The knowledge to adjust the allowance for impairment of trade receivables is crucial for both the N-Level and O-Level Principles of Accounts (POA) examinations. Such adjustments can appear either as additional information for the preparation of financial statements (FS) in Paper 2, Question 1 or they can also appear as individual question in either Paper 1 or Paper 2. In this article, Mr. Wong will share with you on how to adjust the allowance for impairment of trade receivables. Let’s go! 🙂
Understanding the accounts involved
There are two accounts that you will need to know when adjusting the allowance for impairment of trade receivables. They are the allowance for impairment of trade receivables account itself and impairment loss on trade receivables account. Let’s call the first one as ‘allowance’ account and the latter as ‘ILOTR’ for ease of reading. The allowance account is a contra-asset account. That means this account has a credit nature. The ILOTR account is an expense account which has a debit nature. The understanding of the nature of each account in POA syllabus is crucial in doing very well in POA exam.
How to adjust the allowance for impairment of trade receivables account?
The question on allowance in POA exams will require you to either adjust the allowance upwards (increase the allowance) or downwards (decrease the allowance). Let’s look at each of them in detail.
Increasing the allowance for impairment of trade receivables
Based on our understanding that the allowance account has a credit nature, that means in order to increase the allowance account, we will need to credit it. Hence, the journal entry to increase the allowance for trade receivables will be as follows.
Dr Impairment loss on trade receivables
Cr Allowance for impairment loss on trade receivables
Please note that the amount should be the difference between the amount of the allowance in the beginning of the year and at the end of the year – not the amount at the end of the year only.
Decreasing the allowance for impairment of trade receivables
Once you understand on how to adjust the allowance account upwards (increasing the allowance), decreasing the allowance simply works the other way. As allowance account has a credit nature, to decrease the allowance, we will need to debit it. Therefore, the journal entry to decrease the allowance will be as follows.
Dr Allowance for impairment of trade receivables
Cr Impairment loss on trade receivables
The decrease in the allowance will cause a negative expense (i.e. impairment loss on trade receivables) account. This is often called ‘reversal’ transaction.
Mr. Wong hopes this article would be helpful for your N-Level and O-Level POA revision. However, should you need further support for your POA exam, do feel free to contact us. We offer both online and classroom based lessons to support you in your POA journey. Let’s work hard for the exam and you can do it! 🙂
Written by Mr. Wong – POA Tutor