BAD DEBTS AND ALLOWANCE FOR DOUBTFUL ACCOUNTS IN THE FINANCIAL STATEMENTS
To understand the recovery of money one needs to understand what goes into a balance sheet and in an allowance sheet? In this blog, we will understand the nuances of how allowance of doubtful accounts or bad debts are adjusted in the balance sheet and how a debt recovery company can identify them by observing the balance sheet of the company. Adjustment to the allowance for doubtful accounts will be recorded in the allowance sheet. If the adjustment of the new allowance for the doubtful accounts has increased it goes under other expenses and if it has decreased it goes into other income. So, if there was an allowance in the previous period and you have a new allowance then if the new allowance is greater than the previous allowance it will be put under expenses and if the old allowance is greater than the new allowance then it is under other income.
For example, in the balance sheet, it is given as
Debtors’ control – New bad debt or bad debts given to this period – The new allowance for doubtful accounts or the one that you have to calculate for this period
Let us illustrate this via some assumed data for the financial year 2017-2018:
Let Debtors control be Rs.65000, bad debts Rs.1500, allowance for doubtful accounts Rs. 2000 is the pre-adjustment trial balance on 28th February 2018. These are related to bad debts/doubtful accounts and the adjustment and additional information will be the account of kredi Los. A debt must be written as unrecoverable and Rs.1000 rent allowance for doubtful accounts must be adjusted to five percent of outstanding receivables. So the requirement will be to prepare the income statement and balance sheet for the year ended 28th February 2018. However, we are going to focus on debt recovery and allowance for doubtful accounts so the calculations and the income statements will be the given allowance for the doubtful accounts of Rs. 2000 which was from the previous period. So, we have debtors control of Rs. 65000 rent. Now, the new allowance for doubtful allowance: (R65000-R1000)×5%=R3200. So now we do know the adjustment to the income statement: the new allowance for the doubtful accounts of 3200 rent minus the old allowance for the doubtful account. This will be an adjustment: R3200 -R2000 =R1200. We can observe that the new allowance for the doubtful accounts has increased from the previous period. So if there is an increase in other redundant expenses we must understand how it goes into the income statement and other operating expenses and how we record the allowance for doubtful accounts. So, how do we record the bad debt? Let us suppose, in the pre-adjustment trial balance, we have a bad debt of Rs. 1500 and in the additional information we have a bad debt of Rs. 1000 rent. So, in this situation, we add them together and we take the 1500 rent plus the 1000 rent which gives us a total of 2500 rent. So, under operating expenses, we put bad debt and put the total as 2500 rent. This is how we record bad debt in the income statement. Now, how do we record these accounts in the balance sheet? In the balance sheet, we record these bad debts by the debtor’s control minus the new bad debt minus the new allowance for the doubtful account. So, now we have 64000 rent for debtor’s control which we got by taking the 65000 rent minus only the new bad debt as mentioned in the pre-adjustment trial. We also have bad debt but we did not deduct that one because it has already been deducted from the debtor’s control so we will only deduct the one given in the additional information. So now we will take the 65000 rent as debtors control minus the 1000 rent which will give us the sixty-four thousand rent then we will be deducting the new allowance for the doubtful accounts of 3200 which we have already calculated in the previous section. This will give us the net realizable value or net realizable amount of sixty thousand eight hundred.
Conclusion- So, remember in the balance sheet the debtor’s control minus the new bad debt given in additional information you don’t deduct only the one in pre-adjustment trial balance but deduct the allowance for the doubtful accounts to get a net realizable amount or a net debtors control of sixty thousand eight hundred rent. That was all about how to read the balance sheet to find out the allowance for bad debts and doubtful accounts. The example which was given in this blog was just for illustration purposes and the real balance sheet might be looking different. These were said to be the basics that any person should understand these financial statements before moving to know the desired impact of fund allotment.