chapter 2 bad debts and allowance for doubtful...

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Chapter 2 Bad Debts and Allowance for Doubtful Accounts

Notestoteachers

1 StartwithChapter3ofFrank Wood’s Introduction to Accountingandbrieflyexplaintostudentshowtorecordcreditsalesinthebooks.

2 Askstudentswhatshouldbedoneinthebooksifitisascertainedthatatradedebtorwillnotbeabletosettlehisoutstandingbalance,beforeexplainingtothemthemeaningofbaddebtsandtherequiredaccountingentries.

3 Similarly,askstudentswhatshouldbedoneinthebooksifitisfoundthatabaddebtwrittenoffpreviouslyhasbeenpaidback,beforetellingthemthemeaningofbaddebtsrecoveredandtherequiredaccountingentries.

4 Baddebtsmaybewrittenoffandrecoveredwithinthesameaccountingperiodorindifferentaccountingperiods.Studentsmustnotethedifferencesintheiraccountingtreatments.

5 Beforeteachingstudentstheadjustingentriesforcreatinganallowancefordoubtfulaccounts,itisnecessarytointroducetheprudence(orconservatism)conceptandexplainhowitaffectstheprofitandlossforanaccountingperiod.

6 Theterm‘allowancefordoubtfulaccounts’isusedintheNSSCurriculumGuide.Studentsshouldknowthealternativenames,suchasprovisionforbaddebts,provisionfordoubtfuldebtsorallowancefordoubtfuldebts.

7 Itismoreappropriatetousetheterm‘allowance’insteadof‘provision’.TeacherscanrefertoChapter13ofFrank Wood’s Financial Accounting 2forthetruemeaningofprovisions.However,itmaynotbenecessaryforstudentstoknowaboutthedifferencesbetween‘provision’and‘allowance’untilthatchapter.

8 Therearetwomethodsforestimatingtheamountofdoubtfulaccounts.Inpractice,theuseofspecificallowancesismorecommon.

9 Moststudentshavedifficultyunderstandingthedifferencebetweenrecordingtheallowancefordoubtfulaccountsforthefirsttimeandinsubsequentperiods.Teacherscanexplainitinthefollowingmanner:

• Year1:Supposeattheendoftheyear,accountsreceivabletotal$100,000.Itisdecidedthata5%allowancefordoubtfulaccountsistobecreatedforthefirsttime.Asaresult,thefollowingentrieswouldbemade:

Dr Profitandloss$5,000 Cr Allowancefordoubtfulaccounts$5,000

• Year2:Year-endaccountsreceivabletotal$120,000.A5%allowancefordoubtfulaccountsistobemaintained.Asaresult,thefollowingentrieswouldbemade:

Dr Profitandloss$6,000

Cr Allowancefordoubtfulaccounts$6,000

Theallowancemadeinthepreviousyearshouldbereversed:

Dr Allowancefordoubtfulaccounts$5,000 Cr Profitandloss$5,000

Chapter 2

Notestoteachers

M01_FWFA_TB_HKG_9645_C02_6.indd 14 2009/11/4 3:50:19 PM

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ThisisbecauseiftheallowancemadeinYear1turnsouttobebaddebtsinYear2,thefollowingentrieswouldbemade:

DrBaddebts(profitandloss)$5,000* Cr Accountsreceivable$5,000*

*Theactualtotalforbaddebtscanbeless.

IftheallowancefordoubtfulaccountsmadeinYear1isnotreversed,thelossof$5,000wouldhavebeenrecordedtwiceinthebooks(inYear1andYear2respectively).

EvenifthedebtscanallbecollectedinYear2,theallowancefordoubtfulaccountsmadeinYear1shouldstillbereversedbecausetheestimatedlosshasnotbeenrealised.

Forsimplicity,therequiredentriesfortheallowancefordoubtfulaccountsinYear2wouldbe:

Dr Profitandloss$1,000 Cr Allowancefordoubtfulaccounts$1,000

Onlytheincrease($6,000−$5,000)intheallowanceshouldberecorded.

Thesamelogicappliestotherecordingofadecreaseintheallowancefordoubtfulaccounts.

10 Furthermore,moststudentshavedifficultydecidingwhetherbaddebtsshouldbedeductedfromaccountsreceivableincalculatingtheallowancefordoubtfulaccounts.Iftherearebaddebtsshowninthetrialbalance,thismeansthattheyhavealreadybeendeductedfromaccountsreceivable.Ifbaddebtsdonotappearinthetrialbalancebutarementionedasadditionalinformationinthequestion,thismeanstheyhavenotbeendeductedfromaccountsreceivable.Anadjustmentshouldthenbemadetowriteoffthebaddebtsfromaccountsreceivable.

11 Studentsshouldbeabletodifferentiatebetween:

• thenatureofthebaddebtsaccountandtheallowancefordoubtfulaccountsaccount(expenseaccountvs.contra-assetaccount)

• grossamountandnetamount(netrealisablevalue)ofaccountsreceivable

12 ThetopicofallowancefordiscountsallowedisnotexplicitlyspelledoutintheNSSCurriculumGuide.However,teachersareadvisedtoteachitasadditionalmaterial.

Q1 Baddebtsrefertoaccountsreceivablethathavebeenprovedtobeuncollectible.Thenetprofitfortheperiodwillbereducedbythebaddebtswrittenoff.

Q2 Baddebtsaretreatedasanexpenseofabusiness.Thebaddebtsaccountisanominalaccount.

Q3 Baddebtsrefertoaccountsreceivablethathavebeenprovedtobeuncollectible.Thiswouldhappenwhenadebtorhasgonebankruptandisunabletopaythedebt.Onceabaddebtarises,itshouldbeimmediatelywrittenofffromtheaffecteddebtor’saccount.

Doubtfuldebtsrefertoaccountsreceivablethatarelikelytobecomeuncollectible.Undertheprudenceconcept,anallowanceshouldbemadefordoubtfulaccountsattheendofanaccountingperiod.Theamountofdoubtfulaccountsisjustanestimate.


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Q4 Theamountofdoubtfulaccountscanbeestimatedoneitherofthefollowingbases:

Specific allowance

Eachdebtor’saccountislookedatindividuallytoseewhetherthedebtislikelytobecomeuncollectible.Ifadebtislikelytobecomeuncollectible,anallowancewouldthenbemade,uptothefullamountofthedebt.

General allowance

Afixedpercentageisappliedtothetotalofaccountsreceivable.Thepercentagecanbeaffectedbymanyfactors,suchastheproportionofaccountsreceivablewrittenoffasbadinpastyears,thecreditworthinessofdebtorsandthegeneralbusinessenvironment.Usually,thelongeradebtisoutstanding,themorelikelyitwillbecomeuncollectible.Therefore,ahigherpercentagewouldbeappliedtothoseaccountsthathavebeenoutstandingforalongerperiod(i.e.,olderaccounts).

Q5 Thenetrealisablevalueofaccountsreceivablereferstotheamountofcashthatisexpectedtobecollectedfromthem.Itisusuallycalculatedastheoriginalamountofaccountsreceivable,lessthebaddebtswrittenoffandtheallowancefordoubtfulaccounts(andtheallowancefordiscountsallowed,ifany).

Q6 Onceabaddebtarises,itshouldbeimmediatelywrittenofffromtheaffecteddebtor’saccount.Attheendofanaccountingperiod,thetotalofbaddebtswillbetransferredtotheprofitandlossaccountasanexpense.

Inaddition,anallowancewillbemadefordoubtfulaccountsattheendofanaccountingperiodasfollows:

1 Whentheallowancefordoubtfulaccountsismadeforthefirsttime:

Dr Profitandlossaccount Cr ‘Allowancefordoubtfulaccounts’account

Theentireallowanceamountwillberecordedintheprofitandlossaccountasanexpense.

2 Whentheallowancefordoubtfulaccountsismadeinsubsequentperiods:

(a) Anincreaseintheallowanceshouldberecordedasanexpense:

Dr Profitandlossaccount Cr ‘Allowancefordoubtfulaccounts’account

Theincreaseinallowancewillberecordedintheprofitandlossaccountasanexpense.

(b) Adecreaseintheallowanceshouldberecordedasotherrevenue:

Dr ‘Allowancefordoubtfulaccounts’account Cr Profitandlossaccount

Thedecreaseinallowancewillberecordedintheprofitandlossaccountasotherrevenue.

A1 Undercashaccounting,salesarerecordedwhenmoneyisreceived.Theuncollectedamountswillnotberecordedandseparatelyshown.Therefore,thereisnoneedtowriteoffbaddebts.


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A2 Accounts Receivable LedgerT Yeung

2009 $ 2009 $Dec 10 Baddebts 1,000 Dec 10 Bank 1,000

General LedgerBad Debts

2009 $ 2009 $May 17 KLau 4,800 Dec 10 TYeung(baddebtsrecovered) 1,000Aug 20 TYeung 2,400 " 31 Profitandloss 6,200 7,200 7,200

A4 Intheincomestatement:

• ‘Netprofit’fortheyearwouldbetotalrevenuesreceivedminustotalexpensespaidduringtheyear.

• ‘Sales’wouldbetheamountactuallyreceivedfromsalesduringtheyear.

• ‘Purchases’wouldbetheamountactuallypaidforpurchasesduringtheyear.‘Discountsreceived’wouldnotbeseparatelyshown.

• Thematchingconcept(whichwillbeexplainedinChapter17ofFrank Wood’s Financial Accounting 2)wouldnolongerapply.Therefore,noadjustmentsforopening/closinginventorywouldberequired.

• ‘Baddebtsrecovered’wouldnotberecordedandseparatelyshown.

• Noadjustmentsforaccruedexpensesandprepaidrentwouldberequired.

• Nobaddebtswouldbewrittenoffandnoallowancewouldbemadefordoubtfulaccounts.

Inthebalancesheet:

• Theitems‘inventory’,‘accountsreceivable’and‘prepaidexpenses’wouldnotappearincurrentassets.

• Theitems‘accountspayable’and‘accruedexpenses’wouldnotappearincurrentliabilities.

A5 Baddebtsanddoubtfuldebtsrefertotheamountsprovedorestimatedtobeuncollectible,respectively.Cashdiscountsareunlikelytobeallowedonuncollectibleaccounts.Onlytheaccountsreceivable,afterdeductingthebaddebtswrittenoffandtheallowancefordoubtfulaccounts,couldenjoycashdiscountsbypayingwithinthecashdiscountperiod.

ASSESSMENT

Short QuestionsShort Questions

1 D Fung

2009 $ 2009 $Jan 1 Balanceb/f 2,000 Feb 1 Cash 1,500 " 1 Baddebts 500 2,000 2,000


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C Chang

2009 $ 2009 $Jan 1 Balanceb/f 1,200 Mar 10 Cash($1,200×30%) 360 " 10 Baddebts 840 1,200 1,200

Bad Debts

2009 $ 2009 $Feb 1 DFung 500 Dec 31 Profitandloss 1,340Mar 10 CChang 840 1,340 1,340

2X Income Statements for the years ended 31 December (extract)

$2008 Baddebts 2,0002009 Baddebts 3,000

Balance Sheets as at 31 December (extract)

$2008 Accountsreceivable 38,0002009 Accountsreceivable 57,000

Application Problems

3 Bad Debts

2005 $ 2005 $Mar 31 Accountsreceivable 10,000 Mar 31 Profitandloss 10,000

2006 2006Mar 31 Accountsreceivable 5,000 Mar 31 Profitandloss 5,000


Allowance for Doubtful Accounts

2005 $ 2005 $Mar 31 Balancec/f 3,000 Mar 31 Profitandloss 3,000 [($70,000−$10,000)×5%]2006 2005Mar 31 Balancec/f 3,750 Apr 1 Balanceb/f 3,000 2006 Mar 31 Profitandloss{[($80,000−$5,000) ×5%]−$3,000} 750 3,750 3,750

2007 2006Mar 31 Profitandloss[$3,750–($60,000×5%)] 750 Apr 1 Balanceb/f 3,750" 31 Balancec/f 3,000 3,750 3,750

2008 2007Mar 31 Balancec/f 3,200 Apr 1 Balanceb/f 3,000 2008 Mar 31 Profitandloss{[($70,000–$6,000) ×5%]−$3,000} 200 3,200 3,200


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Incomes Statements for the years ended 31 March (extract)

$ $2005 Baddebts 10,000 Allowancefordoubtfulaccounts 3,000

2006 Baddebts 5,000 Allowancefordoubtfulaccounts (increase) 750

2007 Allowancefordoubtfulaccounts (reduction) 750

2008 Baddebts 6,000 Allowancefordoubtfulaccounts (increase) 200

Balance Sheets as at 31 March (extract)

$ $2005 Accountsreceivable 60,000 Less Allowancefordoubtfulaccounts (3,000) 57,000

2006 Accountsreceivable 75,000 Less Allowancefordoubtfulaccounts (3,750) 71,250



4X (a)(i) Bad Debts

2006 $ 2006 $Dec 31 Accountsreceivable 2,980 Dec 31 Profitandloss 2,980

2007 2007Dec 31 Accountsreceivable 3,860 Dec 31 Profitandloss 3,860



(ii) Allowance for Doubtful Accounts

2006 $ 2006 $Dec 31 Balancec/f 3,000 Dec 31 Profitandloss 3,000

2007 2007Dec 31 Balancec/f 3,300 Jan 1 Balanceb/f 3,000 Dec 31 Profitandloss 300 3,300 3,300

2008 2008Dec 31 Profitandloss 150 Jan 1 Balanceb/f 3,300" 31 Balanceb/f 3,150 3,300 3,300

2009 2009Dec 31 Balancec/f 3,500 Jan 1 Balanceb/f 3,150 Dec 31 Profitandloss 350 3,500 3,500

2010 Jan 1 Balanceb/f 3,500


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(iii) Income Statements for the years ended 31 December (extract)


2007 Baddebts 3,860 Allowancefordoubtfulaccounts 300

2008 Baddebts 3,440 2008 Allowancefordoubtfulaccounts 150

2009 Baddebts 4,770 Allowancefordoubtfulaccounts 350

(iv) Balance Sheets as at 31 December (extract)

$ $2006 Accountsreceivable 120,000 Less Allowancefordoubtfulaccounts (3,000) 117,000




(b) Baddebtsrefertoaccountsreceivablethathavebeenprovedtobeuncollectible.Thiswouldhappenwhenadebtorhasgonebankruptandisunabletopaythedebt.

Undertheprudenceconcept,anallowanceshouldbemadeattheendofanaccountingperiodforaccountsreceivablethatarelikelytobecomeuncollectible(i.e.,doubtfulaccounts).Theamountofdoubtfulaccountsisjustanestimate.

5X (a)(i) Allowance for Doubtful Accounts

2007 $ 2007 $Sept30 Balancec/f 1,060 Sept30 Profitandloss 1,060

2008 [($12,000–$600–$800)×10%]

Sept30 Profitandloss 60 Oct 1 Balanceb/f 1,060" 30 Balancec/f 1,000 1,060 1,060

(ii) T Young Income Statements for the years ended 30 September (extract)

$ $2007 Baddebts($600+$800) 1,400 Allowancefordoubtfulaccounts 1,060 2008 Allowancefordoubtfulaccounts 60

(iii) T Young Balance Sheets as at 30 September (extract)

$ $2007 Accountsreceivable 10,600 Less Allowancefordoubtfulaccounts (1,060) 9,540 2008 Accountsreceivable 10,000 Less Allowancefordoubtfulaccounts (1,000) 9,000


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(b) Afixedpercentageisappliedtothetotalofaccountsreceivable.Thepercentagecanbeaffectedbymanyfactors,suchastheproportionofaccountsreceivablewrittenoffasbadinpastyears,thecreditworthinessofdebtorsandthegeneralbusinessenvironment.Themanagementshouldreviewthepercentageregularlyandmakechangesifnecessarytoensurethatanadequateallowanceismadetocoverpossiblebaddebts.

6 (a) Bad Debts

2008 $ 2008 $Mar 31 Accountsreceivable 2,000 Mar 31 Profitandloss 2,000


(b) Bad Debts Recovered

2009 $ 2009 $Mar 31 Profitandloss 500 Jan 31 MrRobinson 500

(c) Allowance for Doubtful Accounts

2008 $ 2008 $Mar 31 Balancec/f 320 Mar 31 Profitandloss[($18,000−$2,000)×2%] 320

2009 2008Mar 31 Balancec/f 480 Apr 1 Balanceb/f 320

2009 Mar 31 Profitandloss[($24,000×2%)−$320] 160 480 480

(d) Income Statements for the years ended 31 March (extract)

$ $2008 Baddebts 2,000 Allowancefordoubtfulaccounts 320

2009 Baddebts 1,500 2009 Baddebtsrecovered 500 Allowancefordoubtfulaccounts (increase) 160

7X (a) Bad Debts




(b) Bad Debts Recovered

2008 $ 2008 $Dec 31 Profitandloss 700 Nov 30 MrsPYip 700

2009 2009Dec 31 Profitandloss 300 Dec 31 Accountsreceivable 300


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(c) Allowance for Doubtful Accounts

2007 $ 2007 $Dec 31 Balancec/f 4,000 Dec 31 Profitandloss 4,000

2008 2008Dec 31 Balancec/f($112,000×5%) 5,600 Jan 1 Balanceb/f 4,000 Dec 31 Profitandloss 1,600 5,600 5,600

2009 2009Dec 31 Profitandloss 1,400 Jan 1 Balanceb/f 5,600" 31 Balancec/f($84,000×5%) 4,200 5,600 5,600

(d) Income Statements for the years ended 31 December (extract)


2008 Baddebts 3,200 2008 Baddebtsrecovered 700 Allowancefordoubtfulaccounts (increase) 1,600

2009 Baddebts 4,700 2009 Allowancefordoubtfulaccounts (reduction) 1,400 Baddebtsrecovered 300

8 Bad Debts


Allowance for Doubtful Accounts

2009 $ 2009 $Dec 31 Balancec/f 1,132 Jan 1 Balanceb/f 672 Dec 31 Profitandloss {[($25,600−$2,960)×5%]−$672} 460 1,132 1,132

Allowance for Discounts Allowed

2009 $ 2009 $Dec 31 Balancec/f 538 Jan 1 Balanceb/f 430 Dec 31 Profitandloss{[($25,600−$2,960 −$1,132)×2%]−$430} 108 538 538

Income Statement for the year ended 31 December 2009 (extract)

$Baddebts 2,960Allowancefordoubtfulaccounts(increase) 460Allowancefordiscountsallowed(increase) 108

Balance Sheet as at 31 December 2009 (extract)

$ $Accountsreceivable 22,640Less Allowancefordoubtful accounts 1,132 Allowancefordiscounts allowed 538 (1,670) 20,970

1212


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9X (a) Income Statement for the year ended 31 March 2006 (extract)

$Baddebts 14,000Allowancefordoubtfulaccounts [($334,000–$14,000)×3%] 9,600Allowancefordiscountsallowed [($334,000–$14,000–$9,600)×2%] 6,208

Income Statement for the year ended 31 March 2007 (extract)

$Allowancefordoubtfulaccounts(increase) [($415,000×3%)–$9,600] 2,850Allowancefordiscountsallowed(increase) {[($415,000–$9,600–$2,850)×2%]–$6,208} 1,843

Income Statement for the year ended 31 March 2008 (extract)

$ Allowancefordoubtfulaccounts(reduction) [($360,000×2%)–$9,600–$2,850] 5,250 Allowancefordiscountsallowed(reduction) {[($360,000–$7,200)×2%]–$6,208–$1,843} 995 Baddebtsrecovered 7,000

(b) Balance Sheet as at 31 March 2006 (extract)

$ $Current assetsAccountsreceivable 320,000Less Allowancefordoubtful accounts 9,600 Allowancefordiscounts allowed 6,208 (15,808) 304,192

Balance Sheet as at 31 March 2007 (extract)


Balance Sheet as at 31 March 2008 (extract)


(c) Possiblereasons:

• Decreasingproportionofaccountsreceivablewrittenoffasbadinpastyears

• Improvementintheoverallcreditworthinessoftradedebtors

• Improvementinthegeneralbusinessenvironment

(Anyacceptablereason)


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10 (a) Allowance for Doubtful Accounts

2006 $ 2006 $Dec 31 Balancec/f 6,810 Jan 1 Balanceb/f 4,200 Dec 31 Profitandloss 2,610 6,810 6,810

2007 2007Dec 31 Balancec/f 12,415 Jan 1 Balanceb/f 6,810 Dec 31 Profitandloss 5,605 12,415 12,415

2008 2008Dec 31 Profitandloss 5,800 Jan 1 Balanceb/f 12,415" 31 Balancec/f 6,615 12,415 12,415

(b) Stephen Co Ltd Balance Sheet as at 31 December 2008 (extract)

$ $Current assetsAccountsreceivable($104,000–$4,750) 99,250Less Allowancefordoubtfulaccounts (6,615) 92,635

11 (a) Dr Allowancefordoubtfulaccounts$900($4,200−$3,300*) Cr Profitandloss$900

*$32,000×2%+$28,000×4%+$14,000×6%+$7,000×10%

Dr Profitandloss$7,736* Cr Allowancefordiscountsallowed$7,736

*$46,000×10%+$32,000×98%×10%(Thisisthemostconservativeestimate.)

(b) $115,964($127,000−$3,300−$7,736)

(c) Usually,thelongeradebtisoutstanding,themorelikelyitistobecomeuncollectible.Therefore,ahigherpercentageisappliedtothoseaccountsthathavebeenoutstandingforalongerperiod(i.e.,olderaccounts).

12X (a) Baddebtsarewrittenoffwhenaccountsreceivablehavebeenprovedtobeuncollectible.Thiswouldhappenwhenadebtorhasgonebankruptandisunabletopaythedebt.

Inaddition,anallowanceistobemadeattheendofthefinancialyearforaccountsreceivablethatarelikelytobecomeuncollectible(i.e.,doubtfulaccounts).Theamountofallowancefordoubtfulaccountsisjustanestimate.

(b) Anincreaseintheallowancefordoubtfulaccountsrepresentsanadditionallossarisingonaccountsreceivablesandisthustreatedasanexpensefortheyear.

(c) Discountsallowedrefertocashdiscountsgiventotradedebtorswhopaywithinthecashdiscountperiod.Inaddition,anallowanceforcashdiscountsismadeattheendofthefinancialyearonaccountsreceivablethatarelikelytobesettledwithinthecashdiscountperiod.Theamountofallowancefordiscountsallowedisjustanestimate.

(d) Adecreaseintheallowancefordiscountsallowedrepresentsareversaloflossarisingfromaccountsreceivablesandisthustreatedasotherrevenuefortheyear.


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(e) Thisisanapplicationoftheprudenceconceptunderaccrualaccounting.Forthesakeofprudence,anallowanceshouldbemadeforpossibleexpensesorlosses,whethertheamountiscertainorjustanestimate.

(f) Thiscouldhappenwhenmoreaccountsreceivableareestimatedtobeuncollectibleandfeweraccountsreceivableareexpectedtobesettledwiththecashdiscountperiod.

Past Exam QuestionsPast Exam Questions

13X (a) Mr Ho Journal

Dr Cr

2005(ii) Mar 31

(iii)" 31

2006(iv)Mar 27

(v) " 31

Baddebts MrTam(debtor)

Profitandloss[($939,000–$6,000)×3%] Provisionfordoubtfuldebts

MrTam(debtor) Baddebtsrecovered

Bank MrTam(debtor)

Provisionfordoubtfuldebts Profitandloss[$27,990–($332,800×2%)]

$6,000

27,990

4,000

4,000

21,334

$

6,000

27,990

4,000

4,000

21,334

(b) (i) Profit and Loss Account for the year ended 31 March 2006 (extract)

$Other incomeDecreaseinprovisionfordoubtfuldebts 21,334Baddebtsrecovered 4,000

(ii) Balance Sheet as at 31 March 2006 (extract)

$Current assetsDebtors 332,800Less Provisionfordoubtfuldebts (6,656) 326,144

(c) Theestimatedamountoftheprovisionfordoubtfuldebtscanbemade:

(i) fromexperienceinpastyears

(ii) bylistingdebtorswhosedebtscanberegardedasdoubtful

(iii)withreferencetothegeneraleconomiccondition

(iv)bypreparinganageingschedulewherethedebtorsareanalysedaccordingtothelengthoftimethatthedebtshavebeenoutstanding

(Anytwopoints)


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