Irrecoverable Debts (Cambridge International A-Level Accounting)

Irrecoverable debts written off

What are irrecoverable debts?

• An irrecoverable debt occurs when a business is unable to receive payment from a credit customer for the amount they owe

  • The customer might have declared bankruptcy
  • The business might no longer be able to contact the customer

• Irrecoverable debts used to be referred to as bad debts

• Irrecoverable debts are written off by the business, as it is unlikely to receive these amounts

• Irrecoverable debts are written off in order to follow the accounting principle of prudence

  • Writing off irrecoverable debts reduces the amount owed by trade receivables
  • As a result, assets are not overstated

• A business will try to collect as much of the amount owed by the customer as possible before writing the debt off

• Irrecoverable debt is an expense to the business

  • It reduces the profit for the year

How do I record irrecoverable debts in the ledger accounts?

• Credit the relevant trade receivables account in the sales ledger

  • The amount they owe is decreasing

• Debit the irrecoverable debts account in the nominal ledger

  • This is an expense

• The book of prime entry for irrecoverable debts written off is the journal

How can a business prevent irrecoverable debts?

• Ideally, a business does not want to write off any debts

• A business can prevent irrecoverable debts by:

  • Setting a credit limit for credit customers

    • This is a limit to how much a customer can owe at any time

  • Performing credit checks on potential new customers

    • This is useful if customers want to purchase a lot of goods

  • Communicating regularly with credit customers

    • Sending regular statements of accounts
    • Sending emails and calling customers to remind them of their balances

  • Taking legal action against customers who fail to pay for their goods

    • This is usually a last resort
    • This will cost the business so sometimes it will not be worthwhile if the debt is less than the legal fee

Worked Example Caesar maintains a full set of accounting records. At the start of January 2024, a credit customer, Julius, owes Caesar $1 200. On 3 January 2024, Caesar received $500 in cash from Julius. On 25 January 2024, Caesar is notified that Julius has declared bankruptcy and decides to write off the rest of his debt and close his account.

Complete the account for Julius in Caesar’s sales ledger.

Answer:

Identify which side to post each transaction.

• At the start of January, Julius owes Caesar money

  • Therefore the opening balance will be on the debit side

• The payment made by Julius reduces the amount he owes

  • Therefore it is entered on the credit side

• The remaining balance, $700, is written off

  • This will be entered on the credit side to balance the account

Final answer: Caesar Julius Sales Ledger Account

Final answer: Date	Final answer: Details	Final answer: $**	Final answer: Date	Final answer: Details	Final answer: **$
Final answer: 2024 Final answer: Jan 1	Final answer: Balance b/d	Final answer: 1 200	Final answer: 2024 Final answer: Jan 3	Final answer: Cash	Final answer: 500
			Final answer: Jan 25	Final answer: Irrecoverable debts	Final answer: 700
		Final answer: 1 200			Final answer: 1 200

Irrecoverable debts recovered

Can irrecoverable debt that have been written off be recovered?

• It is possible that a business receives a payment from a customer for a debt that has already been written off

  • The payment could be for the full amount or part of the amount

• This can happen if:

  • the business manages to contact the customer
  • the customer makes an unexpected payment
  • the money is retrieved using debt collection services

How do I record the recovery of irrecoverable debts written off in the ledger accounts?

• The book of prime entry for the recovery of debts written off is the cash book

• There are two methods for recording the recovery of debts written off

• One method is usually used if the recovery occurs within the same financial period as the debts being written off

  • The debt is added back to the relevant trade receivables account

    • Debit the trade receivables account in the sales ledger with the amount received
    • Credit the debts recovered account

  • The payment then is recorded as normal

    • Debit the cash or bank account
    • Credit the trade receivables account

• The other method is usually used if the debt was written off in a previous financial period

  • The sales ledger is not used

    • Debit the cash or bank account
    • Credit the debts recovered account

Exam Hint You can use either method in an exam question.

How does the recovery of debts written off affect the profit for the year?

• Recovery of debts written off increases profit for the year

  • It can be treated as an income to the business

• There are two options for dealing with debts recovered at the end of the year

  • The balance in the debts recovered account can be transferred to the irrecoverable debts account to reduce that balance

    • This reduced balance is then transferred as an expense to the statement of profit or loss
    • This method is usually used if the recovery occurs within the same financial period as the debts being written off

  • Or the balance in the debts recovered account can be transferred as an income directly to the statement of profit or loss

    • This method is usually used if the debt was written off in a different financial period
    • This method is also used if the balance in the debts recovered account is bigger than the balance in the irrecoverable debts account

Worked Example Tim sells goods on credit. Tim maintains a full set of accounting records, and his financial year ends on 29 February 2024.

Henry, a customer, had a balance of $750 owing to Tim. On 3 May 2023, Henry’s balance of $750 was written off by Tim as irrecoverable debt after six months of failed attempts at contacting Henry. On 1 December 2023, Tim received a cheque for $300 from Henry. No other debts were written off, and no other debts were recovered in that financial year.

Record the information in the irrecoverable debts account and the debts recovered account. Close the accounts at the end of the financial year by balancing or by making a transfer to an appropriate account.

Answer:

• Post the written off debt, $750, to the debit side of the irrecoverable debts account as it is an expense

  • Label the entry as Henry

• Post the recovered debt, $300, to the credit side of the debts recovered account as it is an income

  • Label the entry as bank or Henry, both are allowed

At the end of the year transfer the balances to the statement of profit or loss

One option is to transfer the balances separately

Final answer: Tim Irrecoverable Debts Account

Final answer: Date	Final answer: Details	Final answer: $**	Final answer: Date	Final answer: Details	Final answer: $
Final answer: 2023 Final answer: May 3	Final answer: Henry	Final answer: 750	Final answer: 2024 Final answer: Feb 29	Final answer: Statement of profit or loss	Final answer: 750
		Final answer: 750			Final answer: 750

Final answer: Tim Debts Recovered Account

Final answer: Date	Final answer: Details	Final answer:****$	Final answer: Date	Final answer: Details	Final answer: $
Final answer: 2024 Final answer: Feb 29	Final answer: Statement of profit or loss	Final answer: 300	Final answer: 2023 Final answer: Dec 1	Final answer: Bank (or Henry)	Final answer: 300
		Final answer: 300			Final answer: 300

Alternatively, transfer the balance from the debts recovered account to the irrecoverable debts account and then close that account by transferring the balance to the statement of profit or loss

Final answer: Tim Debts Recovered Account

Final answer: Date	Final answer: Details	Final answer:****$	Final answer: Date	Final answer: Details	Final answer: $
Final answer: 2024 Final answer: Feb 29	Final answer: Irrecoverable debts	Final answer: 300	Final answer: 2023 Final answer: Dec 1	Final answer: Bank (or Henry)	Final answer: 300
		Final answer: 300			Final answer: 300

Final answer: Tim Irrecoverable Debts Account

Final answer: Date	Final answer: Details	Final answer:****$	Final answer: Date	Final answer: Details	Final answer: **$
Final answer: 2023 Final answer: May 3	Final answer: Henry	Final answer: 750	Final answer: 2024 Final answer: Feb 29	Final answer: Debts recovered	Final answer: 300
			Final answer: Feb 29	Final answer: Statement of profit or loss	Final answer: 450
		Final answer: 750			Final answer: 750