Year-End Adjustments: Bad and Doubtful Debts Flashcards
(8 cards)
Which of the following best describes a bad debt in financial accounting?
A. A debt that might be paid late due to administrative delays
B. A debt for which payment is expected, but disputed
C. A debt the business has a legal charge over
D. A debt the business knows it will not recover
D. A debt the business knows it will not recover
Explanation: A bad debt is one that is certain not to be paid (e.g. debtor insolvent). It must be written off from the receivables account and recorded as an expense.
What is the correct accounting treatment of doubtful debts?
A. Shown as a liability matched against receivables on the balance sheet
B. Deducted directly from income in the profit and loss account
C. Offset against capital in the balance sheet
D. Written off completely in the trial balance
A. Shown as a liability matched against receivables on the balance sheet
Explanation: A provision for doubtful debts is treated as a liability and shown as a deduction from the receivables account to reflect possible non-payment.
Panache Ltd has £10,000 in receivables. One customer owing £2,000 goes into liquidation before year-end. What is the correct adjustment?
A. Create a doubtful debt provision of £2,000
B. Write off £2,000 as a bad debt expense and reduce receivables accordingly
C. Defer the income related to the £2,000 into the next period
D. Make a general provision of £2,000
B. Write off £2,000 as a bad debt expense and reduce receivables accordingly
Explanation: Since recovery is no longer possible, the amount is treated as a bad debt. It is shown as an expense and deducted from receivables.
Nightingales Ltd had a provision for doubtful debts of £3,000 last year. This year, it increases to £3,800. How should the increase be recorded?
A. £3,800 added as an expense
B. Deduct £800 from capital
C. Show the £3,800 as a liability only
D. Record £800 as an expense in the Profit and Loss Account
D. Record £800 as an expense in the Profit and Loss Account
Explanation: Only the increase in the provision is treated as an expense in the P&L. The total provision (£3,800) appears on the balance sheet.
How does a bad debt adjustment affect the business’s net asset value?
A. It reduces the receivables and overall net assets
B. It increases liabilities and equity
C. It increases income for the period
D. It has no effect on the balance sheet
A. It reduces the receivables and overall net assets
Explanation: A bad debt reduces the amount expected to be received, thereby lowering the value of current assets and net assets.
A £1,000 doubtful debt is eventually paid in full. What should the business do?
A. Transfer it to capital reserve
B. Reverse the provision and recognise the income
C. Do nothing – it was never written off
D. Create a bad debt write-off
B. Reverse the provision and recognise the income
Explanation: If a doubtful debt is recovered, the provision is reversed, and the income is recognised, reflecting the actual payment received.
Which combination below correctly describes where bad debts and doubtful debts appear in the financial statements?
A. Both are shown as capital movements only
B. Doubtful debts in income, bad debts in liabilities
C. Bad debts in expenses and receivables, doubtful debts in expenses and liability matched to receivables
D. Bad debts increase capital, doubtful debts reduce expenses
C. Bad debts in expenses and receivables, doubtful debts in expenses and liability matched to receivables
Explanation: Bad debts reduce receivables and appear as an expense. Doubtful debts reduce net receivables and only the increase appears as an expense.
Why are accruals and provisions for bad and doubtful debts necessary under accounting rules?
A. To improve the tax position of the business
B. To ensure income and expenses are matched to the correct period
C. To enable cash flow planning
D. To avoid posting liabilities on the balance sheet
B. To ensure income and expenses are matched to the correct period
Explanation: This is required by the accruals concept, which underpins proper matching of income and related expenses to give a fair financial picture.
