collect in the future. Unlike an irrecoverable debt, the specific debts have NOT been identified as definitely uncollectable — the provision is a general precaution.

Prudence concept: Assets should not be overstated. If it is probable that some receivables will not be collected, it would be misleading to show the full gross receivables on the SFP.

How the provision works: The provision is a CREDIT balance account that sits alongside trade receivables on the SFP as a deduction — it does not eliminate any specific customer's account but reduces the NET VALUE of receivables overall.

Typical calculation: The provision is usually expressed as a PERCENTAGE of trade receivables at year-end (after writing off any known irrecoverable debts).

Example: Trade receivables after write-offs = $50 000. Provision rate = 3%. Required provision = $50 000 × 3% = $1 500.

Important: first write off irrecoverable debts, THEN calculate the provision on the remaining (reduced) balance of trade receivables.

Creating the provision for the first time:

Date	Account	Dr $	Cr $
31 Dec	Irrecoverable Debts Expense	1 500
	Provision for Doubtful Debts		1 500
	Creating provision for doubtful debts at 3% of trade receivables

The full $1 500 goes to the income statement in the year of creation.

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Increasing the provision (subsequent years):

If the required provision rises from $1 500 to $1 800, only the increase of $300 is charged to the income statement.

Date	Account	Dr $	Cr $
31 Dec	Irrecoverable Debts Expense	300
	Provision for Doubtful Debts		300

The provision account now shows a balance of $1 800.

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Decreasing the provision:

If the required provision falls from $1 800 to $1 200, the reduction of $600 is CREDITED to the income statement (it is a reduction in expense / gain).

Date	Account	Dr $	Cr $
31 Dec	Provision for Doubtful Debts	600
	Irrecoverable Debts Expense		600

The provision account now shows a balance of $1 200.

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Provision account (ledger):

Provision for Doubtful Debts	Dr $	Cr $
		Balance b/d (Year 1 created)
		Increase (Year 2)
		Balance c/d Year 2
Decrease (Year 3)	600	Balance b/d
Balance c/d Year 3	1 200

On the statement of financial position, trade receivables are shown at their NET value:

Current assets	$
Trade receivables (gross)	50 000
Less: Provision for doubtful debts	(1 500)
Net trade receivables	48 500

The net figure of $48 500 represents the amount the business realistically expects to collect.

Step-by-step SFP calculation:

1. Start with GROSS trade receivables from the trial balance.
2. Deduct any irrecoverable debts written off in the current year (if not yet removed from the trial balance figure).
3. Calculate the required provision on the REMAINING balance.
4. Deduct the provision to give net receivables.

Income statement effect summary:

Item	IS Effect
Irrecoverable debts written off	Expense (Dr) — reduces profit
Increase in provision	Expense (Dr) — reduces profit
Decrease in provision	Income/reduction of expense (Cr) — increases profit

Combined entry example: Year 3: Trade receivables $60 000. Write off $1 000 bad debt. Required provision = 2% of remainder.

• After write-off: $60 000 − $1 000 = $59 000
• Required provision: 2% × $59 000 = $1 180
• Previous provision: $1 500
• Change in provision: $1 180 − $1 500 = −$320 (decrease)
• IS charge: $1 000 write-off − $320 provision reduction = net expense $680
• SFP: Trade receivables $59 000 − $1 180 = $57 820