What is Accounting Bad Debts?
Accounting for bad debts is the process of recording and reporting uncollectible accounts or outstanding receivables on a company’s financial statements. It involves estimating the amount of bad debts that are likely to occur based on past experiences, and making necessary adjustments to the company’s financial records.
Table of Content
Sundry Debtors
The sum total or aggregate of the amounts, which the customers owe to the business for purchasing goods on credit, is known as Sundry Debtors, or Trade Debtors, or Book Debts or simply Debtors. These sundry debtors may again be classified as under :
- Good Debt : The debts which are sure to be realized are called Good Debt.
- Doubtful Debts : The debts which may or may not be realized are called Doubtful Debts.
- Bad Debts : The Debts which cannot be realized at all are called Bad Debts or Unrealizable or irrecoverable Debts.
Bad Debts
It is an amount which is written off by the business as a loss to the business and considered as an expense because the debtors of the business have turned to be bad and now no amount could be collected from them any more even after making all reasonable efforts.
This usually occurs when the debtor has been declared bankrupt or the cost of pursuing further action in an attempt to collect the debt exceeds the debt itself. The accounting process is that the debtor’s account is immediately written off by crediting the debtor’s account and this writes off any balance remaining in the account of debtor. A bad debt represents the loss of income that is why it is regarded as an expense.
The following entries are required to be passed :
- For actual bad debt (if there is no provision for bad debts)
Bad Debts A/c Dr.
To Sundry Debtors A/c
Profit & Loss A/c Dr.
To Bad Debts A/c
- For actual bad debts (if there is an existing provision i.e., old reserve)
Provision for Bad Debts A/c Dr. (Actual amount)
To Bad Debts A/c
Thus, for Final Accounts:
Bad Debts –
(iii) If given in the Trial Balance: To be debited to Profit & Loss A/c
(iv) If outside the Trial Balance: To be debited to Profit & Loss A/c
(i.e., in the adjustment) And, to be deducted from Sundry Debtors in the Balance Sheet
Provision Reserve for Bad Debts
Doubtful debts are those debtors from whom the chances of getting the payment are very low. There may be many reasons for non–payment that may be able to include disputes over supply, delivery, and conditions of goods, the appearance of financial stress within customers operation.
In the business whenever such a dispute occurs it is very sensible to add this debt or portion thereof to the doubtful debt reserve. This is based on the principle of conservatism and this is done to avoid over–stating the assets of the business as trade debtors is reported net of Doubtful debt.
Accounting Steps
To sum up, the following entries are required to be passed for Bad Debts and Provision for Bad Debt –
(a) Whenever provision is made for the 1st time (at the end of the first year)
(i) Bad Debts –
Profit & Loss A/c Dr. (With the actual amount)
To Provision / Reserve for Bad Debts A/c
(ii) For creating provision for Bad debts
Profit & Loss A/c Dr.
To Provision / Reserve for Bad Debts A/c (With the amount of further provision)
(b) At the end of subsequent year
(i) For Bad Debts
Provision / Reserve for Bad debts Dr. (With the actual amount)
To Bad Debts A/c
(ii) Then the next year’s provision is estimated which is carried forward and the extra or excess provisions are adjusted (against the old provision) which is transferred to Profit & Loss Account, that is, the entry will be
Profit and Loss A/c Dr.
To Provision / Reserve for Bad Debts A/c (With the amount of further provision)
If any reserve for bad debt is in excess will be credited to P&L A/c
Methods of Accounting
Basically there are two methods used for recording for bad and doubtful debts.
First Method
In the first method Provision for Bad and Doubtful Debts is created by debiting the Profit and Loss Account. Any bad debts arising in the subsequent years are adjusted against this Provision for Bad and Doubtful Debts.
Journal Entries in the First Year
- When a provision is created for the first time.
Profit &Loss A/c Dr.
To Provision for Bad and Doubtful Debts A/c - For bad debts after Trial Balance:
Bad Debts A/c Dr.
To Sundry Debtors A/c - For writing–off bad debts in the Profit & Loss Account
Profit & Loss A/c Dr.
To Bad Debts A/c (Trial Balance figure & Bad Debts after
Trial Balance)
Journal Entries in the Second and Subsequent Years
- For bad debts after Trial Balance :
Bad Debts A/c Dr.
To Sundry Debtors A/c
- For writing–off bad debts in the Profit & Loss Account:
Provision for Bad and doubtful Debts A/c Dr.
To Bad Debts A/c - For creating necessary provision at the year end:
Profit & Loss A/c Dr.
To Provision for Bad and Doubtful Debts A/c The amount of
provision to be created is calculated as under:
Second Method
Here bad debt is directly charged to Profit and Loss Account in the 1st year and in subsequent years as well. Provision to be created depends on the amount of provision at the beginning of the year.
Journal Entries in the First Year
For the bad debts of the period for which no entry has been made
Bad Debts A/c Dr.
To Sundry Debtors A/c
- For writing–off bad debts in the Profit and Loss Account
Profit & Loss A/c Dr.
To Bad Debts A/c - When provision is created for the first time
Profit & Loss A/c Dr.
To Provision for Bad & Doubtful Debts A/c
Journal Entries in the Second and Subsequent Years
- For the bad debts of the period for which no entry has been made
Bad Debts A/c Dr.
To Sundry Debtors A/c
2.For writing–off bad debts in the Profit & Loss Account:
Profit & Loss A/c Dr.
To Bad Debts A/c
(Bad Debts during the year and after the Trial Balance)
3. For creating provision at the year end :
(a) (Closing provision > Opening provision
Profit &Loss A/c Dr.
To Provision for Bad and Doubtful Debts A/c
(b) (Closing provision < Opening provision)
Provision for Bad and Doubtful Debts A/c Dr.
To Profit & Loss A/c
This method differs from the first method in the manner that it shows bad debts and provision for Bad and doubtful Debts is maintained in the Profit and Loss Account. This is done as bad debts are not adjusted against the Provision for bad & Doubtful Debts Account.
Provision for Discount on Debtors
In almost all the business there is always an effort to collect our payments from the debtors quickly so in order to promote quick payments from the debtors we offer they discount for all the early payment. Here all those debtors who clear their dues before their due dates are given some discount.
It is advisable to charge this expenditure i.e. discount to debtors to the period in which sales has been made, so a provision is created in the same manner, as in case of provision for doubtful debts No discount should be allowed on debts which have turned bad.
Here the provision is created only on good debtors. So the amount of provision for discount should be calculated after deducting the provision for bad debts from sundry debtors.
Accounting Steps
(a) When provision is made for the first time (at the end of first year)
(i) for Discount Allowed –
Profit & Loss A/c Dr. (with the amount of actual discount)
To Discount Allowed A/c
(ii) For Provision for Discount on Debtors –
Profit & Loss A/c Dr. (with the amount of Provision
To Provision for Discount on Debtors A/c for Discount on
Debtors)
(b) At the end of subsequent years
(i) for Discount Allowed –
Provision for Discount on Debtors A/c Dr. (with the amount of discount To Discount Allowed A/c allowed)
(ii)Then, the next year’s provision is estimated which is carried forward and the extra or excess provision is adjusted (against the old provision which is transferred to Profit & Loss Account. That is, the entry will be –
Profit & Loss A/c Dr. (with the amount of further provision)
To Provision for Discount on Debtors A/c
The Balance Sheet contains The Bad Debts (after Trial Balance), Provision for Bad and Doubtful Debts and Provision for Discount on Debtors as follows:
Balance Sheet as on…….
Less : Bad Debts
Less : Provision for Bad & doubtful Debts
Less : Provision for Discount on Debtors
Provision for Discount on Creditors
Just as we give discount to our debtors in the same way our creditors give us discount for any prompt payments. But whether this discount is considered as income in the period when purchases were made or the period when the payment is made when both belong to different accounting years.
Therefore it should be treated as income in the period when the particular purchase was made. Hence, on the last date of accounting period if some amount is still payable to creditors, a provision should be made to account for it in the profit and loss account of that year when purchases are made. Following adjusting entry is passed :
Provision for discount on creditor’s a/c Dr.
To Profit and loss account
Accounting Steps
Accounting procedures are similar to provision for Discount on Debtors but the entries are converse.
Bad Debts Recovery
As states earlier, when the seller mentions any loss due to bad debt, it is written off by debiting account of Bad Debt and crediting the account of Sundry Debtors. Sometimes the debts determined as bad debts and are not likely to receive is received, such bad debt realised is known as Bad Debt Recovered.
Such an amount of debts realised is to be credited to Bad Debts Recovery Account. It is transferred to Profit & Loss Account in the year in which the same is recovered.
Thus following entries should be passed for the purpose –
(i) For recovering Bad Debts –
Cash / Bank A/c Dr.
(With the amount of bad debt recovery)
To Bad Debts Recovery A/c
(ii) For transferring to Profit & Loss Account –
Bad Debts Recovery A/c Dr.
To Profit &Loss A/c