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Sir I watched your lecture again but I didn’t understand about the allowance. Would you please correct me here.
1) We create allowance when we are not sure whether the customers would pay or not?
2) IF we have allowance $12000 in Year 1 but $8000 in Year 2 then it means our doubtful debtors becomes irrecoverable and we will not get the money back?
3) IF we have allowance $12000 in Year 1 but $15000 in Year 2 then it means we expected more receivables to pay (but there is no guarantee that they will pay)?
4) Why do we need to create an allowance when we can simply remove the receivables from our accounts?
Thanks for your help.
1. We create an allowance when we are concerned that they might not pay.
2 & 3 No.
At the end of the year we look to see how much our receivables are at the end of the year, and decide how much of them are doubtful. This is then the amount that we want to show as a balance on the allowance account. There is already a balance there that was put there at the end of the previous year, and so we simply adjust it (either higher or lower) to get the balance we want at the end of this year.
4. Although on the SOFP we do show the balance on receivables less the balance on the allowance account, we do not remove the doubtful debts in the receivables account itself. If we did that we would risk forgetting that they ever owed the money and therefore stop chasing them for the money. Even though they are doubtful we are still hoping we will get the money (and I do explain this in my lectures 🙂 )
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Thanks. It was really helpful. One more thing i would like to know.
When our allowance increased from one year to another it means that more customers might not pay so we have more receiveables (and vice versa if allowance decreases). Does that mean that we failed to recover the money?
When we realize that the customer who was previously doubtful does not pay then we should record it as irrecoverable (correct?)
Regarding your first point, the most likely reason for increasing the allowance is that it is a general allowance. If we sell more this year then we will probably have more receivables and therefore will need a bigger general allowance.
For your second point, if a debtor is irrecoverable (whether or not it was previous doubtful) then we credit receivables and debit irrecoverable debts expense.
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