In my two previous posts, I discussed bad debts and doubtful debts as separate considerations for year-end adjustments. In practice though, when it comes to preparing financial statements for a company, both adjustments would be made in one combined calculation. When adjusting for ‘bad and doubtful debts’, it is important that the receivables figures are adjusted first, This means that you must deduct any bad debts written off at the year-end first. This is necessary because any general provision for doubtful debts is calculated by applying a percentage to the balance of the receivables asset account. You will only know the correct balance on this account after you have adjusted for any bad debts written off at the year-end.
Adjustment for bad debts
When you are given a preliminary trial balance:
- the receivables asset account will show the balance on the account before taking into account the bad debt written off at the end of the year.
- there may be a bad debt expense account, if the business has already written off bad debts during the course of the year and the receivables asset account (as it appears in the trial balance) will already have been reduced to take account of them.
To make the year-end adjustment for bad debts, you have to:
- Deduct the amount of the bad debt from the receivables asset balance in the trial balance. The remainder constitutes the up-to-date figure for receivables and will appear on the balance sheet.
- EITHER (if the trial balance already has a bad debts expense account) add the bad debt to the balance of the expense account OR (if the trial balance does not have a bad debts account) create a new expense account and show the bad debt as its balance.
Adjustment for doubtful debts
When you are given a preliminary trial balance:
- the ‘Provision for Doubtful Debts’ account in the trial balance will show the provision for doubtful debts at the end of last year/start of the current year, so the actual figure shown on the trial balance is out-of-date and should not appear at all in the current year’s financial statements.
- there will be no ‘Bad and Doubtful Debts’ expense account for the year shown on the trial balance. There may however be a ‘Bad Debts’ expense account, depending on whether or not bad debts have already been written off during the year.
To make the year-end adjustment for doubtful debts, you should:
- calculate the current year end’s provision for doubtful debts figure (the ‘new provision figure’) in accordance with the method decided by the business itself. Eventually this figure will be shown on the balance sheet.
- EITHER (where the new Provision for Doubtful Debts is more than the provision shown in the trial balance) add the amount by which the provision has increased to the (new or renamed) bad and doubtful debts expense account for the year OR (where the new Provision is less than the provision shown in the trial balance) subtract the amount by which the provision has decreased from the (new or renamed) bad and doubtful debts expense account for the year. The new provision figure is then shown in the ‘provision for doubtful debts’ liability account.