Adjustments for Allowances for Irrecoverable Debts

The $950 is an expense (reducing profit) and trade receivables fall by $950 in the statement of financial position.

Only the increase is the expense: 2,900 − 2,200 = $700 charged to the statement of profit or loss.

Write off the $4,000 first: remaining receivables = 84,000 − 4,000 = 80,000.

(a) Required allowance = 4% × 80,000 = $3,200.

(b) Increase in allowance = 3,200 − 2,800 = 400. Total charge = write-off 4,000 + allowance increase 400 = $4,400.

(a) Statement of financial position (current assets)

(b) Increase in allowance = 3,300 − 2,900 = $400, charged as an expense in the statement of profit or loss.

(a) Dr Bank $700; Cr Irrecoverable debts recovered (income) $700.

(b) The original receivable was already written off in a previous year, so it is no longer in the accounts. The recovery is therefore new income of the business when the cash is received, shown in the statement of profit or loss (often netted against this year's irrecoverable debts). Reinstating the old receivable would double-count, so it is treated as income instead.

• Write-offs (expense): +2,100.
• Decrease in allowance (income): 3,400 − 3,000 = −400.
• Recovery (income): −500.

Net = 2,100 − 400 − 500 = $1,200 charge (expense) in the statement of profit or loss.

An irrecoverable debt is a debt the business is certain will not be paid (e.g. the customer is bankrupt). It is written off: removed from trade receivables and charged in full as an expense. It is recognised because the loss has definitely occurred, and prudence requires it to be recognised at once.

An allowance for irrecoverable debts is a prudent estimate of receivables that may not be paid, even though no specific debt is yet certain to be lost. Receivables are not removed, but the allowance is deducted from them in the statement of financial position, and only the change in the allowance is recognised in profit each year. It is recognised so that receivables and profit are not overstated (prudence) and the likely loss is matched to the period of the sales that created the debts.

So a write-off deals with a certain, specific loss, while an allowance covers estimated, general doubtful debts.

The write-off of $1,000 was correctly recorded, so it has the right effect.

The omitted $300 increase in the allowance, however, means:

• the $300 expense was not charged → profit is overstated by $300;
• the allowance is too low → net trade receivables are overstated by $300 in the statement of financial position;
• the overstated profit increases capital by $300.

So omitting the allowance increase overstates both profit and net assets by $300, breaching the prudence concept (receivables and profit are overstated).

Required closing allowance = 3% × 90,000 = $2,700. Increase = 2,700 − 2,500 = $200.

Allowance for irrecoverable debts account

The $200 increase is the expense in the statement of profit or loss; the $2,700 closing balance is deducted from receivables in the statement of financial position.

Past experience shows that some receivables will not be paid, even if the specific customers are not yet known. The prudence concept requires that assets and profit are not overstated, so a reasonable estimate of these likely losses is recognised now as an allowance, reducing receivables to a more realistic figure.

This also reflects matching: the likely loss is charged to the same period as the sales that created the doubtful debts, rather than being delayed until specific debts are written off, giving a fairer measure of that period's profit.