Question

Explain with the use of a numerical example why any adjustment for the allowance for irrecoverable receivables at the year-end will either lead to a decrease or an increase in the allowance for irrecoverable receivables. How would both an increase and a decrease in the allowance for irrecoverable receivables be shown in the income statement? Use 175 words or less for your whole answer to this question.

Answer 1

Answer:

Receivables or Account Receivables: When there is a credit sale, the purchaser or the Debtor agrees to pay the debt amount within the given credit period or the time period given to pay the debt or due. In practice every business makes credit sale for the convenience of the buyer or to increase the sale. The debt or the due amount should be paid within 30 days from the day of sale or as per the agreement decided between the parties. Most of Business encourage prompt payment by allowing 2% discount on the sale amount, if the payment is made by the debtor within 10 days from the time of sale. In short it is the debt owned by the customer to the company for the goods and services used. It is considered as the part of working capital and shown under current assets in the balance sheet.

Irrecoverable Receivables (or) Bad Debts: There can be are number of reasons such as customer going bankrupt, trade dispute, or even fraud due to which customer fails to make the payment on the due date. If the company realize it is impossible to collect the debt from the customer, then the amount is considered as irrecoverable receivables or bad debt. Company write off this amount as an expense in the Income Statement and the same amount is reduced from the Debtors in the current assets. There are also instances where the company considers an amount as irrecoverable debt and write off however the amount gets paid. These amounts are considered as bad debts recovered and considered as income for the company.

Allowance for Irrecoverable Debts: Every year a company arrives at a percentage to provide an allowance for irrecoverable receivables. The percentage for the allowance of irrecoverable debts is arrived considering various factors such as percentage of previous bad debts of the customer or economic condition. Amount which is consider as worthless and written off as bad debts in current year may at times be recovered in the subsequent year. The amount recovered is considered as income.

For Example: Company A made a sale of inventory of $ 100,000 to Company B on 22nd December 2018. The debt is due on 22nd January 2019. Company B has an historical pay record of paying dues promptly. However, legal suit was filed on company B on 25th December by an outsider for breach of Patent right. Company A decides to Provide an allowance of 15% as irrecoverable Debts.

On 22nd January 2019 Company B made a payment of $90,000 and the remaining amount is considered as bad debt are written off. Previously written off bad debts is recovered on 26th December 2018.