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Potential Refund of Turnover to Customer After Year-End?
I am working on a job where a client has been paid for an invoice raised at £7,000. However the company who paid him the money as a payment on account, is now being sued by another company whom the work related to, and he may have to pay this £7,000 back.
How do I enter this on the P & L and balance sheet, as it does not seem to be a provision for doubtful debts, as it is not money owed to him that he might not get.
How would I do the double entry on this please, can anyone help. As I am assuming with this in mind, I can reduce my profit thus his tax bill now, as he is 90% certain he will have to pay this income received back again.
Many Thanks Caspar
Thanks for the question Caspar, it is a very good one! You are correct in looking to record this as an expense and reduce profit and tax bill now. It can definitely be recorded as an expense now. The rule is you record a loss (which this is) as soon as you become aware that it is likely to occur.
But since you are not losing assets right now, but will in future, what is the other entry or account to go along with the expense?
The answer is a provision.
A provision is a liability (future loss of assets) that will definitely occur but whose amount or timing is uncertain. We know s/he will lose £7,000, but we don't know when exactly. So it is a provision.
In this case, because the owner is 90% sure he will have to pay the £7,000 back, this should be recorded as an expense (loss) and a liability (provision) right now. The main reason is because it is highly probable that s/he will "lose" the money, and we record a loss right away if it is likely to occur (even if it will occur in future) and it is as if he "owes" it for now.
I am not convinced that this is NOT a provision "for bad debts." But if you do not consider the losing of this £7,000 a "bad debt," then you can call it something else. Maybe "income returned" or whatever accurately represents what is happening here. The exact wording of the provision is not so important. Recording a provision, whatever you call it, is more important.
Right now you can simply record:
Dr Expense ("Income Returned" or whatever you want to call it) Cr Provision ("for income returned" or whatever you want to call it)