Accounting for Doubtful Debts

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Accounting for Doubtful Debts

Allowance for doubtful debts is created by forming a credit balance which is

netted off against the total receivables appearing in the balance sheet. A
corresponding debit entry is recorded to account for the expense of the
potential loss. Accounting entry to record the allowance for receivable is as
follows:

Debit Allowance for Doubtful Debts (Expense)

Credit Allowance for Doubtful Debts (Balance Sheet)

Once an allowance for doubtful debts has been created, only the movement in
the allowance will need to be charged to the income statement in future
accounting period. So if estimated allowance for doubtful debt is same as last
accounting period, no accounting entry will be required in the current period
as the total receivables will be reduced by the amount of allowance which has
already been created.

Example
ABC LTD has trade receivable of worth $50,000 as at 31 December 2010.
XYZ LTD, a receivable owing $10,000 to ABC LTD at the year end, has been
recently been wound up. Consequently, ABC LTD does not expect to recover
the amount due from XYZ LTD. Based on past experience, ABC LTD
estimates that 5% of its receivables will default. Allowance for doubtful debts
on 31 December 2009 was $1500.

ABC LTD must write off the $10,000 receivable from XYZ LTD as bad debt.
Accounting entry to record the bad debt will be as follows:

Debit Bad Debt Expense $10,000

Credit XYZ LTD (Receivable) $10,000

A general allowance of $2,000 [( 50,000-10,000) x 5%] must be made. As a

general allowance of $1500 has already been created, only $500 additional
allowance must be charged to the income statement:

Debit Allowance for Doubtful Debts $500

 (Expense)
Allowance for Doubtful Debts
Credit $500
(Balance Sheet)

Note that $10,000 in respect of receivable from XYZ LTD has been excluded
from the calculation of the general allowance as it has already been written off
in full.

Bad Debt Expense

Debit $ Credit $
XYZ LTD
10,000 Income Statement 10,000
(Receivable)
10,000 10,000

XYZ LTD Receivable

Debit $ Credit $
Sales 10,000 Bad Debt Expense 10,000
10,000 10,000

Allowance for Doubtful Debts

Debit $ Credit $
Balance c/d 2,000 Balance c/d 1,500
Income Statement 500
2,000 2,000