Adjustments: Bad Debts & Prevision For Doubtful Debts

Question 1

Explain the meaning of the term bad debts

Answer 1

The actual amount that the business will not be able to collect from debtors (written off as irrecoverable)

Question 2

Explain the meaning of the term doubtful debts

Answer 2

Estimated amounts that aren’t bad debts yet but will probably become bad debts

Question 3

Explain the meaning of the term provision for doubtful debts

Answer 3

Estimate of the amount the business will lose due to possible bad debts

Question 4

Explain the meaning of the term bad debts recovered

Answer 4

Money received from debtors after the business has written off their debts

Question 5

What type of account is bad debts?

Answer 5

Expense

Question 6

What type of account is bad debts recovered?

Answer 6

Income

Question 7

What type of account is provision for doubtful debts?

Answer 7

Negative asset (increase on credit side)

Question 8

Explain the need for credit control

Answer 8

• Set credit limits: Keeping control of the amount a debtor owes/ amount the debtor may buy for on credit. This is linked to the debtors income and ability to pay for goods on credit. The higher the income the more can be bought on credit.
• Credit history: Check whether the debtors are previously backlisted and check whether the debtor are credit worthy.

Question 9

Name two objectives that a business wants to achieve when including Provision for Doubtful Debts in the final accounts

Answer 9

1. To charge in the profit and loss account for that year, an amount representing the sales for that year which we will be paid
2. To show in the balance sheet as correct a figure as possible of the true value of debtors at the balance sheet date.

Question 10

When money is received from a debtor who was previously written off as bad the accounting entries will be?

Answer 10

Debit bank/cash

Credit bad debts recovered

Question 11

Name a few ways in which a business could reduce the risk of bad debts

Answer 11

• Obtain references from new credit customers (bank references & other suppliers)
• Set fixed credit limits
• Send out invoices & statements of accounts promptly
• Follow up on overdue accounts
• Supply goods on cash on a delivery basis (cash sales)
• Refuse further supplies until customer pays outstanding amounts.

Question 12

Explain to the bookkeeper why the business maintains a bad debts account, as well as a provision for doubtful debts account.

Answer 12

Bad debts - the actual amount proved to be bad and written off. This is an application of the prudence principle which states that profits shouldn’t be overstated & assets shouldn’t be overvalued.

Provision of doubtful debts - only an estimation, bad debts haven’t been accrued yet. This is application of the matching principle which states that profit is the difference between revenue and expenses within the same financial year.