These are amounts which are owed by a debtor and are not recovered, for example, due to a company going bankrupt. It is a loss to business and reduce the amount of debtors. The full amount should be written off to the “profit and loss account” of the related period or to a provision for bad debts. They are losses, hence they are debited and a debtor’s account is credited.
Journal entry to record bad debts
|Bad Debts A/C||Debit||Nominal Account||Dr. All Losses|
|To Debtors A/C||Credit||Personal Account||Cr. The Giver|
At the time of preparing final accounts, the bad debts written off during a period and after preparing a trial balance are transferred to the profit and loss account by passing a below journal entry.
|Profit & Loss A/C||Debit|
|To Bad Debts A/C||Credit|
Let us assume that Mr.Unreal, a sole proprietor, was supposed to pay 1,00,000 on an invoice to ABC Corp. However, he filed for bankruptcy and is declared insolvent. In this case, ABC Corp will go through the following accounting for bad debts in their books:
At the time of realization (Assuming there were nil bad debts till now)
|Bad Debts A/C||1,00,000|
|To Mr Unreal A/C||1,00,000|
At the time of transferring the amount to P&L Account
|Profit & Loss A/C||1,00,000|
|To Bad Debts A/C||1,00,000|
How is Accounting For Recovery of Bad Debts Done?
Sometimes, when a debtor pays for a debt which is already accounted in the books it is considered as bad debts recovered. The amount received in lieu of such bad debts is a gain to the business, because it was earlier written off as a bad debt (loss).
The journal entry will be
|To Bad Debts Recovered A/C||Credit|
If the company is not maintaining a provision for a doubtful debts account, the closing entry would be
|Bad Debts Recovered A/C||Debit|
|To Profit & Loss A/C||Credit|