Many businesses sell their goods and services on credit, and once a credit sale
takes place it is recorded in the sales day book and then debited to the sales ledger
control account and credited to the sales account in compliance with the double
entry principle and accruals concept.
Credit sales give rise to the risk of one or more customers not paying after they have
received the goods or services. This may not be a regular occurrence in businesses,
but where the goods or services of a business are offered to its clients on credit, the
risk of bad debt can’t be eliminated completely with certainty, even if the customers
have to sign contracts and credit checks are carried out before offering the customer
any credit facilities.
In compliance with the prudence concept in accounting, profits should only be
recognised when it is reasonably certain that they will be realised. Where there is
any uncertainty or doubt in receiving the money for a credit sale, statement of profit
or loss should not be overstated, and so there may need to be an adjustment made
for irrecoverable or doubtful debt.
Irrecoverable debts are amounts owed to a business which may not likely be paid by
the debtor, having exhausted all possible means of chasing for the payment.
Hence, such amounts need to be written off the books of accounts and should not
continue to be presented within the debtors amounts as a current asset. A bad debt
is a loss to the business as it is a cost the business has to bear and so should be
written off as expenditure.
The effect of the double entry treatment for irrevocable debts is to reduce the debtors
in the statement of financial position, since we are trying to cancel a debt that is
owed to us and to reduce our profit for the accounting period by increasing the
irrevocable debts expense account in the statement of profit or loss.
Dr- Irrevocable debts account (Statement of profit or loss)
Cr- Receivables ledger control account (Statement of financial position)
Illustration 1:
In going through the debtors list of the business, the manager realises there is a debt
of £320 owed from Thames Vision for over 2 years. Having chased for payment of
this debt over the period, he has decided to write it off as irrecoverable debt.
You are required to set out the double entry posting.
Solution:
Dr- Irrevocable debts account £320
Cr- Receivables ledger control account £320