Question

The financial manager of Steven Traders hired an inexperienced bookkeeper, on 1 February 20.19, who was immediately required to assist with the creation of an allowance for credit losses (current financial year ends on 28 February 20.19). The auditors of Steven Traders raised an audit finding in the previous financial period, stating that trade and other receivables were overstated since no allowances for credit losses has been created although there was evidence that some of the debtors did not pay their accounts in the previous financial periods. The financial manager wants to avoid this audit finding in the current financial period.

The financial manager requested the bookkeeper to write a memo and indicate which accounts will be affected when the allowance for credit losses is created? The bookkeeper has written the following statements down and requires you to confirm which of the statement/s is/are true when the allowance for credit losses is created.

1. When the allowance for credit losses is created, you will debit the credit losses account and credit the allowance for credit losses account.
2. The balance on the trade receivable control account in the general ledger will be affected by the allowance for credit losses.
3. The allowance for credit losses must be deducted from the trade receivables control account to determine the amount at which debtors must be disclosed under trade and other receivables in the statement of financial position.
4. When the allowance for credit losses is created, credit the credit losses account and debit the allowance for credit losses account.
5. Trade receivables control account balance in the general ledger will only be reduced when the actual credit losses are verified, by either; (i) debiting the allowance for credit losses and crediting trade receivable/control account, or by (ii) debiting the credit losses and crediting trade receivable/control account (while the allowance for credit losses remain unchanged).

• A.

  b and e

• B.

  a, b, c and e

• C.

  c and d

• D.

  a, c and e

• E.

  b and c

Answer 1

Option D is correct (meaning that statements a, c and e are correct).

a.) When the allowance for credit losses is created, you will debit the credit losses account and credit the allowance for credit losses account.

This is the basic accounting entry made for recording an allowance for Doubtful debts.Expense is booked and the amount is credited to a special allowance account instead of directly crediting the Accounts Receivable.

c.) The allowance for credit losses must be deducted from the trade receivables control account to determine the amount at which debtors must be disclosed under trade and other receivables in the statement of financial position.

While showing the financial position, the allowance is reduced from Accounts Receivables and only the net receivable amount is disclosed in the financial position.

e.) Trade receivables control account balance in the general ledger will only be reduced when the actual credit losses are verified, by either; (i) debiting the allowance for credit losses and crediting trade receivable/control account, or by (ii) debiting the credit losses and crediting trade receivable/control account (while the allowance for credit losses remain unchanged).

On actual credit losses are verified, they are adjusted with the allowance already created instead of booking a seperate expense (because allowance is already created by booking an estimated expense). Alternatively, the Receivables may be reduced by directly crediting the receivables account and booking (debiting) a credit loss expense, in which case, the amount of allowance remains as it is.

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