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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: Old UK GAAP excluding FRS 26 lenders: accrual accounting: impaired debt

The following guidance covers Old UK GAAP (applied before 2015) where FRS 26 was not applied.

Impaired debt

Impaired debt is debt of any kind that is unlikely to be repaid in full. The Companies Act requires a lender to state any loan held as a debt (and any other loan held as a current asset investment) at the lower of cost or net realisable value.

Where it is felt that the net realisable value of a loan asset is less than its balance sheet carrying value, companies will often create a bad debt ‘provision’, although strictly speaking the reduction in value of the loan is an adjustment to the carrying amount of a debt, rather than a provision.

Where a lender expects to make a recovery but is doubtful that it will recover the full amount of the debt, or it is uncertain that it will make any recovery, it will write down the carrying value of the debtor to the amount that it believes is recoverable, by creating a provision. It will charge this provision to the profit and loss account. The company should in future regularly reassess the amount of the recoverability of a loan, including taking account of any receipts reflecting any change in its realisable value through the profit and loss account.

An example would be:

On 31 December 2006 Company A lends £10,000 to Company F. In the year ended 31 December 2007, Company F suffered a significant loss, such that now Company A believes that Company F will only ever be able to repay £6,000 of the original loan.

The bookkeeping in Company A in the year ended 31 December 2007 would be:

  Debit Credit
  £ £
Provision against loan (in P&L) 4,000  
Loan with Company E   4,000

As a result of the above, the loan is restated in Company A’s balance sheet at 31 December 2007 at £6,000 (i.e. £10,000 less £4,000).

If in the following accounting period, Company A was of the opinion that Company F would now be able to repay £7,500 of the loan, then the bookkeeping would be:

  Debit Credit
  £ £
Loan with Company E 1,500  
Provision against loan (in P&L)   1,500

The loan is now stated in Company A’s balance sheet at £7,500 being the £6,000 brought forward plus £1,500.

Write off

Where a lender has foregone all reasonable expectation of recovery, it will write off the loan completely, taking the loan out of its debtors, and expensing the full amount of the item to bad debt expense in the profit and loss account.