The second article in our three-part series on Accounting adjustments in an ETB or journals.
Study Tips: Accounting adjustments in an ETB or journals
- Part 1 – Accounting adjustments
- Part 2 – Irrecoverable debts and doubtful debts
- Part 3 – Correcting common errors
This series looks at one of the most difficult areas of accounts preparation within the AAT Advanced Diploma in Accounting; making corrections and adjustments.
In part one we utilised a step by step overview of year-end adjustments and then started looking at the key elements of closing inventory. We were aiming to increase our chances of successfully making adjustments and corrections by being as thoroughly prepared as Freya was for her exam, which she passed with an impressive crop of exceeded, you’ll be pleased to hear!
So, let’s continue by looking at what we do when customers don’t pay their bills.
An irrecoverable debt is a credit sales that hasn’t been paid for and, after all attempts to collect the money have failed, the business believes will never be paid.
Say we had an irrecoverable debt from Customer X of £100 plus VAT. This is step 1, the value of the adjustment.
Step 2 – post the adjustment (in this case we’ll use 2 x SPL accounts as we need to account for the VAT and 1 x SFP account – overall total debits must equal total credits)
The journal will therefore be:
Note: Journals are only written for general ledger accounts so the memorandum posting to Customer X’s account isn’t included.
Here’s the ETB:
Note: The balance on the SLCA is listed as Receivables on the ETB.
The difference between an irrecoverable debt and doubtful debts is certainty. We write off an irrecoverable debt when we know that it won’t be paid and we make a contingency for doubtful debts when we think there might be a problem with some of our customers. We may know about a specific doubtful invoice or account, or we may not know which customers will default or the exact value of the debt. Irrecoverable and doubtful debts are related but not the same.
On top of the irrecoverable debt we’ve just written off for Customer X, let’s say we wish to make an allowance for doubtful debts which is 5% of the receivables.
First thought – how much should the allowance be?
|Less adjustment for irrecoverable debt||120|
|3,760||x 5% =||188||required allowance|
Second thought – is there an allowance from the previous year?
- No – the value of the adjustment will be the same as the required allowance.
- Yes – the value of the adjustment will be the amount needed to change the current allowance to the required allowance.
In this case there is a balance already for £266, therefore we need to decrease that to £188. Now we can use our overview steps starting with calculating the adjustment:
Note: the allowance for doubtful debts account will always have a credit balance but as the allowance required can both increase and decrease, the adjustment to make it correct can be either a debit or a credit entry.
The journal will therefore be:
Here’s the ETB again:
Read the final part of this series now, where we’ll look at how to correct errors using the same four steps for year-end adjustments and a continuation of the thought processes developed at Level 2.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.