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What are Bad Debts?

Bad Debts

In a business scenario, amounts which are overdue to a business owner by the debtor(s) and declared irrecoverable are called bad debts. Few reasons for debtors to not pay their debts on time may be; filing for bankruptcy, experiencing hardship due to losses, etc. 

This can either be the complete amount owed or a part of the debt. Sometimes the amount may be recovered (partially or fully) in future. This is recorded with a journal entry for recovery of debts turned bad.

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

 

Journal Entry for Bad Debts

Bad Debts A/CDebitNominal AccountDr. all losses
 To Debtor’s A/CCreditPersonal AccountCr. the giver

As per modern rules of accounting;

Bad Debts A/CDebitLossDr. the increase in loss
 To Debtor’s A/CCreditAssetCr. decrease in asset

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 recording the below journal entry.

Profit & Loss A/CDebit
 To Bad Debts A/CCredit

Related Topic – Difference Between Discount and Rebate

 

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/C1,00,000
 To Mr Unreal A/C1,00,000

At the time of transferring the amount to P&L Account

Profit & Loss A/C1,00,000
 To Bad Debts A/C1,00,000

Related Topic – What are Non-performing assets or NPA?

 

Bad Debts Shown in Trial Balance

Bad Debts Shown in Trial Balance

 

Bad Debts Shown in Income Statement

Bad debts shown in income statement

 

Short Quiz for Self-Evaluation

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>Read Provision for Discount on Debtors