Some companies and institutions that sell to their customers on credit or credit sales may face some problems when collecting debts owed to them by debtors. This is due to the inability of the debtors to pay the debts owed to them, for several reasons that may be due to their bankruptcy, death, or other reasons.
But, what are the common types of debt? What are the methods of accounting treatment of it? This is what we will learn about in this new article on the "Program Idea" educational blog.
What are the types of debt?
Companies, business establishments, and various commercial and service activities shall, at the end of each financial period, take an inventory of the debtors’ account and divide the debts owed to them into three basic sections, as follows:
Companies, business establishments, and various commercial and service activities shall, at the end of each financial period, take an inventory of the debtors’ account and divide the debts owed to them into three basic sections, as follows:
good debt
These are debts whose amounts due from the debtors of the company or institution are expected to be collected regularly and at predetermined dates for repayment. As these debtors have a good reputation with the company from their previous experiences with it, they are known to it that they pay their financial dues on a regular basis and at the dates agreed upon between the two parties.
These are debts whose amounts due from the debtors of the company or institution are expected to be collected regularly and at predetermined dates for repayment. As these debtors have a good reputation with the company from their previous experiences with it, they are known to it that they pay their financial dues on a regular basis and at the dates agreed upon between the two parties.
Doubtful debts
As for the second type, it is the doubtful debts, which are the debts that the creditor company or institution expects that it will most likely not be able to collect in whole or even part of it.
As for the second type, it is the doubtful debts, which are the debts that the creditor company or institution expects that it will most likely not be able to collect in whole or even part of it.
This expectation of the creditor company may be due to its previous bad experiences with debtors known to it that they do not pay regularly on the agreed upon dates.
Not only bad past experiences, but it is possible to spread news about financial insolvency of one of the debtors or other matters that make them unable to meet the due payment dates.
Bad debt
From its name, they are, of course, debts that the creditor company makes sure that it will not be able to collect the amounts owed by the debtors, for several reasons, whether the debtor’s death, bankruptcy, or other reasons that prevent him from paying at all.
From its name, they are, of course, debts that the creditor company makes sure that it will not be able to collect the amounts owed by the debtors, for several reasons, whether the debtor’s death, bankruptcy, or other reasons that prevent him from paying at all.
These were the most important types of debt, but what about the accounting treatment for each type? This is what we will learn in the next paragraph.
How can debt be processed mathematically?
The accounting treatment of debts is done according to the type of debt, that is, the accounting treatment method for good debts differs from the accounting treatment method for doubtful debts, and thus differs from the accounting treatment for bad debts.
The accounting treatment of debts is done according to the type of debt, that is, the accounting treatment method for good debts differs from the accounting treatment method for doubtful debts, and thus differs from the accounting treatment for bad debts.
First: The accounting treatment of doubtful debts
At the end of each Gregorian year, companies and establishments estimate the value of doubtful debts and record them as potential losses, based on the principle of caution that takes expected losses into account when preparing financial statements for companies or business establishments in general.
At the end of each Gregorian year, companies and establishments estimate the value of doubtful debts and record them as potential losses, based on the principle of caution that takes expected losses into account when preparing financial statements for companies or business establishments in general.
Accordingly, companies open two financial accounts, the first account in the name of doubtful debt expenses, and it is recorded on the debit side. As for the second account in the name of provision for doubtful debts, it is recorded on the credit side, as follows:
At the end of the period, the doubtful debt expense account is closed to the profit and loss account (income summary):
Although the allowance account for doubtful debts is of a credit nature, it appears for disclosure purposes in the balance sheet on the assets side and is deducted from the debtors’ balance as in the following figure:
List of financial position for the year...
💡 Note: The debtors account, whose net value appears, represents the value of good debts that are expected to be collected from customers during the next financial period.
Methods for determining the percentage of doubtful debts
The facility determines the value of doubtful debts, of course, after reviewing the debtors' balances, and as we emphasized, it is determined based on the facility's previous experiences with debtors.
The facility determines the value of doubtful debts, of course, after reviewing the debtors' balances, and as we emphasized, it is determined based on the facility's previous experiences with debtors.
There are various methods for determining and estimating the provision for doubtful debts, the most important of which are the following:
Estimation based on net future sales
Estimate based on receivables balances
The estimate is based on the chronological age of the debt
Below we explain each of these methods separately with a practical example.
Estimate based on receivables balances
The estimate is based on the chronological age of the debt
Below we explain each of these methods separately with a practical example.
Estimation based on net future sales
The value of the provision is estimated under this method by determining a percentage of net deferred sales (total deferred sales - sales returns and allowances - allowable discount on sales). This method is known as income statement entry.
The value of the provision is estimated under this method by determining a percentage of net deferred sales (total deferred sales - sales returns and allowances - allowable discount on sales). This method is known as income statement entry.
💡 Practical example:
On 31/12/2015, the net sales balance of Al Salam Company was $20,000, and the value of doubtful debts was estimated at 3% of the net sales of futures.
On 31/12/2015, the net sales balance of Al Salam Company was $20,000, and the value of doubtful debts was estimated at 3% of the net sales of futures.
Required
Calculating the value of the provision for doubtful debts and recording them in the books.
Calculating the value of the provision for doubtful debts and recording them in the books.
the solution:
First: The provision is extracted by multiplying the estimated percentage of doubtful debts by net deferred sales, which will equal
20000 * 3% = $600, then the following entry is recorded:
First: The provision is extracted by multiplying the estimated percentage of doubtful debts by net deferred sales, which will equal
20000 * 3% = $600, then the following entry is recorded:
Second: The doubtful debt expense account is closed in the profit and loss account (income summary) as shown in the following table:
Estimation based on receivable balances
The value of the provision under this method is estimated by determining a percentage of the balance of the accounts receivable, based on previous experiences with debtors. This method is known as the budget entry, and it is the most used method compared to the previous method that we explained in the previous example.
The method of settling the allowance for doubtful debts account
If there is a previous account balance for the allowance for doubtful debts, at the end of the financial period, then the old balance is compared with the new balance. Based on this comparison, we will have the following possibilities:
If there is a previous account balance for the allowance for doubtful debts, at the end of the financial period, then the old balance is compared with the new balance. Based on this comparison, we will have the following possibilities:
The balance of the new allowance is equal to the old balance
Then no adjustment entries are made
Then no adjustment entries are made
The balance of the new allowance is greater than the old allowance
In this case, an entry is prepared with the value of the increase as shown in the following figure:
In this case, an entry is prepared with the value of the increase as shown in the following figure:
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