Here is a designed answer for chapter 9 - Allowances for doubtful debts based on IACEW learning and the guideline IACEW WORD with example:

Allowances for Doubtful Debts

Overview

An allowance for doubtful debts is a provision made to cover estimated losses from receivables that may not be collected. It ensures that the carrying amount of receivables reflects their net realizable value.

Purpose

• To prudently estimate and recognize potential losses on receivables.
• To avoid overstating assets and profits.
• To comply with the matching principle by recognizing expected losses in the correct period.

Calculation and Accounting Treatment

• The allowance is calculated based on historical data, aging of receivables, or specific customer circumstances.
• The allowance is a contra asset account that reduces the gross receivables balance.
• Movements in the allowance are recorded as an expense or income in the statement of profit or loss.

Journal entries:

• To increase allowance:
  Dr Irrecoverable Debts Expense
  Cr Allowance for Doubtful Debts

• To decrease allowance:
  Dr Allowance for Doubtful Debts
  Cr Irrecoverable Debts Expense

Example

At the start of the year, the allowance for doubtful debts is £6,800. During the year, debts of £15,000 are written off as irrecoverable. At year-end, the business estimates that an allowance of £3,000 is required.

Accounting for write-offs:
Dr Irrecoverable Debts Expense £15,000
Cr Trade Receivables £15,000

Adjusting allowance:
Opening allowance: £6,800
Less write-offs: £15,000 (already expensed)
Required allowance: £3,000
Movement = Required allowance - (Opening allowance - Write-offs) = £3,000 - (£6,800 - £15,000) = £11,200 increase

Journal to adjust allowance:
Dr Irrecoverable Debts Expense £11,200
Cr Allowance for Doubtful Debts £11,200

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Impact on Financial Statements

Overview

Accounting adjustments such as write-offs, allowances, accruals, prepayments, and depreciation affect the financial statements by altering reported profits and asset/liability values. Understanding these impacts is essential for accurate financial reporting.

Key Impacts

1. Irrecoverable Debts and Allowances

• Writing off irrecoverable debts reduces trade receivables (asset) and increases expenses, lowering profit.
• Creating or adjusting allowances for doubtful debts reduces net receivables and affects profit through expense recognition.

2. Accruals and Prepayments

• Accruals increase expenses and liabilities, reducing profit.
• Prepayments decrease expenses and increase assets, increasing profit.

3. Depreciation and Provisions

• Depreciation expense reduces profit and the carrying amount of non-current assets.
• Provisions increase liabilities and expenses, reducing profit.

4. Inventory Valuation

• Changes in inventory valuation affect cost of sales and thus profit.
• Lower of cost and net realisable value rule may require write-downs, reducing profit.

5. Errors and Corrections

• Errors can distort profit and asset/liability balances.
• Corrections via suspense accounts and journal entries restore accurate financial reporting.

Example

A company has trade receivables of £100,000 with an allowance for doubtful debts of £5,000. During the year, £3,000 of debts are written off, and the allowance is increased by £2,000.

Effect on financial statements:

• Trade receivables net value decreases by £3,000 (write-off) plus £2,000 (allowance increase) = £5,000.
• Expenses increase by £5,000, reducing profit.
• Assets decrease by £5,000 due to lower net receivables.

References

• IACEW Chapter 9: Irrecoverable debts and allowances
• IACEW Chapter 6: Cost of sales, accruals and prepayments
• IACEW Chapter 8: Non-current assets and depreciation
• IACEW WORD Chapter 8 & 9 guidelines

References

• IACEW learning Chapter 9: Irrecoverable debts and allowances
• IACEW WORD Chapter 8 guidelines