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Irrecoverable debts and the provision
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Some customers never pay. Businesses write off these debts and make a provision for others that may not be paid.
Irrecoverable debts
An irrecoverable debt is one the business is sure will never be paid, for example because the customer has gone bankrupt.
It is written off: Dr irrecoverable debts (expense), Cr the customer's account (trade receivable).
It is written off: Dr irrecoverable debts (expense), Cr the customer's account (trade receivable).
Provision for irrecoverable debts
A provision for irrecoverable debts is an estimate of debts that might not be paid, often a percentage of trade receivables.
It applies prudence: receivables are not overstated.
The provision is shown as a deduction from trade receivables in the statement of financial position.
It applies prudence: receivables are not overstated.
The provision is shown as a deduction from trade receivables in the statement of financial position.
Changing the provision
Only the change in the provision affects profit.
Increase: Dr irrecoverable debts (expense), Cr provision. Profit falls.
Decrease: Dr provision, Cr irrecoverable debts (or income). Profit rises.
Example: receivables £20 000, provision 5% = £1000. Last year's provision was £800. Increase = £200 charged as an expense.
Increase: Dr irrecoverable debts (expense), Cr provision. Profit falls.
Decrease: Dr provision, Cr irrecoverable debts (or income). Profit rises.
Example: receivables £20 000, provision 5% = £1000. Last year's provision was £800. Increase = £200 charged as an expense.
Trade receivables are £30 000 before writing off a £2000 irrecoverable debt. The provision is 4% of the remaining receivables. Find the provision.
- Receivables after write-off = 30 000 − 2000 = £28 000
- Provision = 4% × 28 000
Answer: £1120
Irrecoverable debts are written off: Dr irrecoverable debts, Cr customer. A provision estimates doubtful debts (prudence) and is deducted from receivables. Only the increase or decrease in the provision goes to the income statement.
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