prepare ledger accounts and journal entries to record recovery of debts written off

Topic 4.4 – Irrecoverable Debts and Provision for Doubtful Debts

Learning objectives

• Explain why trade receivables become irrecoverable.
• Distinguish between the direct write‑off method and the provision (allowance) method.
• Prepare the journal entries and T‑accounts for:
  • creating a provision,
  • writing‑off a debt,
  • recovering a debt that has been written off (both methods).
• Analyse the effect of each entry on the profit‑and‑loss account and the statement of financial position.
• Apply the above in exam‑style questions (Cambridge IGCSE 0452).

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1. The fundamentals of accounting (Syllabus Section 1)

• Purpose of accounting – to provide reliable, relevant information for decision‑making.
• Accounting equation – Assets = Liabilities + Owner’s equity.
• Double‑entry principle – every transaction affects at least two accounts, one debit and one credit, keeping the equation in balance.

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2. Sources and recording of data (Syllabus Section 2)

2.1 Business documents

• Invoices, receipts, credit notes, bank statements, purchase orders, etc.

2.2 Books of prime entry

Book	Purpose
Sales journal	Record credit sales of goods/services
Purchases journal	Record credit purchases of goods/services
Cash book	Record all cash receipts & payments
General journal	Record non‑repetitive or adjusting entries (e.g., bad‑debt provision)

2.3 Posting to the ledger

Each entry from a book of prime entry is posted to the appropriate T‑account in the ledger. The ledger balances are later used to prepare the trial balance.

2.4 Example – posting a credit sale

Invoice No 101 – £5 000 sold on credit to ABC Ltd.

Sales journal      Debit   Credit
---------------------------------
Trade Receivables          5 000
   Sales Revenue           5 000

Post to the ledger:

Trade Receivables	Debit (£)	Credit (£)
	5 000

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3. Verification of accounting records (Syllabus Section 3)

3.1 Trial balance

• Lists the debit and credit balances of all ledger accounts.
• Must balance (total debits = total credits); otherwise an error exists.

3.2 Common errors

Error type	Effect on trial balance
Omission	No effect – both debit and credit omitted
Commission	Unbalanced – totals differ
Reversal	Unbalanced – totals differ
Transposition	Unbalanced – totals differ

3.3 Bank reconciliation (brief)

• Adjusts the cash‑book balance for deposits in transit, outstanding cheques, bank charges, and errors.
• Ensures the cash balance shown in the statement of financial position is correct.

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4. Accounting procedures (Syllabus Section 4)

4.1 Revenue vs. capital items

• Revenue items affect profit‑and‑loss (e.g., sales, expenses).
• Capital items affect the balance sheet (e.g., purchase of equipment).

4.2 Depreciation (example)

Method	Journal entry (annual)
Straight‑line (cost £12 000, residual £2 000, 5 years)	Depreciation Expense  £2 000   Accumulated Depreciation – Equipment  £2 000
Reducing‑balance (20 % p.a.)	Depreciation Expense  £2 400 (20 % of £12 000)   Accumulated Depreciation – Equipment  £2 400

4.3 Accruals and pre‑payments

Situation	Adjusting entry
Rent due but not yet paid (£1 200)	Rent Expense  £1 200   Accrued Expenses (Rent Payable)  £1 200
Insurance prepaid for 12 months (£1 200) – one month used	Insurance Expense  £100   Pre‑paid Insurance  £100

4.4 Inventory valuation (lower of cost or NRV)

When the net realisable value (NRV) of stock falls below cost, write‑down the inventory and recognise a loss.

4.5 Provision for doubtful debts (core of this topic)

Required by the Cambridge syllabus. It is a contra‑asset account that anticipates that a portion of trade receivables will become irrecoverable. It satisfies the matching principle and the principle of prudence.

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5. Irrecoverable debts – detailed treatment

5.1 Why debts become irrecoverable

• Bankruptcy or cessation of trading.
• Dispute over goods or services supplied.
• Long periods of non‑payment with no reasonable prospect of collection.

5.2 Methods of accounting for irrecoverable debts

5.2.1 Direct write‑off method (used by very small businesses)

1. Identify a specific debt as irrecoverable.
2. Remove it from Trade Receivables and charge the amount to Bad Debts Expense.

Write‑off of £2 500
Account	Debit (£)	Credit (£)
Bad Debts Expense	2 500
Trade Receivables		2 500

5.2.2 Provision (allowance) method – required for Cambridge

Two steps: create/adjust a provision and then write‑off against it.

Creating a provision

At period‑end estimate the doubtful‑debt amount (e.g., 5 % of total receivables) and record:

Create provision of £1 200 (5 % of £24 000 receivables)
Account	Debit (£)	Credit (£)
Bad Debts Expense	1 200
Provision for Doubtful Debts		1 200

Adjusting the provision (if the estimate changes)

Only the difference between the new estimate and the existing balance is recorded.

Increase provision by £300
Account	Debit (£)	Credit (£)
Bad Debts Expense	300
Provision for Doubtful Debts		300

Writing‑off a specific debt using the provision

When a debtor is confirmed as irrecoverable, use the provision to remove the amount from receivables.

Write‑off £2 500 using the provision
Account	Debit (£)	Credit (£)
Provision for Doubtful Debts	2 500
Trade Receivables		2 500

5.3 Recovering a debt that has been written off

5.3.1 Recovery after a direct write‑off

1. Reverse part of the original write‑off (re‑establish the receivable).
   

   Step 1 – Reverse £1 200 of the write‑off
   Account	Debit (£)	Credit (£)
   Trade Receivables	1 200
   Bad Debts Expense		1 200

2. Record the cash receipt.
   

   Step 2 – Cash receipt of £1 200
   Account	Debit (£)	Credit (£)
   Cash	1 200
   Trade Receivables		1 200

5.3.2 Recovery after a write‑off using the provision

1. Reduce the provision (reverse part of the write‑off).
   

   Step 1 – Reverse £1 200
   Account	Debit (£)	Credit (£)
   Provision for Doubtful Debts	1 200
   Bad Debts Expense		1 200

2. Record the cash receipt (same as above).
   

   Step 2 – Cash receipt of £1 200
   Account	Debit (£)	Credit (£)
   Cash	1 200
   Trade Receivables		1 200

5.3.3 T‑account illustration (both methods)

Bad Debts Expense		Provision for Doubtful Debts		Trade Receivables		Cash
Debit	Credit	Debit	Credit	Debit	Credit	Debit	Credit
2 500 (write‑off)					2 500 (write‑off)
	1 200 (reversal)			1 200 (reversal)
					1 200 (cash receipt)	1 200 (cash receipt)
1 200 (create provision)			1 200 (provision created)
		2 500 (write‑off)			2 500 (write‑off)
	1 200 (recovery reversal)	1 200 (recovery)				1 200 (cash receipt)

5.4 Effect on the profit‑and‑loss account

• Creating a provision – debits Bad Debts Expense, reducing profit for the period.
• Writing‑off a debt (direct method) – also debits Bad Debts Expense, further reducing profit.
• Writing‑off using the provision – no new expense; the provision already reduced profit when created.
• Recovery (both methods) – credits Bad Debts Expense, partially reversing the earlier expense and therefore increasing profit in the recovery period.

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6. Preparation of financial statements (Syllabus Section 5)

6.1 Where the provision appears

• On the Statement of Financial Position (balance sheet) as a contra‑asset, reducing the gross amount of Trade Receivables.
• On the Statement of Profit or Loss as part of Bad Debts Expense (or “Operating expenses”).

6.2 Checklist for a sole‑trader (example)

1. Adjust the trial balance for:
   • Depreciation
   • Accrued expenses / pre‑payments
   • Provision for doubtful debts
2. Prepare the Income Statement – include all expense adjustments.
3. Calculate net profit (or loss).
4. Transfer net profit to the Capital account (owner’s equity).
5. Prepare the Statement of Financial Position – show net trade receivables (gross receivables less provision).

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7. Exam‑style questions (Cambridge IGCSE 0452)

1. Provision only
   “At 31 March a company’s trade receivables total £30 000. The accountant estimates that 4 % will be uncollectible. Prepare the journal entry to create the provision.”
2. Write‑off using the provision
   “On 10 April a customer owing £3 600 is declared bankrupt. Record the write‑off using the provision for doubtful debts.”
3. Recovery after a direct write‑off
   “A debt of £2 500 was written off on 31 March. The customer pays £1 200 on 15 June. Prepare the journal entries required to record the recovery and show the effect on the profit‑and‑loss account.”
4. Recovery after a provision write‑off
   “A provision of £1 200 was created on 31 March. On 20 May a debt that had been written off against that provision is partially recovered for £500. Record the necessary journal entries and comment on the impact on profit.”
5. Full question covering all steps
   “A company’s trade receivables at 31 December are £40 000. The accountant decides to provide for 5 % doubtful debts. During the year a specific debt of £3 000 becomes irrecoverable and is written off using the provision. In February of the following year the customer pays £1 200 of that debt.
   1. Prepare the journal entry to create the provision.
   2. Record the write‑off.
   3. Record the recovery.
   4. Explain how each entry affects the profit‑and‑loss account.

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8. Expanded checklist for recording a recovery

1. Identify the amount being recovered and whether the original write‑off used the direct method or the provision.
2. Make the reversal entry:
   • Direct method – Debit Trade Receivables, Credit Bad Debts Expense.
   • Provision method – Debit Provision for Doubtful Debts, Credit Bad Debts Expense.
3. Record the cash receipt – Debit Cash, Credit Trade Receivables.
4. Post all entries to the relevant T‑accounts and verify that the trial balance remains in balance.
5. Show the net effect on the profit‑and‑loss account (the credit to Bad Debts Expense increases profit).
6. Update the Statement of Financial Position – net trade receivables should reflect the recovered amount.
7. Check that the total of the two entries equals the cash actually received.

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9. Summary of key points

• Irrecoverable debts are inevitable; the provision method is the preferred approach for IGCSE because it matches the expense with the related revenue.
• Creating a provision reduces profit in the period of estimation; writing‑off against the provision does not affect profit again.
• Recoveries always involve a reversal of part of the original expense (credit to Bad Debts Expense) and a cash receipt.
• On the balance sheet, the provision is shown as a deduction from Trade Receivables, giving the net amount expected to be collected.
• All adjustments (provision, depreciation, accruals, pre‑payments) must be reflected in the trial balance before the final financial statements are prepared.