Topic 11 - Irrecoverable debts Flashcards
What actions does a credit control system involve?
- Seek trade credit references for large orders
- Seek bank references
- Establish credit limits & continuously review them
- Issue invoices and send them to trade receivables promptly
- Keep accurate and updated records of trade receivables
- Send statements to customers regularly
- Produce an aged trade receivable’s schedule and chase longstanding debts (letters, calls, visits, legal action)
- Evaluate effectiveness of credit control system and revise it to meet the firm needs
Why is it important for a firm’s credit control policy to be successful?
The firm needs to receive money from trade receivables so that it has enough liquidity to pay its own obligations, otherwise the firm may go bankrupt.
What is an irrecoverable debt?
A debt owing to our business which is unlikely to be paid, therefor is written off and recorded as an expense in the income statement.
What is the effect of irrecoverable debts on the financial statements?
- Profit for the year is reduced since irrecoverable debts is an expense
- Capital is reduced
- Current asset of trade receivables is reduced
Why do we account for irrecoverable debts?
- Statement of financial position shows an accurate value for trade receivables
- Income statement shows lower profit for the year after irrecoverable debts is recorded as an expense
- Prudence concept is followed as profits are shown at a correctly conservative figure and asset of trade receivable is not overstated
- Accruals concept is followed as irrecoverable debts are recorded in the year they happen
Why do we account for provision for irrecoverable debts?
Firms have to estimate what proportion of their trade receivables at the end of the year are doubtful and will eventually become irrecoverable debts.
What type of allowances are made regarding provisions for irrecoverable debts?
- General allowances to estimate that a certain part of our trade receivables will not be recovered
- Specific allowances in regards to the financial position of a certain debtor/trade receivable
What is the difference between irrecoverable debts and provision for irrecoverable debts?
- Irrecoverable debts are specific debts that the business knows they will definitely not receive from trade receivables and are written off
- Provision for irrecoverable debts is an estimate of the likely amount of the remaining trade receivables that are doubtful
What is the effect of provision for irrecoverable debts on the financial statements?
- Income statement
- Increase in provision for irrecoverable debts is an expense so profit for the year is reduced
- Decrease in provision for irrecoverable debts is a revenue so profit for the year is increased - Statement of financial position
- Reduced profit for the year will reduce capital
- Provision for irrecoverable debts balance will be deducted from the current asset of trade receivables
Why do we need a provision for irrecoverable debts?
- To show a true and fair view of the results of the business
- To follow accounting concepts
Which accounting concepts does the provision for irrecoverable debts follow and how?
Prudence concept: Final accounts should always report a conservative figure for profit or the valuation of assets and profits are not to be anticipated and any known liabilities should be provided for.
Accruals concept: Charge an expense in the income statement that is related to the sales of that year thus acknowledging possible loss.
When does an irrecoverable debt recovered occur?
When a debt that has been written off in the past is eventually received.
