QCE Accounting - Unit 4 - Fully classified financial statement reporting and analysis for a sole trader business

Bad debts, doubtful debts and inventory adjustments

Learn bad debts, provision for doubtful debts, net realisable value, lower of cost and NRV inventory adjustments and reporting effects for QCE Accounting.

Part of the free QCE Accounting notes library for Unit 4: Fully classified financial statement reporting and analysis for a sole trader business.

Updated 2026-05-18 - 4 min read

QCAA official coverage - Accounting 2025 v1.4

Exact syllabus points covered

  1. Describe balance day adjustments and their purpose.
  2. Record prepaid expenses at balance date.
  3. Record accrued expenses at balance date.
  4. Record unearned revenue at balance date.
  5. Record accrued revenue at balance date.
  6. Record a bad debt written off.
  7. Record a bad debt recovered.
  8. Record interest charged on overdue accounts.
  9. Describe provision for doubtful debts as a negative asset account.
  10. Calculate and record an increase or decrease in provision for doubtful debts.
  11. Explain the relationship between accounts receivable and provision for doubtful debts.
  12. Apply lower of cost and net realisable value to inventory.
  13. Record inventory adjustments for discrepancies, damage or obsolescence.
  14. Analyse the effect of receivable and inventory adjustments on profit, assets, equity and liquidity.

Credit sales increase revenue before cash is collected. That improves sales opportunities, but it creates risk: some customers may not pay. Accounting handles this through bad debts and doubtful debts. Inventory also needs adjustment when its selling value falls below cost. These adjustments make financial statements more faithful to the business's economic position.

The guiding idea is prudence. Assets should not be overstated and profit should not be inflated by amounts unlikely to be recovered.

Doubtful debts and inventory flow

Original Sylligence diagram for accounting doubtful debts flow.

Doubtful debts and inventory flow

Bad debts

A bad debt is a specific account receivable judged uncollectable. The business removes the customer's balance and records an expense.

| Debit | Credit | |---|---| | Bad Debts Expense | Accounts Receivable |

This reduces assets and increases expenses. If GST is involved, the task may require a GST adjustment, but follow the instructions given.

Provision for doubtful debts

Provision for doubtful debts is an estimate of accounts receivable that may become uncollectable. It is a negative asset account deducted from accounts receivable in the Statement of Financial Position.

$ \text{Net accounts receivable}=\text{Accounts receivable}-\text{Provision for doubtful debts} $

If the required provision is higher than the existing provision, the increase is recorded as Doubtful Debts Expense. If the required provision is lower, the decrease may be recorded as a reduction in doubtful debts expense or as income, depending on the account structure used in class.

| Situation | Entry logic | |---|---| | Required provision increases | Debit Doubtful Debts Expense, credit Provision for Doubtful Debts | | Required provision decreases | Debit Provision for Doubtful Debts, credit Doubtful Debts Expense or related income |

The provision improves matching because the expense is recognised in the period of the related credit sales, not only when a later customer fails to pay.

Interest on overdue accounts

Some businesses charge interest on overdue accounts. This increases the amount owed by the customer and creates income for the business.

| Debit | Credit | |---|---| | Accounts Receivable | Interest Revenue |

The interest may encourage payment, but it can also damage customer relationships or be difficult to collect. In analysis, consider both financial effect and practical effectiveness.

Inventory lower of cost and net realisable value

Inventory is usually recorded at cost. However, if inventory becomes damaged, obsolete or unsellable at normal prices, reporting it at original cost may overstate assets. The lower of cost and net realisable value rule reports inventory at the lower amount.

Net realisable value is the expected selling price less costs needed to complete and sell the item.

$ \text{NRV}=\text{Expected selling price}-\text{costs to sell} $

If NRV is lower than cost, the inventory is written down and an expense is recorded.

| Inventory cost | NRV | Reported amount | |---:|---:|---:| | \$12 000 | \$10 500 | \$10 500 | | \$8 000 | \$9 200 | \$8 000 |

Effects on reports

Bad debts and doubtful debts reduce profit because they increase expenses. Provision for doubtful debts reduces net accounts receivable, weakening current assets and possibly liquidity ratios. Inventory write-downs increase expenses and reduce inventory, which can reduce profit, current assets and owner's equity.

These adjustments make results less optimistic but more useful. A lender would rather see realistic collectability and inventory values than inflated assets that cannot be converted into cash.

Worked example

Quick check

Sources

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