Accounting for Bad debts in business.
Accounting for bad debts in business is crucial. If not, you will not know the exact profitable amount in your industry. Bad debt expense relates to accounts receivable; these expenses are doubtful customer payments. Even in a prosperous economy, business failure is common, and businesses will be unable to pay the amounts they owe; in recession, bad debts will be more, and we should have a way of accounting for it. Therefore, evil results when the goods or services are sold on credit the customer cannot pay the amount they owed.
Accounting records for bad debts
Bad debts are an expense, a debit, and the credit goes to accounts receivable.
Bad debt account
| Dec 18 $ | |
| Joseph 200 |
Accounts Receivable
| Feb 19 $ | |
| Joseph 200 |
When selling goods or services on credit, you might have two things
- Your company will face an increase in sales, bringing in a higher profit.
- If your customer does not pay for the invoice issued, you will suffer losses, and the company will run at a loss.
When the sales increase, the sales revenue is reported on the income statement — moreover, the unpaid invoices are taken as the asset in the balance under debtors.
When the customer does not pay, the bad debt expense is shown in the income statement, and the lousy debt reduces the income receivable shown in the balance sheet.
In addition, in the trial balance, the balance for debtors (Accounts receivable) should show after subtracting the amount for bad debts. However, the information comes into effect after finalizing the trial balance; the figure for debtors is calculated by deducting the bad liabilities.
Provision for bad debts.
If you want to manage smartly, the amount of money you owe depends on your customers’ actual amount receivable. Therefore, an assumption is made to take a certain percentage as bad debts before including the figure in the financial statements. It is called provision for bad debts. You are setting an amount you might not receive from customers.
The Accounting entries for provision for bad debts accounts
All arrangements for bad debts are credit entries. A company naturally estimates its bad debts depending on its historical experience. It charges this expense as a debit to the wrong debt expense account (which goes as a debit to the income statement) and credits the provision for bad debts accounts (appears in the balance sheet). An organization should make these entries in the same period, and then revenues matched with applicable expenses.
Example showing the entries
Year Debtors as of 31 December Size of provision made 5%
2010 $3000 $150
2011 $6000 $300
Provision for doubtful debts
| $ | $ |
| 2010 Dec 31st Balance b/f 150 | Dec 31st Income statement 150 |
| 2011 Dec 31st Balance b/f 300 | Jan 1 Balance b/f 150 |
| Dec 31 st Income statement 150 | |
| 300 | 300 |
In 2010, the total amount of provision for doubtful debts was debited to the statement of financial accounts, as there were no provisions made in the previous year, and the balance was carried forward for the following year.
In 2011, the provision increased due to the increase in debtors, but only the increase was debited to financial statements.
Bad debt recovery
Sometimes if we are lucky enough, the amount is written off as the bad debt we recover for some reason. Therefore, the accounting entry for the improvement is as follows.
Joseph
| $ | |
| Bad debt recovered 200 |
Bad debts recovered
| $ | |
| Joseph 200 |
Joseph
| $ | $ |
| Bad debt recovered 200 | Bank 200 |
Bank
| $ | |
| Joseph 200 |