A bad debt is written off once the business decides it will not be paid. The allowance for doubtful debts is a separate estimate for debts that might go bad next year, and only its change goes to the income statement.
This lesson sits in SPM Accounting adjustments. The other year-end entries are in adjusting inventory and drawings.
What are the two steps?
Step 1 writes off the debts the business knows it will not collect. Step 2 sets the allowance on the debts that remain.
Keeping them in this order matters, because the allowance is a percentage of the balance after the write-off.
Worked example: write off first, then the allowance
Kedai Ramli has trade receivables of RM30 000 at 31 December. The owner decides that RM1 200 owed by one customer is a bad debt. The business keeps an allowance of 5% on remaining debtors, and the old allowance balance is RM900.
- Write off the bad debt: debit Bad debts RM1 200, credit Trade receivables RM1 200. Receivables become 30 000 − 1 200 = RM28 800.
- Work out the new allowance: 5% × 28 800 = RM1 440.
- Compare it with the old balance: 1 440 − 900 = RM540 increase.
- Record the increase: debit Allowance adjustment (income statement) RM540, credit Allowance for doubtful debts RM540.
The income statement shows bad debts RM1 200 and an allowance increase of RM540, so the total expense is RM1 740.
In the statement of financial position, receivables are shown as RM28 800 less allowance RM1 440, giving RM27 360.
The mistake that costs marks
Two slips appear in year-end answers. One is applying 5% to RM30 000, which gives RM1 500 and ignores the write-off. The other is charging the full RM1 440 to the income statement, forgetting that RM900 was already there.
| Step | Wrong | Right |
|---|---|---|
| Base for the allowance | 30 000 | 28 800 |
| Allowance needed | 1 500 | 1 440 |
| Income statement effect | 1 440 | 540 |
The working looks tidy either way, which is why the error survives a quick check. The fix is to write the four steps above in order every time.
What if the allowance decreases?
Suppose the new allowance is lower than the old balance. The difference is a reduction of the allowance, so it is credited to the income statement as a gain. It is written on the income side, not hidden inside expenses.
The business is then saying it expects to lose less than it thought last year.
Check yourself
Trade receivables are RM50 000. A bad debt of RM2 000 is to be written off. The allowance is 4% of remaining debtors, and the old allowance is RM1 500. Find the total expense to the income statement and the net receivables.
Answer
Receivables after write-off: 50 000 − 2 000 = RM48 000.
New allowance: 4% × 48 000 = RM1 920. Increase: 1 920 − 1 500 = RM420.
Total expense: 2 000 + 420 = RM2 420.
Net receivables: 48 000 − 1 920 = RM46 080.
What to study next
Move on to connecting adjustments to both financial statements, then use the adjustments practice set.
For guided help with why each entry is needed, see online one-to-one Accounting tuition.