Some customers never pay. Accounting handles this two ways — one for debts that are certainly lost, one for debts that might be lost.
Irrecoverable (bad) debt
A debt known to be uncollectable is written off in full:
Dr Irrecoverable debts (income statement) · Cr Trade receivables.
Provision (allowance) for doubtful debts
An estimate of receivables that may not pay, usually a % of the remaining receivables:
$\text{Provision} = \text{Receivables} \times \text{rate}\%$Only the change in the provision affects the income statement — an increase is an expense, a decrease is an income.
Worked example
Receivables after write-offs are $50{,}000$; a $4\%$ provision is required $= 2{,}000$. If last year's provision was $1{,}500$, only the increase of $500$ is charged to the income statement.
In the balance sheet, receivables are shown net: Trade receivables − allowance for doubtful debts.
Exam tips
- Irrecoverable = certain loss, written off in full. Doubtful = possible loss, provided for only.
- Never charge the whole provision to the income statement — only the movement.
- Calculate the provision on receivables after removing any irrecoverable debts.