Section A: Key terms and recall
Define the term 'irrecoverable debts'. [2 marks]
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Money that is owed to a business but is unlikely to be paid by the customer. [1 mark] These debts are written off as they are not expected to be recovered. [1 mark]
What does it mean when an irrecoverable debt is 'recovered'? [2 marks]
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When a debt that was previously written off as irrecoverable is actually paid by the customer. [1 mark] This means the business can reinstate the debt and record the payment received. [1 mark]
List the journal entries required to record an irrecoverable debt. [2 marks]
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Debit: Irrecoverable Debts Account [1 mark] Credit: Debtors Control Account [1 mark]
List the journal entries required to record the recovery of an irrecoverable debt. [2 marks]
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Debit: Bank Account [1 mark] Credit: Irrecoverable Debts Account [1 mark]
Why is it necessary to maintain an allowance for irrecoverable debts? [2 marks]
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To estimate the amount of debts that are likely to be irrecoverable in the future. [1 mark] This allows the business to be realistic about the value of its debts and to avoid overstating its assets. [1 mark]
Section B: Applying your knowledge
On 1st January 2023, ABC Ltd wrote off a debt of £500 owed by a customer who had gone bankrupt. On 1st June 2023, the customer unexpectedly paid the debt in full. Prepare the journal entries to record these transactions. [4 marks]
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1st January 2023: Debit: Irrecoverable Debts Account £500 [1 mark] Credit: Debtors Control Account £500 [1 mark] 1st June 2023: Debit: Bank Account £500 [1 mark] Credit: Irrecoverable Debts Account £500 [1 mark]
On 31st December 2022, XYZ Ltd estimated that 2% of its debtors were likely to be irrecoverable. The debtors control account balance at this date was £20,000. Prepare the journal entry to record the allowance for irrecoverable debts. [4 marks]
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31st December 2022: Debit: Profit and Loss Account £400 [1 mark] Credit: Allowance for Irrecoverable Debts Account £400 [1 mark] Calculation: 2% of £20,000 = £400 [2 marks]
On 31st December 2022, DEF Ltd had an allowance for irrecoverable debts of £300. During the year ended 31st December 2023, the company wrote off debts totalling £250. Prepare the journal entry to adjust the allowance for irrecoverable debts. [4 marks]
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31st December 2023: Debit: Allowance for Irrecoverable Debts Account £250 [1 mark] Credit: Profit and Loss Account £250 [1 mark] The remaining balance on the Allowance for Irrecoverable Debts Account is £50 (£300 - £250). [2 marks]
On 1st January 2023, GHI Ltd had an allowance for irrecoverable debts of £500. During the year, the company wrote off debts totalling £400. On 31st December 2023, the company estimated that 3% of its debtors were likely to be irrecoverable. The debtors control account balance at this date was £25,000. Prepare the journal entries to adjust the allowance for irrecoverable debts. [6 marks]
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1st January 2023 to 31st December 2023: Debit: Allowance for Irrecoverable Debts Account £400 [1 mark] Credit: Profit and Loss Account £400 [1 mark] 31st December 2023: Debit: Profit and Loss Account £750 [1 mark] Credit: Allowance for Irrecoverable Debts Account £750 [1 mark] Calculation: 3% of £25,000 = £750 [2 marks] The remaining balance on the Allowance for Irrecoverable Debts Account is £750 (£500 + £750 - £400). [1 mark]
Section C: Explain and analyse
Explain the need for an allowance for irrecoverable debts and discuss the factors that a business might consider when estimating the allowance. [6 marks]
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An allowance for irrecoverable debts is needed to estimate the amount of debts that are likely to be irrecoverable in the future. [1 mark] This allows the business to be realistic about the value of its debts and to avoid overstating its assets. [1 mark] Factors that a business might consider when estimating the allowance include: - The age of the debts [1 mark] - The financial position of the debtors [1 mark] - The industry norms and historical data [1 mark] - The economic conditions [1 mark] By considering these factors, the business can make a more accurate estimate of the allowance for irrecoverable debts. [1 mark]
Analyse the impact of writing off an irrecoverable debt on the financial statements of a business. [6 marks]
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Writing off an irrecoverable debt has the following impacts on the financial statements of a business: 1. The debt is removed from the Debtors Control Account, which reduces the value of the debtors on the Statement of Financial Position. [1 mark] 2. The irrecoverable debt is recorded as an expense in the Profit and Loss Account, which reduces the profit for the period. [1 mark] 3. The allowance for irrecoverable debts is adjusted to reflect the change in the estimated amount of irrecoverable debts. [1 mark] 4. The reduction in debtors and the increase in expenses may affect the liquidity and profitability ratios of the business. [1 mark] 5. The business may need to disclose the amount of irrecoverable debts written off in the notes to the financial statements. [1 mark] 6. The overall impact on the financial statements depends on the size of the irrecoverable debt and the financial position of the business. [1 mark]
Section D: Challenge
A business has the following information at the end of its financial year:
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1. Journal entries: Irrecoverable debts written off during the year: Debit: Allowance for Irrecoverable Debts Account £500 [1 mark] Credit: Profit and Loss Account £500 [1 mark] Adjustment of the allowance for irrecoverable debts: Debit: Profit and Loss Account £150 [1 mark] Credit: Allowance for Irrecoverable Debts Account £150 [1 mark] Calculation: 2.5% of £30,000 = £750 [2 marks] The remaining balance on the Allowance for Irrecoverable Debts Account is £1,250 (£600 + £750 - £500). [1 mark] 2. Impact on the financial statements: 1. The Debtors Control Account balance is reduced by the amount of irrecoverable debts written off, which reduces the value of the debtors on the Statement of Financial Position. [1 mark] 2. The allowance for irrecoverable debts is adjusted to reflect the change in the estimated amount of irrecoverable debts, which affects the value of the debtors on the Statement of Financial Position. [1 mark] 3. The adjustments to the allowance for irrecoverable debts are recorded as expenses in the Profit and Loss Account, which reduces the profit for the period. [1 mark] 4. The overall impact on the financial statements depends on the size of the irrecoverable debts and the financial position of the business. [1 mark]