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Questions and Answers
What percentage of trade debtors should Peter provide for in year 1 if his trade debtors total 100K?
Which account is debited when accounting for bad debts?
If Peter's trade debtors at the end of year 2 are 200K and the provision is increased to 6%, what is the total provision required?
How much should Peter increase his provision for bad debts from year 2 to year 3 if his existing provision stands at 12,000?
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What is the new provision required for year 3 after writing off 10K from Peter’s debtors?
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Which entries should be made when recovering a bad debt that was previously written off, based on a total debt of 1,000?
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What effect does the prudence principle have on the accounting treatment of bad debts?
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If a company determines the provision for bad debts based on a percentage of trade debtors, what would be a potential drawback of this method?
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Study Notes
Provision for Bad Debts
- The Prudence Principle states that potential future losses must be accounted for immediately.
- A provision for bad debts is an amount set aside to cover potential losses in the future on debts that may not be collected.
Double Entry for Provisions
- An expense account, "Bad Debts Expense," is debited.
- A provision account, "Provision for Bad Debts," is credited on the balance sheet.
Example: Peter's Trade Debtors
- At the end of year 1, Peter has €100,000 in trade debtors.
- A provision for bad debts is required at 4% of the trade debtors.
- The provision for bad debts is €4,000 (4% of €100,000).
- The following journal entries are created: Debit "Bad Debts Expense" €4,000 and Credit "Provision for Bad Debts" €4,000.
Adjusting the Provision
- At the end of year 2, Peter's trade debtors increase to €200,000.
- The provision for bad debts is increased to 6% of trade debtors.
- The total provision required is €12,000 (6% of €200,000).
- The existing provision is €4,000, therefore an increase of €8,000 is required.
- The following journal entries are created: Debit "Bad Debts Expense" €8,000 and Credit "Provision for Bad Debts" €8,000.
Year 3 Adjustments
- At the end of year 3, there are two situations that occur:
- Write-off: A specific debt of €10,000 is written off as uncollectible.
- Change to provision: The provision is adjusted to 6% of the remaining trade debtors after the write-off.
Write-Off
- Trade debtors at the beginning of year 3: €160,000.
- After writing off €10,000, the remaining trade debtors are €150,000.
Adjusting the Provision after Write-Off
- The required provision after the write-off is €9,000 (6% of €150,000).
- The existing provision from year 2 is €12,000.
- A reduction of €3,000 is required to reach the new provision amount.
- The following journal entries are created: Debit "Provision for Bad Debts" €3,000 and Credit "Bad Debts Expense" €3,000.
Bad Debts Recovered
- If a previously written-off debt is recovered, the transaction is recorded with the following journal entries:
- Debit the debtor's account to re-establish the balance.
- Credit "Bad Debts Recovered" to reflect the recovery.
- Debit "Cash" to reflect the receipt of payment.
- Credit an appropriate account, such as "Accounts Receivable," to balance the entry.
- For example, if €200 from a previously written-off debt of €1,000 was recovered, the entries would debit the debtor's account €200, credit "Bad Debts Recovered" €200, debit "Cash" €200, and credit "Accounts Receivable" €200.
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Description
This quiz covers the principles and double-entry bookkeeping related to provisions for bad debts. It explains the Prudence Principle and provides examples of how to adjust provisions based on changes in debtors. Test your understanding of these key accounting concepts and practices.
