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There is a possible situation where a debt is written off as bad in one accounting period, perhaps because the debtor has been declared bankrupt, and the money, or part of the money, due is then unexpectedly received in a subsequent accounting period.

When a debt is written off, the double entry is:

The full doube entry for the cash being received is:

and

These can be simplified to:

As the debit and crdit to the receivables account cancel each other out. However, it may be useful to pass the transaction through the customer’s account so that the fact that the debt was eventually paid, or paryly paid, is recorded there.

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A bad debt written off is considered to be uncollectable, a doubtful debt allowance is some doubt as to its collectability.

As known, a bad debt written off is as an expense shown in the income statement. It is considered to be uncollectable. A doubtful debt allowance is an amount owing to the business concerning which there is some doubt as to its collectability. It’s for purdent and reasonable and shown under the accounts receiable.

When a bad debt ocurred, the expense is written off in the bad debts expense account but this time the debt is not removed from receivables. Instead, an allowance is set up which is a credit balance. This is netted off against trade receivables in the balance sheet to give a net figure for receivables that are probably recoverable.

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Example to explain and analyse the allowance for doubtful debt.

Aspring has accounts receivable of $11,200 at his year end of 31 May 20X9. Of these he decides that there is some doubt as to whether or not he will receive a sum of $500 from B and he also wishes to allow for the possibility of not receiving 2% of his remaining receivables.

At 1 June 20X9 Aspring had a balance on his allowance for doubtful debts account of $230.

Solution:

Step1

Calcuate the allowance for doubtful debts required at 31 May 20X9.

Step2

Write up the allowance for doubtful debts account, putting in the opening balance of $230 and the closing balance required of $714. The difference is the expense to the bad debts expense account and subsequently to the income statement.

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Bad debt is an item of expense shown in the income statement.

You can see the “T” account (Bad debt) in the article (Allowance for doubtful debt):

When the bad debts is recovered, the part of bad debt corresponding to the expense in the income statement should be deducted in the income statement.

The doube entry of bad debt is:

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The double entry of bad debt is:

Example:

Aspring have total accounts receivable at the end of their accounting period of $45,000. Mr A who owes $790, has been declared bankrupt, and another who gave his name as B has totally disappeared owing Aspring $1,240.

Step1

Enter the opening balance in the accounts receivable account.

Step2

As the two debt are considered to be irrecoverable, they must be removed from accounts receivable by a credit entry and a corresponding debit entry to a bad debts expense account.

Step3

The account receivable account must now be balanced and the closing balance would appear in the balance sheet as the accounts receivable figure at the end of the period.

$42,970 would appear in the balance sheet as the figure for accounts receivable under current assets at the end of the accounting period.

Step4

Finally, the bad debts in the balance sheet as the figure for accounts receivable under current assets at the end of the accountng period.

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A doubtful debt is an amount owing to the business concerning which there is some doubt as to its collectability.

A doubtful debt is one about which there is some cause for concern but which is not yet definitely irrecoverable. Therefore, although it is prudent immediately to recognise the possible expense of not collecting the debt in the income statement, it would also be wise to keep the original debt in the accounts in case the debtor does in fact pay up.

The double entry of doubtful debt is:

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If a business is faced with a situation where it is highly unlikely that the amount owing by a customer will be received, then the debt is known as a bad debt. So a bad debt is a debt which is uncollectable.

If a debt is considered to be uncollectable then it would be prudent to remove it totally from the accounts and to charge the amount as an expense to the income statement. The original sale remains in the accounts as this did actually take place. The debt is removed as it is considered that the debt will never be paid and an expense is charged to the income statement for bad debts.

The bad debt in accounting shows the double entry:

Example

Aspring have total accounts receivable at the end of their accounting period of $45,000. Mr A who owes $790, has been declared bankrupt, and another who gave his name as B has totally disappeared owing Aspring $1,240.

Step1

Enter the opening balance in the accounts receivable account.

Step2

As the two debt are considered to be irrecoverable, they must be removed from accounts receivable by a credit entry and a corresponding debit entry to a bad debts expense account.

Step3

The account receivable account must now be balanced and the closing balance would appear in the balance sheet as the accounts receivable figure at the end of the period.

$42,970 would appear in the balance sheet as the figure for accounts receivable under current assets at the end of the accounting period.

Step4

Finally, the bad debts in the balance sheet as the figure for accounts receivable under current assets at the end of the accountng period.

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When a sale is made, it might be a sale for cash or it might be a sale on credit. If the sale is on credit terms then the customer will probably take the goods with him or arrange to have them delivered but he will not pay for the goods at that time. Instead, the customer will be given or sent an invoice detailing the goods and their price and the normal payment terms. This will tell the customer when he is expected to pay for those goods.

Under the accruals concept, a sale is included in the ledger accounts at the time that it is made. For a sale on credit, the sale is made at the time that the invoice is sent to the customer and therefore the accounting entries are made at that time as follows:

When the customer eventually settles the invoice the double entry will be:

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The cost of inventory should include all costs of pruchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Cost of purchase includes: import duties, other taxes and transport costs. The discount can be deducted.

For manufactured goods or work in progress, cost must include direct labour and an allocation of fixed and variable overheads. The allocation of fixed overheads needs to be based on the normal level of production, otherwise the cost of inventory could be higher to lower than it should be.

And you should know the overhead expenses which must be excluded are: selling costs, storage costs, abnormal wastage of materials, labour or other production costs, administrative overheads.

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There’re several inventory valuation methods of deciding which items are deemed to be held in inventory:

1. unit cost inventory
2. first-in-first-out (FIFO)
3. last-in-first-out (LIFO)
4. average inventory cost.

Other possibilities are: stardard cost, selling price less gross margin.

Standard cost means the cost taking the normal levels of materials, labour, efficiency and capacity utilisation as determined by the costing system of the business.

Selling price less gross margin may be convenient for retailers for whom the selling price is more accessible than the cost price. The inventory is taken at selling price and then reduced to cost by deducting the appropriate percentage gross margin.

The objective inventory valuation methods are required for goods whose costs can be specifically identified. For other goods, we know the inventory valuation methods: FIFO and LIFO, IAS 2 nominates FIFO or weighted average as benchmark treatment, with LIFO as an allowed alternative. Standard cost or selling price less gross margin could only be used if it was clear that the resulting inventory figures approximate to the actual cost. If LIFO is used, some extra inventory disclosure are added.