What are Bad Debts?

Bad Debts

In a business scenario, amount which is overdue to a business owner by its debtor(s) and is declared irrecoverable is called bad debts. There are few reasons for debtor(s) to not pay their debts on time, for example a debtor going bankrupt or experiencing hardship due to business losses. This can either be the complete amount owed or a part of the debt. In some cases the amount may be recovered in future or may completely be lost.

While accounting for b/debts it is treated as a loss to business and reduces the amount of debtors. The full amount should be written off to “profit and loss account” of the related period or against provision for b/debts. They are losses, hence they are debited and debtor’s account is credited.

 

Journal Entry for Bad Debts

 Bad Debts A/C  Debit  Nominal Account  Dr. All Losses
   To Debtor’s A/C  Credit  Personal Account  Cr. The Giver

 

At the time of preparing final accounts debts which are written off during the period post finalization of trial balance are transferred to profit and loss account by passing the below journal entry.

 Profit & Loss A/C  Debit
   To Bad Debts A/C  Credit

 

 

Explanation with Example

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 in their books:

At the time of realization (Assuming the opening balance was nil)

 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

 

 

Placement Inside Books of Accounts

Bad Debts Shown in Trial Balance

 

Income Statement Showing Bad Debts

 

>Read Bad Debts Recovered with Journal Entry