Learning Outcomes
After reading this article, you will be able to distinguish between recoverable and irrecoverable debts, explain when and why a receivable is written off, prepare the journal entries for irrecoverable debt write-off, and state the consequences for both the statement of profit or loss and the statement of financial position. You will also understand the key terms used in exam questions on this subtopic.
ACCA Maintaining Financial Records (FA2) Syllabus
For ACCA Maintaining Financial Records (FA2), you are required to understand how irrecoverable debts are accounted for, including their write-off and impact on financial statements. Focus your revision on the following areas:
- Define and identify irrecoverable debts in the context of receivables
- Prepare and explain the journal entries to write off irrecoverable debts
- Record adjustments in the general ledger and understand their effect on the statement of profit or loss and the statement of financial position
- Recognise when to write off a trade receivable based on available evidence
- Understand the principles of prudence and accruals in relation to irrecoverable debts
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the correct double-entry to record the write-off of an irrecoverable trade receivable?
- Which qualitative characteristic is directly applied when an irrecoverable debt is written off? a) Faithful representation b) Timeliness c) Comparability d) Understandability
- True or false? If a previously written-off trade receivable pays in a later period, it should be credited to sales revenue in that period.
- How does writing off an irrecoverable debt affect both the statement of profit or loss and the statement of financial position?
Introduction
Entities that sell goods or services on credit face the risk that some customers will be unable to pay. When it becomes certain that a trade receivable will not be collected, it is written off as an irrecoverable debt, removing it from the receivables balance and recording an expense in the statement of profit or loss. This adjustment ensures financial statements do not overstate assets or profit.
Key Term: irrecoverable debt
An amount owed to the entity by a credit customer which is considered uncollectible and is written off as an expense.Key Term: trade receivable
An individual or entity that owes money to the business as a result of goods or services sold on credit.Key Term: prudence
The accounting principle requiring that potential losses are recognised as soon as they are foreseen, but profits are only recognised when earned.
Identifying and Writing Off Irrecoverable Debts
Recognition of Irrecoverable Debts
Irrecoverable debts arise when there is strong evidence that an amount due from a credit customer will not be collected. This could occur if:
- The debtor has been declared bankrupt
- The debtor cannot be traced
- Legal action to recover the debt has failed or is not economical
When a debt is concluded to be irrecoverable, it should be removed from receivables and recorded as an expense. This action applies the principle of prudence, ensuring assets and profit are not overstated.
Journal Entry for Write-off
The accounting entry to write off an irrecoverable debt is as follows:
- Debit: Irrecoverable debts expense (statement of profit or loss)
- Credit: Trade receivables
This entry reduces assets (trade receivables) and records an expense in the correct period.
Worked Example 1.1
Situation:
Aris Ltd has trade receivables of $15,200. After reviewing the accounts, it is discovered that Rasheed owes $500 and has been declared bankrupt, and another customer, Kestrel Ltd, owing $750, has been uncontactable for months. Both amounts are considered irrecoverable. Show the journal entries and state the effect on the financial statements.
Answer:
Journal entry:
- Debit Irrecoverable debts expense $1,250 ($500 + $750)
- Credit Trade receivables $1,250 Effect:
- The trade receivables balance in the statement of financial position is reduced by $1,250.
- The irrecoverable debts expense increases expenses in the statement of profit or loss by $1,250, decreasing net profit.
Accounting in the General Ledger
Writing off an irrecoverable debt involves both the trade receivables ledger account and the irrecoverable debts expense account. The trade receivable’s account will be credited with the amount written off, and the irrecoverable debts expense account will be debited.
Key Term: general ledger
The main set of accounts that summarises all of an entity’s financial transactions, including receivables and expenses.
Recovery of Previously Written-off Debts
Sometimes, payment is received for a debt that was written off in a prior period. This should not be recorded as revenue. Instead, the cash is credited to the irrecoverable debts expense account, reducing the total expense for the current period.
Worked Example 1.2
Situation:
Last year, Ace Consultants wrote off a $300 receivable from Maya Ltd as irrecoverable. In the current year, Maya Ltd unexpectedly pays the $300 in full.
Answer:
Journal entry:
- Debit Cash at bank $300
- Credit Irrecoverable debts expense $300 This reduces the current period’s irrecoverable debts expense and does not affect revenue.
Exam Warning
The write-off of an irrecoverable debt is not a reversal of the original sales transaction. Only remove the receivable and record the expense. Do not adjust sales revenue.
Financial Statement Impact
Statement of Profit or Loss
The amount written off appears as ‘Irrecoverable debts expense’ under administrative expenses. This reduces net profit for the period in which the write-off occurs.
Statement of Financial Position
Trade receivables are reported net of any amounts written off. Only amounts considered collectible are shown as assets.
Worked Example 1.3
Situation:
A trial balance includes the following at year-end: Trade receivables $22,100, Irrecoverable debts expense $0. After a review, debts totalling $1,600 are found to be irrecoverable.
Show the revised balances as they would appear in the financial statements.
Answer:
- Statement of profit or loss: Irrecoverable debts expense increases by $1,600.
- Statement of financial position: Trade receivables reported as $20,500 ($22,100 - $1,600).
Revision Tip
Review the specific evidence required to determine when a debt is irrecoverable. In the exam, irrelevant write-offs or delays in action can result in incorrect answers.
Summary
An irrecoverable debt is a receivable that will not be collected and must be written off promptly, reducing both profit and receivables. The journal entry is always: Debit irrecoverable debts expense, Credit trade receivables. If a previously written-off amount is later received, it is credited to irrecoverable debts expense, not sales. Writing off irrecoverable debts ensures financial statements show a realistic value of assets and an accurate measure of profit in accordance with prudence.
Key Point Checklist
This article has covered the following key knowledge points:
- Define irrecoverable debt and trade receivable
- Identify when a debt becomes irrecoverable
- Prepare the correct journal entry to write off an irrecoverable debt
- Record a recovery of a previously written-off debt
- Explain the impact on the statement of profit or loss and the statement of financial position
- Apply the principle of prudence in receivables adjustments
Key Terms and Concepts
- irrecoverable debt
- trade receivable
- prudence
- general ledger